UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
WASHINGTON,
D.C. 20549
FORM
10-Q/A
(Amendment
No.1)
x
|
QUARTERLY
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
|
For the
quarterly period ended June 30, 2008
OR
¨
|
TRANSITION
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
|
For the
transition period from
to
Commission
File No. 000-12536
China
Recycling Energy Corporation
(Exact
Name of Registrant as Specified in Its Charter)
Nevada
|
90-0093373
|
(State
or other jurisdiction of
incorporation
or organization)
|
(I.R.S.
Employer
Identification
No.)
|
|
|
Suite
909, Tower B
Chang
An International Building
No.
88 Nan Guan Zheng Jie
Xi
An City, Shan Xi Province
China
710068
|
(Address
of Principal Executive Offices, Zip
Code)
|
Registrant’s
Telephone Number, Including Area Code: (011) 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.
Yes x No ¨
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).
Yes ¨ No ¨
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 ¨ Accelerated
filer ¨ Non-accelerated
filer ¨ 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).
Yes ¨ No x
As of
September 21, 2009, the registrant had 38,778,035 shares of Common Stock
outstanding..
INDEX
PART
I - FINANCIAL INFORMATION
|
|
|
|
|
|
Explanatory
Note
|
1
|
|
|
|
Item
1.
|
Financial
Statements
|
2
|
|
|
|
|
Consolidated
Balance Sheet as of June 30, 2008 (Unaudited) and December 31,
2007
|
2
|
|
|
|
|
Consolidated
Statements of Operations (Unaudited) – Three and Six Months Ended June 30,
2008 and June 30, 2007
|
3
|
|
|
|
|
Consolidated
Statements of Cash Flows (Unaudited) – Six Months Ended June 30, 2008 and
June 30, 2007
|
4
|
|
|
|
|
Notes
to Consolidated Financial Statements (Unaudited)
|
5
|
|
|
|
Item
2.
|
Management’s
Discussion and Analysis of Financial Condition and Results of
Operations
|
19
|
|
|
|
Item
3.
|
Quantitative
and Qualitative Disclosures About Market Risk
|
27
|
|
|
|
Item
4T.
|
Controls
and Procedures
|
27
|
|
|
PART
II - OTHER INFORMATION
|
|
|
|
|
Item
1.
|
Legal
Proceedings
|
29
|
|
|
|
Item
1A.
|
Risk
Factors
|
29
|
|
|
|
Item
2.
|
Unregistered
Sales of Equity Securities and Use of Proceeds
|
29
|
|
|
|
Item
3.
|
Defaults
Upon Senior Securities
|
29
|
|
|
|
Item
4.
|
Submission
of Matters to a Vote of Security Holders
|
29
|
|
|
|
Item
5.
|
Other
Information
|
29
|
|
|
|
Item
6.
|
Exhibits
|
29
|
Explanatory Note
China
Recycling Energy Corporation (the “Company,” “we,” “us” or “our”) is filing this
Amendment No. 1 on Form 10-Q/A to our Quarterly Report on Form 10-Q for the
three and six month periods ended June 30, 2008, originally filed with the
Securities and Exchange Commission (the “SEC”) on August 14, 2008 (the “Original
Form 10-Q”), to restate our consolidated financial statements as of and for the
six months ended June 30, 2008. In addition, we are concurrently filing
Forms 10-Q/A to restate our consolidated financial statements as of and for the
periods ended each of September 30, 2008 and March 31, 2009. We
are also concurrently filing Form 10-K/A to restate our consolidated financial
statements as of and for the year ended December 31, 2008.
The
accounting issues that resulted in misstatements in our consolidated financial
statements as of and for the periods ended June 30, 2008, September 30, 2008,
December 31, 2008 and March 31, 2009 relate to (i) the reclassification of
current tax payable to deferred tax liability on the Company’s sales-type
leases, as the Company did not separately record the deferred tax liability;
(ii) the expensing of the unamortized amount of the beneficial conversion
feature in connection with the 2008 amendment of a convertible note that was
issued by the Company to certain investors in 2007; (iii) the reclassification
of interest expense from interest income for the three months ended June 30,
2008; and (iv) the reclassification of 3,000,000 stock options under the
Company’s 2007 Nonstatutory Stock Option Plan from the fair value of the options
as a liability to equity recorded as additional paid in capital. See
Note 21 to our consolidated financial statements contained in Item 1 of
Part I of this report for more information regarding the restatement and
details of the impact of the restatement on our consolidated financial
statements as of and for the six months ended June 30, 2008.
In
connection with the restatement, our management has re-evaluated our disclosure
controls and procedures and internal control over financial reporting as of June
30, 2008. See Item 4T of Part I of this report for further
discussions on these matters.
Item 6
of Part II of this report has been revised to contain the currently-dated
certifications from our principal executive officer and chief accounting
officer, as required by Sections 302 and 906 of the Sarbanes-Oxley Act of
2002.
Because
this Form 10-Q/A sets forth the Original Form 10-Q in its entirety, it includes
items that have been changed as a result of the restatement and items that are
unchanged from the Original Form 10-Q. Other than the revising of the
disclosures relating to the restatement, this Form 10-Q/A speaks as of the
original filing date of the Original Form 10-Q and has not been updated to
reflect other events occurring subsequent to the original filing date. This
includes forward-looking statements and all other sections of this Form 10-Q/A
that were not directly impacted by the restatement, which should be read in
their historical context. This Form 10-Q/A also should be read in conjunction
with our Annual Report on Form 10-KSB for the year ended December 31, 2007.
The following items have been amended as a result of the
restatement:
Part I,
Item 1. Financial Statements;
Part I,
Item 2. Management’s Discussion and Analysis of Financial Condition and
Results of Operations;
Part I,
Item 4T. Controls and Procedures; and
Part II,
Item 6. Exhibits.
PART
I – FINANCIAL INFORMATION
Item 1.
|
Financial
Statements
|
CHINA
RECYCLING ENERGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED
BALANCE SHEETS
|
|
AS
OF JUNE 30, 2008
(RESTATED)
(UNAUDITED)
|
|
|
AS
OF DECEMBER 31, 2007
|
|
ASSETS
|
|
|
|
|
|
|
CURRENT
ASSETS
|
|
|
|
|
|
|
Cash
& cash equivalents
|
|
$ |
7,001,594 |
|
|
$ |
1,634,340 |
|
Accounts
receivable
|
|
|
867,473 |
|
|
|
- |
|
Investment
in sales type leases, net
|
|
|
1,247,448 |
|
|
|
1,081,981 |
|
Interest
receivable
|
|
|
- |
|
|
|
144,262 |
|
Prepaid
equipment rent
|
|
|
9,479,730 |
|
|
|
- |
|
Other
receivables
|
|
|
57,828 |
|
|
|
32,902 |
|
Inventory
|
|
|
10,497,157 |
|
|
|
9,870,315 |
|
Total
current assets
|
|
|
29,151,230 |
|
|
|
12,763,800 |
|
NON-CURRENT
ASSETS
|
|
|
|
|
|
|
|
|
Investment
in sales type leases, net
|
|
|
7,918,642 |
|
|
|
7,933,780 |
|
Advance
for equipment
|
|
|
2,624,930 |
|
|
|
2,467,579 |
|
Property
and equipment, net
|
|
|
83,133 |
|
|
|
- |
|
Construction
in progress
|
|
|
5,613,063 |
|
|
|
- |
|
Intangible
assets, net
|
|
|
- |
|
|
|
6,169 |
|
Total
non-current assets
|
|
|
16,239,768 |
|
|
|
10,407,528 |
|
TOTAL
ASSETS
|
|
$ |
45,390,998 |
|
|
$ |
23,171,328 |
|
LIABILITIES
AND STOCKHOLDERS' EQUITY
|
|
|
|
|
|
|
|
|
CURRENT
LIABILITIES
|
|
|
|
|
|
|
|
|
Accounts
payable
|
|
$ |
6,963,837 |
|
|
$ |
2,298,201 |
|
Tax
payable
|
|
|
497,848 |
|
|
|
191,982 |
|
Accrued
liabilities and other payables
|
|
|
3,521,508 |
|
|
|
2,565,726 |
|
Advance
from management
|
|
|
- |
|
|
|
71,508 |
|
Convertible
notes, net of discount due to beneficial
conversion feature
|
|
|
5,000,000 |
|
|
|
315,068 |
|
Total
current liabilities
|
|
|
15,983,193 |
|
|
|
5,442,485 |
|
DEFERRED
TAX LIABILITY
|
|
|
357,767 |
|
|
|
342,540 |
|
ACCRUED
INTEREST ON CONVERTIBLE NOTES
|
|
|
42,466 |
|
|
|
63,014 |
|
CONTINGENCIES
AND COMMITMENTS
|
|
|
|
|
|
|
|
|
MINORITY
INTEREST
|
|
|
16,095 |
|
|
|
15,080 |
|
STOCKHOLDERS'
EQUITY
|
|
|
|
|
|
|
|
|
Common
stock, $0.001 par value; 100,000,000 shares
authorized, 36,425,094 and 25,015,089 shares
issued and outstanding as of June 30, 2008
and December 31, 2007, respectively
|
|
|
36,425 |
|
|
|
25,015 |
|
Additional
paid in capital
|
|
|
33,724,010 |
|
|
|
19,070,908 |
|
Statutory
reserve
|
|
|
926,328 |
|
|
|
832,467 |
|
Accumulated
other comprehensive income
|
|
|
2,828,735 |
|
|
|
1,718,260 |
|
Accumulated
deficit
|
|
|
(8,524,021 |
) |
|
|
(4,338,441 |
) |
Total
stockholders' equity
|
|
|
28,991,477 |
|
|
|
17,308,209 |
|
TOTAL
LIABILITIES AND STOCKHOLDERS' EQUITY
|
|
$ |
45,390,998 |
|
|
$ |
23,171,328 |
|
The
accompanying notes are an integral part of these consolidated financial
statements.
CHINA
RECYCLING ENERGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED
STATEMENTS OF OPERATIONS
(UNAUDITED)
|
|
SIX
MONTHS ENDED JUNE 30,
|
|
|
THREE
MONTHS ENDED JUNE 30,
|
|
|
|
2008
(RESTATED)
|
|
|
2007
|
|
|
2008
(RESTATED)
|
|
|
2007
|
|
Revenue
|
|
|
|
|
|
|
|
|
|
|
|
|
Sales
of products
|
|
$ |
- |
|
|
$ |
4,781,163 |
|
|
$ |
- |
|
|
$ |
- |
|
Rental
income
|
|
|
2,616,416 |
|
|
|
- |
|
|
|
2,616,416 |
|
|
|
- |
|
Total
revenue
|
|
|
2,616,416 |
|
|
|
4,781,163 |
|
|
|
2,616,416 |
|
|
|
- |
|
Cost
of sales
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost
of products
|
|
|
- |
|
|
|
3,677,818 |
|
|
|
- |
|
|
|
- |
|
Rental
expense
|
|
|
1,832,609 |
|
|
|
- |
|
|
|
1,832,609 |
|
|
|
- |
|
Total
cost of sales
|
|
|
1,832,609 |
|
|
|
3,677,818 |
|
|
|
1,832,609 |
|
|
|
- |
|
Gross
profit
|
|
|
783,807 |
|
|
|
1,103,345 |
|
|
|
783,807 |
|
|
|
- |
|
Interest
income on sales-type leases
|
|
|
1,139,727 |
|
|
|
198,386 |
|
|
|
574,775 |
|
|
|
148,150 |
|
Total
operating income
|
|
|
1,923,534 |
|
|
|
1,301,731 |
|
|
|
1,358,582 |
|
|
|
148,150 |
|
Operating
expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
General
and administrative expenses
|
|
|
1,503,779 |
|
|
|
343,543 |
|
|
|
855,169 |
|
|
|
86,501 |
|
Total
operating expenses
|
|
|
1,503,779 |
|
|
|
343,543 |
|
|
|
855,169 |
|
|
|
86,501 |
|
Income
from operations
|
|
|
419,755 |
|
|
|
958,188 |
|
|
|
503,413 |
|
|
|
61,649 |
|
Non-operating
income (expenses)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest
income
|
|
|
14,846 |
|
|
|
104 |
|
|
|
14,846 |
|
|
|
59 |
|
Interest
expense
|
|
|
(4,664,384 |
) |
|
|
- |
|
|
|
(3,921,106 |
) |
|
|
- |
|
Other
expense
|
|
|
(1,001 |
) |
|
|
(95 |
) |
|
|
(579 |
) |
|
|
- |
|
Other
income
|
|
|
1,604 |
|
|
|
208,909 |
|
|
|
23 |
|
|
|
208,909 |
|
Exchange
loss
|
|
|
(80,445 |
) |
|
|
- |
|
|
|
(69,256 |
) |
|
|
- |
|
Total
non-operating expenses
|
|
|
(4,729,380 |
) |
|
|
208,918 |
|
|
|
(3,976,072 |
) |
|
|
208,968 |
|
Income
(loss) before income tax
|
|
|
(4,309,625 |
) |
|
|
1,167,106 |
|
|
|
(3,472,659 |
) |
|
|
270,617 |
|
Income
tax expense
|
|
|
368,498 |
|
|
|
211,593 |
|
|
|
317,551 |
|
|
|
51,436 |
|
Net
income (loss) from operations
|
|
|
(4,678,123 |
) |
|
|
955,513 |
|
|
|
(3,790,210 |
) |
|
|
219,181 |
|
Income
from operations of discontinued component
|
|
|
- |
|
|
|
23,105 |
|
|
|
- |
|
|
|
- |
|
Less:
minority interest
|
|
|
56 |
|
|
|
- |
|
|
|
29 |
|
|
|
- |
|
Net
income (loss)
|
|
|
(4,678,179 |
) |
|
|
978,618 |
|
|
|
(3,790,239 |
) |
|
|
219,181 |
|
Other
comprehensive item
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Foreign
currency translation gain (loss)
|
|
|
1,110,475 |
|
|
|
(303,894 |
) |
|
|
1,035,750 |
|
|
|
40,098 |
|
Comprehensive
income (loss)
|
|
$ |
(3,567,704 |
) |
|
$ |
674,724 |
|
|
$ |
(2,754,489 |
) |
|
$ |
259,279 |
|
Basic
weighted average shares outstanding
|
|
|
27,718,959 |
|
|
|
17,147,268 |
|
|
|
30,422,829 |
|
|
|
17,147,268 |
|
Diluted
weighted average shares outstanding
|
|
|
32,668,493 |
|
|
|
17,147,268 |
|
|
|
34,659,643 |
|
|
|
17,147,268 |
|
Basic
net earnings per share *
|
|
$ |
(0.17 |
) |
|
$ |
0.06 |
|
|
$ |
(0.12 |
) |
|
$ |
0.01 |
|
Diluted
net earnings per share *
|
|
$ |
(0.17 |
) |
|
$ |
0.06 |
|
|
$ |
(0.12 |
) |
|
$ |
0.01 |
|
*
Interest expense on convertible notes are added back to net income for the
computation of diluted EPS.
* Basic
and diluted loss per share is the same due to anti-dilutive feature of the
securities.
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,
|
|
|
|
2008
(RESTATED)
|
|
|
2007
|
|
CASH
FLOWS FROM OPERATING ACTIVITIES:
|
|
|
(4,678,179 |
) |
|
$ |
978,618 |
|
Net
income (loss)
|
|
|
|
|
|
|
|
|
Adjustments
to reconcile net income (loss) to net cash
|
|
|
|
|
|
|
|
|
(used
in) provided by operating activities:
|
|
|
|
|
|
|
|
|
Depreciation
and amortization
|
|
|
5,000 |
|
|
|
- |
|
Amortization
of discount related to conversion feature of convertible
note
|
|
|
4,684,932 |
|
|
|
- |
|
Stock
option compensation expense
|
|
|
632,444 |
|
|
|
- |
|
Accrued
interest on convertible notes
|
|
|
(20,548 |
) |
|
|
- |
|
Minority
interest
|
|
|
56 |
|
|
|
- |
|
Change
in deferred tax
|
|
|
357,767 |
|
|
|
- |
|
(Increase)
decrease in current assets:
|
|
|
|
|
|
|
|
|
Accounts
receivable
|
|
|
(843,015 |
) |
|
|
6,361 |
|
Advances
to suppliers
|
|
|
- |
|
|
|
688,311 |
|
Prepaid
expenses
|
|
|
(9,213,073 |
) |
|
|
- |
|
Other
receivables
|
|
|
(22,193 |
) |
|
|
- |
|
Inventory
|
|
|
- |
|
|
|
(1,309,002 |
) |
Increase
(decrease) in current liabilities:
|
|
|
|
|
|
|
|
|
Accounts
payable
|
|
|
4,392,250 |
|
|
|
2,278,701 |
|
Unearned
revenue
|
|
|
- |
|
|
|
(7,776 |
) |
Advance
from customers
|
|
|
- |
|
|
|
(143,527 |
) |
Taxes
payable
|
|
|
(90,063 |
) |
|
|
254,109 |
|
Accrued
liabilities and other payables
|
|
|
1,041,821 |
|
|
|
1,432,657 |
|
Net
cash (used in) provided by operating activities
|
|
|
(3,752,801 |
) |
|
|
4,178,452 |
|
CASH
FLOWS FROM INVESTING ACTIVITIES:
|
|
|
|
|
|
|
|
|
Investment
in sales type leases
|
|
|
559,436 |
|
|
|
(4,471,351 |
) |
Acquisition
of property & equipment
|
|
|
(85,789 |
) |
|
|
(3,751 |
) |
Construction
in progress
|
|
|
(5,613,063 |
) |
|
|
- |
|
Net
cash used in investing activities
|
|
|
(5,139,416 |
) |
|
|
(4,475,102 |
) |
CASH
FLOWS FROM FINANCING ACTIVITIES:
|
|
|
|
|
|
|
|
|
Issuance
of common stock
|
|
|
9,032,258 |
|
|
|
- |
|
Issuance
of convertible notes
|
|
|
5,000,000 |
|
|
|
- |
|
Advance
from shareholder
|
|
|
- |
|
|
|
36,137 |
|
Due
from management
|
|
|
(73,906 |
) |
|
|
- |
|
Net
cash provided by financing activities
|
|
|
13,958,352 |
|
|
|
36,137 |
|
EFFECT
OF EXCHANGE RATE CHANGE ON CASH & CASH EQUIVALENTS
|
|
|
301,119 |
|
|
|
11,981 |
|
NET
INCREASE (DECREASE) IN CASH & CASH EQUIVALENTS
|
|
|
5,367,254 |
|
|
|
(248,532 |
) |
CASH
& CASH EQUIVALENTS, BEGINNING OF PERIOD
|
|
|
1,634,340 |
|
|
|
252,125 |
|
CASH
& CASH EQUIVALENTS, END OF PERIOD
|
|
$ |
7,001,594 |
|
|
$ |
3,593 |
|
Supplemental
Cash flow data:
|
|
|
|
|
|
|
|
|
Income
tax paid
|
|
$ |
105,433 |
|
|
$ |
35,281 |
|
Interest
paid
|
|
$ |
- |
|
|
$ |
- |
|
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, 2008 (UNAUDITED) AND DECEMBER 31, 2007
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 Data Technology Co., Ltd (“TCH”), sells and leases energy saving
equipment. The businesses of mobile phone distribution and provision of pager
and mobile phone value-added information services were discontinued in 2007. On
March 8, 2007, the Company changed its name to “China Recycling Energy
Corporation”.
Since
January 2007, the Company has gradually phased out and substantially scaled down
most of its business of mobile phone distribution and provision of pager and
mobile phone value-added information services. In the first and second quarters
of 2007, the Company did not engage in any substantial transactions or activity
in connection to these businesses. On May 10, 2007, the Company ceased and
discontinued the businesses related to mobile phones and pages. These businesses
are reflected in continuing operations for all periods presented based on the
criteria for discontinued operations prescribed by Statement of Financial
Accounting Standards (SFAS) No. 144, “Accounting for the Impairment or Disposal
of Long-Lived Assets (“SFAS 144”).
On
February 1, 2007, the Company’s subsidiary, TCH, entered into two TRT Project
Joint-Operation Agreements (“Joint-Operation Agreement”) with Xi’an Yingfeng
Science and Technology Co., Ltd. (“Yingfeng”). TRT is an electricity generating
system that utilizes the exhaust pressure and heat produced in the blast furnace
of steel mill to generate electricity. Yingfeng is a joint stock company
registered in Xi’an, Shaanxi Province, Peoples Republic of China (the “PRC”),
and engages in the business of designing, installing, and operating TRT systems
and sales of other renewable energy products. In October 2007, the Company
terminated the joint operation agreement with Yingfeng and became fully entitled
to the rights, titles, benefits and interests in the TRT Projects.
Under the
Joint-Operation Agreement, TCH and Yingfeng jointly operated a top gas recovery
turbine project (“TRT Project”) which designed, constructed, installed and
operated a TRT system and leased it to Zhangzhi Iron and Steel Holdings Ltd.
(“Zhangzhi”). The total investment costs contributed by TCH were approximately
$1,426,000 (equivalent to Renminbi (“RMB”) 10,690,000). TCH provided various
forms of investments and properties into the TRT Project including cash,
hardware, software, equipment, major components and devices. The construction of
the TRT Project was completed and put into operation in August 2007. In October
2007, the Company terminated the Joint-Operation Agreement with Yingfeng. TCH
became entitled to the rights, titles, benefits and interests in the TRT Project
and receives monthly rental payments of approximately $147,000 (equivalent to
RMB 1,100,000) from Zhangzhi for a lease term of thirteen years. At the end of
the lease term, TCH will transfer the rights and titles of the TRT Project to
Zhangzhi without cost.
Under
another Joint-Operation Agreement, TCH and Yingfeng jointly operated a TRT
Project which designed, constructed, installed and operated a TRT system and
lease to Xingtai Iron and Steel Company Ltd. (“Xingtai”). TCH provided various
forms of investments and properties into the TRT Project including cash,
hardware, software, equipment, major components and devices. The total estimated
investment costs of this TRT Project were approximately $3,900,000 (equivalent
to RMB 30,000,000). The construction of the TRT Project was completed and put
into operation in February 2007. In October 2007, the Company terminated the
Joint-Operation Agreement with Yingfeng. TCH became fully entitled to all the
rights, titles, benefits and interests of the TRT Project and receives monthly
rental payments of approximately $117,000 (equivalent to RMB 900,000) from
Xingtai for a lease term of five years. At the end of the lease term, TCH will
transfer all the rights and titles of the TRT Project to Xingtai without
cost.
On
September 21, 2007, the Company’s subsidiary, TCH changed its name to “Shanghai
TCH Energy Technology Co., Ltd.”
Except as
indicated, amounts reflected in the condensed consolidated financial statements
or the notes thereto relate to our continuing operations.
The
unaudited financial statements have been 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) which 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 have been 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 2007 audited financial statements. The
results for the six months ended June 30, 2008 are not necessarily indicative of
the results to be expected for the full year ending December 31,
2008.
2.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis
of presentation
These
accompanying consolidated financial statements have been prepared in accordance
with generally accepted accounting principles in the United States of America
(“US GAAP”) and pursuant to the rules and regulations of the SEC for annual
financial statements.
Basis
of consolidation
The
consolidated financial statements include the accounts of CREG and, its
subsidiaries, Sifang Holdings, TCH, and TCH’s newly incorporated subsidiaries
Xi'an TCH Energy Tech Co., Ltd. (Xi’an TCH) and Xingtai Huaxin Energy Tech Co.,
Ltd. (Huaxin). Xi’an TCH and Huaxin engage in the same business with TCH.
Substantially all of the Company's revenues are derived from the operations of
TCH and its subsidiaries, which represent substantially all of the Company’s
consolidated assets and liabilities as of June 30, 2008 and December 31, 2007,
respectively. All significant inter-company accounts and transactions have been
eliminated in consolidation.
Use
of estimates
In
preparing these consolidated financial statements, management makes estimates
and assumptions that affect the reported amounts of assets and liabilities in
the balance sheets and revenues and expenses during the period reported. Actual
results may differ from these estimates.
Cash
and cash equivalents
Cash and
cash equivalents are carried at cost and represent cash on hand, demand deposits
placed with banks or other financial institutions and all highly liquid
investments with an original maturity of three months or less as of the purchase
date of such investments.
Accounts
receivable and concentration of credit risk
Accounts
receivable are recorded at the invoiced amounts and do not bear interest. The
Company extends unsecured credit to its customers in the ordinary course of
business but mitigates the associated risks by performing credit checks and
actively pursuing past due accounts. An allowance for doubtful accounts is
established and determined based on managements’ assessment of known
requirements, aging of receivables, payment history, the customer’s current
credit worthiness and the economic environment. As of June 30, 2008 and December
31, 2007, the Company had accounts receivable of $867,473 and $0,
respectively.
Financial
instruments that potentially subject the Company to credit risk consist
primarily of accounts receivable and other receivables. The Company does not
require collateral or other security to support these receivables. The Company
conducts periodic reviews of its clients' financial condition and customer
payment practices to minimize collection risk on accounts
receivable.
The
operations of the Company are located in the PRC. Accordingly, the Company's
business, financial condition, and results of operations may be influenced by
the political, economic, and legal environments in the PRC, as well as by the
general state of the PRC economy.
Inventory
Inventory
is valued at the lower of cost or market. Cost of work in progress and finished
goods comprises direct material cost, direct production cost and an allocated
portion of production overheads (See Note 5).
Property
and equipment
Property
and equipment are stated at cost, net of accumulated depreciation. Expenditures
for maintenance and repairs are expensed as incurred; additions, renewals and
betterments are capitalized. When property and equipment are retired or
otherwise disposed of, the related cost and accumulated depreciation are removed
from the respective accounts, and any gain or loss is included in operations.
Depreciation of property and equipment is provided using the straight-line
method over the estimated lives ranging from 5 to 20 years as
follows:
Building
|
|
|
20
years
|
|
Vehicle
|
|
|
2 -
5 years
|
|
Office
and Other Equipment
|
|
|
2 -
5 years
|
|
Software
|
|
|
2 -
3 years
|
|
Impairment
of long-life assets
In
accordance with SFAS 144, the Company reviews its
long-lived assets, including property, plant and equipment, for impairment
whenever events or changes in circumstances indicate that the carrying amounts
of the assets may not be fully recoverable. If the total of the expected
undiscounted future net cash flows is less than the carrying amount of the
asset, a loss is recognized for the difference between the fair value and
carrying amount of the asset. There has been no impairment as of June 30,
2008.
Sales-type
leasing and related revenue recognition
The
Company leases TRT systems to Xingtai and Zhangzhi. The Company will transfer
all benefits, risks and ownership of the TRT systems to Xingtai and Zhangzhi at
the end of each lease term. The Company’s investment in these projects is
recorded as investment in sales-type leases in accordance with SFAS No. 13,
“Accounting for Leases” and its various amendments and interpretations. The
sales and cost of goods sold are recognized at the point of sale. The investment
in sales-type leases consists of the sum of the total minimum lease payments
receivable less unearned interest income. Unearned interest income is amortized
to income over the lease term as to produce a constant periodic rate of return
on the net investment in the lease.
Cost
of sales
Cost of
revenue consists primarily of the purchase price of the two TRT machines, and
expenses incurred directly for project construction, and rental expenses for two
power generation leases.
Income
taxes
The
Company utilizes SFAS No. 109, “Accounting for Income Taxes,” which requires the
recognition of deferred tax assets and liabilities for the expected future tax
consequences of events that have been included in the financial statements or
tax returns. Under this method, deferred income taxes are recognized for the tax
consequences in future years of differences between the tax bases of assets and
liabilities and their financial reporting amounts at each period end based on
enacted tax laws and statutory tax rates applicable to the periods in which the
differences are expected to affect taxable income. Valuation allowances are
established, when necessary, to reduce deferred tax assets to the amount
expected to be realized.
The
Company does not have any significant deferred tax asset or liability that
related to tax jurisdictions not covered by the tax holiday provided by Tax
Bureau of the PRC.
The
Company adopted the provisions of Financial Accounting Standards Board (“FASB”)
FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes,
(“FIN 48”), on January 1, 2007. As a result of the implementation of FIN 48, the
Company made a comprehensive review of its portfolio of tax positions in
accordance with recognition standards established by FIN 48. As a result of the
implementation of FIN 48, the Company recognized no material adjustments to
liabilities or stockholders equity. When tax returns are filed, it is highly
certain that some positions taken would be sustained upon examination by the
taxing authorities, while others are subject to uncertainty about the merits of
the position taken or the amount of the position that would be ultimately
sustained. The benefit of a tax position is recognized in the financial
statements in the period during which, based on all available evidence,
management believes it is more likely than not that the position will be
sustained upon examination, including the resolution of appeals or litigation
processes, if any. Tax positions taken are not offset or aggregated with other
positions. Tax positions that meet the more-likely-than-not recognition
threshold are measured as the largest amount of tax benefit that is more than 50
percent likely of being realized upon settlement with the applicable taxing
authority. The portion of the benefits associated with tax positions taken that
exceeds the amount measured as described above is reflected as a liability for
unrecognized tax benefits in the accompanying balance sheets along with any
associated interest and penalties that would be payable to the taxing
authorities upon examination.
Interest
associated with unrecognized tax benefits are classified as interest expense and
penalties are classified in selling, general and administrative expenses in the
statements of income. The adoption of FIN 48 did not have a material impact on
the Company’s financial statements.
Statement
of cash flows
In
accordance with SFAS No. 95, “Statement of Cash Flows,” cash flows from the
Company's operations are calculated based upon the local currencies. As a
result, amounts related to assets and liabilities reported on the statement of
cash flows may not necessarily agree with changes in the corresponding balances
on the balance sheet.
Fair
value of financial instruments
SFAS No.
107, “Disclosures about Fair Value of Financial Instruments,” requires that the
Company disclose estimated fair values of financial instruments. The carrying
amounts reported in the statements of financial position for current assets and
current liabilities qualifying as financial instruments are a reasonable
estimate of fair value.
Basic
and diluted earnings per share (EPS)
Basic 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:
|
|
Six Months
Ended, June
30, 2008
(Restated)
|
|
|
Six Months
Ended June
30, 2007
|
|
|
Three
Months
Ended June
30, 2008
(Restated)
|
|
|
Three Months Ended
June 30, 2008
|
|
Net
(loss) income
|
|
$ |
(4,678,179 |
) |
|
$ |
978,618 |
|
|
$ |
(3,790,239 |
) |
|
$ |
219,181 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
average shares outstanding - basic
|
|
|
27,718,959 |
|
|
|
17,147,268 |
|
|
|
30,422,829 |
|
|
|
17,147,268 |
|
Effect
of dilutive securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Convertible
notes
|
|
|
4,101,751 |
|
|
|
- |
|
|
|
3,985,883 |
|
|
|
- |
|
Options
granted
|
|
|
847,783 |
|
|
|
- |
|
|
|
250,931 |
|
|
|
- |
|
Weighted
average shares outstanding - diluted
|
|
|
32,668,493 |
|
|
|
17,147,268 |
|
|
|
34,659,643 |
|
|
|
17,147,268 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(Loss)
Earnings per share – basic *
|
|
$ |
(0.17 |
) |
|
$ |
0.06 |
|
|
$ |
(0.12 |
) |
|
$ |
0.01 |
|
(Loss)
Earnings per share - diluted *
|
|
$ |
(0.17 |
) |
|
$ |
0.06 |
|
|
$ |
(0.12 |
) |
|
$ |
0.01 |
|
* These securities are anti-dilutive,
therefore, basic and diluted loss per share are the same.
*
Interest expense on convertible note issued on April 29,
2008 has been added back to net income (net loss) for the computation of diluted
earnings per share.
Diluted
weighted average shares outstanding used for computing diluted loss per share do
not include estimated shares that will be converted from the Second Note issued
on Apr 29, 2008 with conversion price contingent upon future net profits as
these will be anti-dilutive as a result of net loss for the six and three months
ended June 30, 2008.
Foreign
Currency Translation and Comprehensive Income (Loss)
The
Company’s functional currency is the Renminbi (“RMB”). For financial reporting
purposes, RMB has been translated into United States dollars (“USD”) as the
reporting currency. Assets and liabilities are translated at the exchange rate
in effect at the balance sheet date. Revenues and expenses are translated at the
average rate of exchange prevailing during the reporting period. Translation
adjustments arising from the use of different exchange rates from period to
period are included as a component of stockholders' equity as “Accumulated other
comprehensive income”. Gains and losses resulting from foreign currency
transactions are included in income. There has been no significant fluctuation
in the exchange rate for the conversion of RMB to USD after the balance sheet
date.
The
Company uses SFAS 130 “Reporting Comprehensive Income”. Comprehensive income is
comprised of net income and all changes to the statements of stockholders’
equity, except those due to investments by stockholders, changes in paid-in
capital and distributions to stockholders.
Segment
Reporting
SFAS No.
131, “Disclosures about Segments of an Enterprise and Related Information”
requires use of the “management approach” model for segment reporting. The
management approach model is based on the way a company's management organizes
segments within the company for making operating decisions and assessing
performance. Reportable segments are based on products and services, geography,
legal structure, management structure, or any other manner in which management
disaggregates a company. SFAS 131 has no effect on the Company's financial
statements as substantially all of the Company's operations are conducted in one
industry segment. All of the Company's assets are located in the
PRC.
Reclassifications
Certain
prior year amounts have been reclassified to conform to the manner of
presentation in the current year.
New
Accounting Pronouncements
The Hierarchy of Generally
Accepted Accounting Principles
In May
2008, the FASB issued SFAS No. 162, “The Hierarchy of Generally Accepted
Accounting Principles.” This Statement identifies the sources of
accounting principles and the framework for selecting the principles to be used
in the preparation of financial statements of nongovernmental entities that are
presented in conformity with generally accepted accounting principles (GAAP) in
the United States (the GAAP hierarchy). This Statement will not have an
impact on the Company’s financial statements.
Disclosures about Derivative
Instruments and Hedging Activities
In March
2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments
and Hedging Activities an amendment of FASB Statement No. 133 (“SFAS
133”). This Statement changes the disclosure requirements for derivative
instruments and hedging activities. Entities are required to provide enhanced
disclosures about (a) how and why an entity uses derivative instruments, (b) how
derivative instruments and related hedged items are accounted for under SFAS 133
and its related interpretations, and (c) how derivative instruments and related
hedged items affect an entity’s financial position, financial performance, and
cash flows. Based on current conditions, the Company does not expect the
adoption of SFAS 161 to have a significant impact on its results of operations
or financial position.
Noncontrolling Interests in
Consolidated Financial Statements - An Amendment of ARB No.
51
In
December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in
Consolidated Financial Statements - An Amendment of ARB No. 51” (“SFAS
160”). SFAS 160 establishes new accounting and reporting standards for the
noncontrolling interest in a subsidiary and for the deconsolidation of a
subsidiary. Specifically, this statement requires the recognition of a
noncontrolling interest (minority interest) as equity in the consolidated
financial statements and separate from the parent’s equity. The amount of net
income attributable to the noncontrolling interest will be included in
consolidated net income on the face of the income statement. SFAS 160 clarifies
that changes in a parent’s ownership interest in a subsidiary that do not result
in deconsolidation are equity transactions if the parent retains its controlling
financial interest. In addition, this statement requires that a parent recognize
a gain or loss in net income when a subsidiary is deconsolidated. Such gain or
loss will be measured using the fair value of the noncontrolling equity
investment on the deconsolidation date. SFAS 160 also includes expanded
disclosure requirements regarding the interests of the parent and its
noncontrolling interest. SFAS 160 is effective for fiscal years, and interim
periods within those fiscal years, beginning on or after December 15, 2008.
Based on current conditions, the Company does not expect the adoption of SFAS
160 to have a significant impact on its results of operations or financial
position.
Business
Combinations
In
December 2007, the FASB issued SFAS No. 141 (Revised 2007), “Business
Combinations” (“SFAS 141R”). SFAS 141R will significantly change the accounting
for business combinations. Under SFAS 141R, an acquiring entity will be required
to recognize all the assets acquired and liabilities assumed in a transaction at
the acquisition-date fair value with limited exceptions. SFAS 141R will change
the accounting treatment for certain specific items, including:
· Acquisition costs will be generally
expensed as incurred;
· Noncontrolling interests (formerly
known as “minority interests” - see SFAS 160 discussion above) will be valued at
fair value at the acquisition date;
· Acquired contingent liabilities will be
recorded at fair value at the acquisition date and subsequently measured at
either the higher of such amount or the amount determined under existing
guidance for non-acquired contingencies;
· In-process research and development
will be recorded at fair value as an indefinite-lived intangible asset at the
acquisition date;
· Restructuring costs associated with a
business combination will be generally expensed subsequent to the acquisition
date; and
· Changes in deferred tax asset valuation
allowances and income tax uncertainties after the acquisition date generally
will affect income tax expense.
SFAS 141R
also includes a substantial number of new disclosure requirements. SFAS 141R
applies prospectively to business combinations for which the acquisition date is
on or after the beginning of the first annual reporting period beginning on or
after December 15, 2008. Earlier adoption is prohibited. Accordingly, since
we are a calendar year-end company we will continue to record and disclose
business combinations following existing GAAP until January 1, 2009. We
expect SFAS 141R will have an impact on accounting for business combinations
once adopted but the effect is dependent upon acquisitions at that
time.
Employers’ Accounting for
Defined Benefit Pension and Other Postretirement Plans, an Amendment of FASB
Statements No. 87, 88, 106, and 132R
In
September 2006, the FASB issued SFAS No. 158, “Employers’ Accounting for Defined
Benefit Pension and Other Postretirement Plans, an Amendment of FASB Statements
No. 87, 88, 106, and 132R (“SFAS 158”), which requires employers to recognize
the underfunded or overfunded status of a defined benefit postretirement plan as
an asset or liability in its statement of financial position and to recognize
changes in the funded status in the year in which the changes occur through
accumulated other comprehensive income. Additionally, SFAS 158 requires
employers to measure the funded status of a plan as of the date of its year-end
statement of financial position. The new reporting requirements and related new
footnote disclosure rules of SFAS 158 are effective for fiscal years ending
after December 15, 2006. We adopted the provisions of SFAS 158 for the year end
2006, and the effect of recognizing the funded status in accumulated other
comprehensive income was not significant. The new measurement date requirement
applies for fiscal years ending after December 15, 2008.
Accounting for Nonrefundable
Advance Payments for Goods or Services Received for use in Future Research and
Development Activities
In June
2007, the FASB issued FASB Staff Position No. EITF 07-3, “Accounting for
Nonrefundable Advance Payments for Goods or Services Received for use in Future
Research and Development Activities” (“FSP EITF 07-3”), which addresses whether
nonrefundable advance payments for goods or services that used or rendered for
research and development activities should be expensed when the advance payment
is made or when the research and development activity has been
performed. Management is currently evaluating the effect of this
pronouncement on financial statements.
3.
NET INVESTMENT IN SALES-TYPE LEASES
Under
sales-type leases, TCH leased TRT systems to Xingtai and Zhangzhi with terms of
five years and thirteen years, respectively. The components of the net
investment in sales-type leases as of June 30, 2008 and December 31, 2007 are as
follows:
|
|
June
30,
2008
|
|
|
December
31,
2007
|
|
Total
future minimum lease payments receivables
|
|
$ |
27,139,525 |
|
|
|
27,162,928 |
|
Less:
unearned interest income
|
|
|
(17,973,435 |
) |
|
|
(18,147,167 |
) |
Net
investment in sales - type leases
|
|
$ |
9,166,090 |
|
|
|
9,015,761 |
|
|
|
|
|
|
|
|
|
|
Current
portion
|
|
$ |
1,247,448 |
|
|
|
1,081,981 |
|
Noncurrent
portion
|
|
$ |
7,918,642 |
|
|
|
7,933,780 |
|
As of
June 30, 2008, the future minimum rentals to be received on non-cancelable sales
type leases are as follows:
Years
ending June 30,
|
|
|
|
2009
|
|
$
|
3,496,654
|
|
2010
|
|
|
3,253,244
|
|
2011
|
|
|
3,253,244
|
|
2012
|
|
|
2,644,719
|
|
2013
|
|
|
1,792,783
|
|
Thereafter
|
|
|
12,698,881
|
|
|
|
$
|
27,139,525
|
|
4.
PREPAID EQUIPMENT RENT FOR OPERATING LEASES
On April
10, 2008, the Company leased energy recycling power generation equipment for
operating under a one-year, non-cancellable lease for the amount of
approximately $4,455,000 (RMB 31,000,000). At the end of this one-year lease
term, the Company has the right to renew the lease for another four-year term at
an aggregate price of approximately $10,940,000 (RMB 75,000,000) with a separate
agreement. The lease payment of approximately $4,455,000 has been paid in full
during the quarter ended June 30, 2008.
On the
same day, the Company entered into a leasing agreement with a lessee to lease
out the above power generation equipment under a one-year, non-cancellable lease
for the lease payment of approximately $583,000 (RMB 4,000,000) per month with
the option to renew. The lessee will pay a lower monthly lease payment of
approximately $486,000 (RMB 3,333,000) under the circumstance that the Company
renews the lease of the equipment from the ultimate lessor after one
year.
On May
21, 2008, the Company leased energy recycling power generation equipment from
the same lessor for operating under a one-year, non-cancellable lease for the
amount of approximately $6,560,000 (RMB 45,000,000). At the end of the one-year
lease term, the Company has the right to renew the lease for another four-year
term at an aggregate price of approximately $17,500,000 (RMB 120,000,000) with a
separate agreement. The lease payment of approximately $1,968,000 has been paid
during the quarter ended June 30, 2008 and the remaining of approximately
$4,592,000 was paid in full in July 2008.
On the
same day, the Company entered into a leasing agreement with the same lessee to
lease out the above power generation equipment under a one-year, non-cancellable
lease for the lease payment of approximately $887,000 (RMB 5,850,000) per month
with the option to renew. The lessee will pay a lower monthly lease payment of
approximately $729,000 (RMB 5,000,000) under the circumstance that the Company
renews the lease of the equipment from the ultimate lessor after one
year.
5.
INVENTORY
Inventory
consisted of two equipment systems that will be used for TRT projects in the
amount of $10,497,157 and $9,870,315 at June 30, 2008 and December 31, 2007,
respectively.
6.
ADVANCE FOR EQUIPMENT
Advance
for equipment represented advance payment of approximately $2,624,931 (RMB
18,000,000) to an independent contractor for constructing a Power Generation
System, and payment made for the equipment that will be used for the
construction. At June 30, 2008, this project has not commenced construction yet.
Upon completion of the construction, the Company will sell the power that is
generated from this system to certain customers or lease out the whole system
for rental income (See Note 19).
7.
CONSTRUCTION IN PROGRESS
Construction
in progress represented the amount paid to an independent contractor for
constructing another Power Generation System for the total amount of
approximately $5,613,063 (RMB 38,500,000). The construction project commenced in
March 2008, and will take about 11 months to complete. Upon completion, the
Company will sell the power that is generated from this system to certain
customers (See Note 19).
8.
TAX PAYABLE
Tax
payable consisted of the following at June 30, 2008 and December 31,
2007:
|
|
June 30,
2008
(Restated)
|
|
|
December 31,
2007
|
|
Income
tax payable
|
|
$ |
401,371 |
|
|
$ |
149,295 |
|
Business
tax payable
|
|
|
86,383 |
|
|
|
41,126 |
|
Other
taxes payable
|
|
|
10,094 |
|
|
|
1,561 |
|
|
|
$ |
497,848 |
|
|
$ |
191,982 |
|
9.
ACCRUED LIABILITIES AND OTHER PAYABLES
Accrued
liabilities and other payables consisted of the following at June 30, 2008
and December 31, 2007:
|
|
June 30,
2008
|
|
|
December 31,
2007
|
|
Other
payables
|
|
$ |
3,178,692 |
|
|
$ |
2,274,805 |
|
Employee
welfare payable
|
|
|
241,891 |
|
|
|
228,923 |
|
Accrued
expenses
|
|
|
100,925 |
|
|
|
61,998 |
|
Total
|
|
$ |
3,521,508 |
|
|
$ |
2,565,726 |
|
Other
payable mainly consisted of employee training and social insurance payable of
approximately $120,000, consulting and legal expenses paid by a third party on
behalf of the Company, which will be repaid by the Company in the amount of
approximately $370,000, payable to Yingfeng for the cost of obtaining the
ownership of two TRT projects which was previously owned by Yingfeng of
approximately $1,670,000 (RMB 11,460,257), and leasing deposits received from
the customer for leasing the power generation equipments of approximately
$1,020,000 (RMB 7,000,000).
10.
ADVANCE FROM MANAGEMENT
Advance
from management represented the balances due to a director for unsecured
advances in 2007 which are interest free and repayable in the next twelve
months. This advance was repaid in the six months ended June 30,
2008.
11.
MINORITY INTEREST
Minority
interest represented a 20% equity interest in Huaxin. Huaxin was incorporated in
November 2, 2007, and engages in a similar business to TCH. At June 30, 2008 and
December 31, 2007, minority interest was $16,095 and $15,080,
respectively.
12. DEFERRED
TAX
Deferred
tax asset arose from accrued maintenance cost on two TRT machines that can be
deducted for tax purposes in the future.
Deferred
tax liability represented differences between the tax bases and book bases of
sales-type leases.
As of
June 30, 2008 and December 31, 2007, deferred tax asset (liability) consisted of
the following:
|
|
2008 (Restated)
|
|
|
2007
|
|
Deferred
tax asset - noncurrent
|
|
$ |
8,045 |
|
|
$ |
- |
|
Deferred
tax liability - noncurrent
|
|
|
(365,812 |
) |
|
|
(342,540 |
) |
Deferred
tax liability, Net
|
|
$ |
(357,767 |
) |
|
$ |
(342,540 |
) |
13. DISCONTINUED
OPERATIONS
Since
January 2007, the Company has gradually phased out and substantially scaled down
most of its business of mobile phone distribution and provision of pager and
mobile phone value-added information services. In the first and second quarters
of 2007, the Company did not engage in any substantial transactions or activity
in connection with these businesses. On May 10, 2007, the Company ceased and
discontinued these businesses. Accordingly, the results of the discontinued
operations have been segregated from continuing operations. The discontinued
operations had an income of $23,105 for the six months ended June 30, 2007. The
income represented the write down of deferred revenue generated from the
provision of pager value-added information services.
14.
INCOME TAX
Effective
January 1, 2008, the PRC government implemented a new corporate income tax law
with a new maximum corporate income tax rate of 25%. The Company is governed by
the Income Tax Law of the PRC concerning privately-run enterprises, which are
generally subject to tax at a statutory rate of 25% (33% prior to 2008) on
income reported in the statutory financial statements after appropriate tax
adjustments.
The
Company’s subsidiaries generated substantially all of its net income from its
PRC operation. Shanghai TCH’s effective income tax rates for 2008 and 2007 are
18% and 15%, respectively. Xi’an TCH’s effective income tax rate for 2008 is
25%. Shanghai TCH and its subsidiaries Xi’an TCH and Xingtai Huaxin filed
separate income tax returns.
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
domiciled. The parent company, China Recycling Energy Co., Ltd., is taxed in the
US and has a net operating loss for the six and three months ended June 30,
2008. A 100% valuation allowance has been established due to the uncertainty of
its realization.
For the
six and three months ended June 30, 2008 and 2007, the Company’s effective
income tax rate differs from the US statutory rate because of the effect of the
tax holiday, effect of tax on loss on nontaxable jurisdiction and valuation
allowance.
15.
CONVERTIBLE NOTES PAYABLE
On
November 16, 2007, the Company entered into a Stock and Notes Purchase Agreement
(“Purchase Agreement”) with Carlyle Asia Growth Partners III, L.P. (“CAGP”) and
CAGP III Co. Investment, L.P. (together with CAGP, the “Investors”). Under the
terms of the Purchase Agreement, the Company sold to the Investors a 10% Secured
Convertible Promissory Note in the principal amount of $5,000,000 (the “First
Note”). Additionally, the Purchase Agreement provides for two subsequent
transactions to be effected by the Company and the Investors, which include (i)
the issuance by the Company and subscription by the Investors of a total of
4,066,706 shares of common stock of Company, at the price of $1.23 per share for
an aggregate purchase price of approximately $5,000,000, and (ii) the issuance
and sale by the Company to the Investors of a 5% Secured Convertible Promissory
Note in the principal amount of $15,000,000 (the foregoing transactions,
together with sale and purchase of the First Note, are hereinafter referred to
as the “Offering”). The subsequent transactions are contingent upon the
satisfaction of certain conditions specified in the Purchase Agreement,
including entry into specified energy and recycling project contracts and the
purchase of certain energy recycling systems.
The First
Note bore interest at 10% per annum and matured on November 16, 2009. The
principal face amount of the First Note, together with any interest thereon was
convertible at the option of the holders at any time on or prior to maturity,
into shares of the Company’s common stock at an initial conversion price of
$1.23 per share (subject to anti-dilution adjustments). The First Note was
subject to mandatory conversion upon the consummation of the aforementioned
issuance and subscription of shares of the Company’s common stock under the
Purchase Agreement. As more fully described in the First Note, the obligations
of the Company under the First Note ranked senior to all other debt of the
Company.
As
collateral for the First Note, the President and a major shareholder of the
Company pledged 9,653,471 shares of the Company’s common stock held by him to
secure the First Note.
The First
Note was considered to have an embedded beneficial conversion feature (“BCF”)
because the conversion price was less than the quoted market price at the time
of the issuance. Accordingly, the BCF of $5,000,000 was recorded separately as
unamortized beneficial conversion feature based on the intrinsic value method.
The First Note was recorded in the balance sheet at face value less the
unamortized BCF. The terms for the First Note were amended on April 29, 2008 and
the First Note was repaid in full on June 25, 2008, as described
below.
On April
29, 2008, the Company entered into an Amendment to the Purchase Agreement with
the Investors (the “Amendment”). Under the terms of the Amendment, (i) the
Company issued and the Investors subscribed for 4,066,706 shares of common stock
of the Company, at $1.23 per share for an aggregate purchase price of
$5,002,048, as originally contemplated under the Agreement; (ii) the Investors
converted the principal amount under the First Note (and waived any accrued
interest thereon) into 4,065,040 shares of common stock of the Company at the
conversion price per share of $1.23, pursuant to the terms and conditions of the
First Note issued under the Agreement; (iii) the Company issued and sold to the
Investors a new 5% Secured Convertible Promissory Note in the principal amount
of $5,000,000 to the Investors (the “Second Note” and collectively with the
First Note, the “Notes”); and (iv) the Company granted to the Investors an
option to purchase a 5% Secured Convertible Promissory Note in the principal
amount of $10,000,000, exercisable by the Investors at any time within nine (9)
months following the date of the closing of the transactions contemplated by the
Amendment (the “Option Note”).
The
Second Note bears interest at 5% per annum and matures on April 29, 2011. The
principal face amount of the Second Note, together with any interest thereon, is
convertible at the option of the holders at any time on or after March 30, 2010
(or such earlier date if the audited consolidated financial statements of the
Company for the fiscal year ending December 31, 2009 are available prior to
March 30, 2010) and prior to maturity, into shares of the Company's common stock
at an initial conversion price that is tied to the after-tax net profits of the
Company for the fiscal year ending December 31, 2009, as described in the Second
Note. The Second Note is subject to mandatory conversion upon the listing of the
Company's common stock on the National Association of Securities Dealers
Automated Quotations main-board, the New York Stock Exchange or the American
Stock Exchange. As more fully described in the Second Note, the obligations of
the Company under the Second Note shall rank senior to all other debt of the
Company.
The
Second Note and the Option Note are both secured by a security interest granted
to the Investors pursuant to the Share Pledge Agreement.
The
Second Note was not considered to have an embedded BCF because the conversion
price and convertible shares are contingent upon future net
profits.
On June
25, 2008, the Company and the Investors entered into a Rescission and
Subscription Agreement (the “Rescission”) to rescind the conversion of the First
Note and the issuance of conversion shares of Common Stock at the Second Closing
pursuant to the Amendment. The Company and the Investors rescinded the
conversion of the principal amount ($5,000,000) under the First Note into
4,065,040 shares of Common Stock, and the Investors waived accrued interest on
the First Note. Accordingly, the interest expense which had accrued on the note
has been recorded as a decrease in interest expense for the period. At the
Rescission closing, the Company repaid in full the First Note and issued to the
Investors 4,065,040 shares of Common Stock at the price of $1.23 per share for
an aggregate purchase price of $5,000,000. This was done through a
cross receipt arrangement; the amortized portion of BCF was reversed to
additional paid in stock. The Company has now concluded that in
substance the transaction resulted in the conversion of the first $5,000,000
note into common stock and that the remaining BCF of $3,472,603 at the date of
conversion should have been expensed (see Note 21).
16.
STOCK-BASED COMPENSATION PLAN
On
November 13, 2007, the Company approved the 2007 Non-statutory Stock Option
Plan, which was later amended and restated in August 2008 (the “2007
Plan”), and granted stock options with an aggregate amount of 3,000,000 shares
of the stock at $1.23 per share to acquire the Company's common stock at par
value $0.001 to twenty (20) managerial and non-managerial employees under the
2007 Plan.
The
vesting terms of options granted under the 2007 Plan is subject to the
Non-Statutory Stock Option Agreements for managerial and non-managerial
employees. For managerial employees, no more than 15% of the total stock options
shall vest and become exercisable on the six month anniversary of the grant
date. An additional 15% and 50% of the total stock options shall vest and become
exercisable on the first and second year anniversary of the grant date,
respectively. The remaining 20% of the total stock options shall vest and become
exercisable on the third year anniversary of the grant date. For non-managerial
employees, no more than 30% of the total stock options shall vest and become
exercisable in the first year anniversary of the grant date. An additional 50%
of the total stock options shall vest and become exercisable in the second year
anniversary of the grant date. The remaining 20% of the total stock options
shall vest and become exercisable on the third year anniversary of the grant
date. Each stock option shall become vested and exercisable over a period of no
longer than five years from the grant date.
Based on
the fair value method under SFAS No. 123 (Revised) “Share Based Payment” (“SFAS
123(R)”), the fair value of each stock option granted is estimated on the date
of the grant using the Black-Scholes option pricing model. The Black-Scholes
option pricing model has assumptions for risk free interest rates, dividends,
stock volatility and expected life of an option grant. The risk free interest
rate is based upon market yields for United States Treasury debt securities at a
maturity near the term remaining on the option. Dividend rates are based on the
Company’s dividend history. The stock volatility factor is based on the
historical volatility of the Company’s stock price. The expected life of an
option grant is based on management’s estimate as no options have been exercised
in the Plan to date. The fair value of each option grant to employees is
calculated by the Black-Scholes method and is recognized as compensation expense
over the vesting period of each stock option award. For stock options issued,
the fair value was estimated at the date of grant using the following range of
assumptions:
The
options vest over a period of three years and have a life of 5 years. The fair
value of the options was calculated using the following assumptions: estimated
life of five years, volatility of 100%, risk free interest rate of 3.76%, and
dividend yield of 0%. No estimate of forfeitures was made as the Company has a
short history of granting options.
Effective
June 25, 2008, the Company cancelled all vested shares and accepted optionees’
forfeiture of any unvested shares underlying the currently outstanding
options.
On 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 new awards were
considered as replacement awards and were recorded in accordance with SFAS
123(R).The options vest over a period of three years and have a life of 5 years.
The fair value of the options was calculated using the following assumptions:
estimated life of five years, volatility of 100%, risk free interest rate of
2.76%, and dividend yield of 0%. No estimate of forfeitures was made as the
Company has a short history of granting options. The options have been accounted
for as a modification to the options which were cancelled on June 25, 2008. No
adjustment has been made for the incremental cost in the six and three months
ended June 30, 2008 as the effect to net income was not material (see Note
20).
The
following table summarizes activity for employees in the Company’s Plan for the
six months ended June 30, 2008:
|
|
Number of
Shares
|
|
|
Average
Exercise
Price per
Share
|
|
|
Weighted
Average
Remaining
Contractual
Term in Years
|
|
Outstanding
at December 31, 2006
|
|
|
- |
|
|
|
|
|
|
|
Granted
|
|
|
3,000,000 |
|
|
$ |
1.23 |
|
|
|
5.00 |
|
Exercised
|
|
|
- |
|
|
|
|
|
|
|
|
|
Forfeited
|
|
|
- |
|
|
|
|
|
|
|
|
|
Outstanding
at December 31, 2007
|
|
|
3,000,000 |
|
|
$ |
1.23 |
|
|
|
4.87 |
|
Granted
|
|
|
- |
|
|
|
|
|
|
|
|
|
Exercised
|
|
|
- |
|
|
|
|
|
|
|
|
|
Forfeited
|
|
|
- |
|
|
|
|
|
|
|
|
|
Outstanding
at March 31, 2008
|
|
|
3,000,000 |
|
|
$ |
1.23 |
|
|
|
4.62 |
|
Exercised
|
|
|
- |
|
|
|
|
|
|
|
|
|
Cancelled
vested shares
|
|
|
450,000 |
|
|
|
|
|
|
|
|
|
Forfeited
unvested shares
|
|
|
2,550,000 |
|
|
|
|
|
|
|
|
|
Granted
|
|
|
3,000,000 |
|
|
$ |
0.80 |
|
|
|
5.00 |
|
Outstanding
at June 30, 2008
|
|
|
3,000,000 |
|
|
$ |
0.80 |
|
|
|
4.98 |
|
The
weighted-average modification date fair value of stock options granted to
employees for the six months ended June 30, 2008 was $0.88 per share. The
Company recorded $632,444 of compensation expense for employee stock options
during the six months ended June 30, 2008. There were no options exercised
during the six months ended June 30, 2008.
17.
SHAREHOLDERS’ EQUITY
On April
29, 2008, the Company issued and the Investor subscribed for a total of
4,066,706 shares of common stock of the Company, at the price of $1.23 per share
for an aggregate purchase price of $5,002,048 under the Stock and Notes Purchase
Agreement signed on November 16, 2007.
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 Amendment to Stock and
Notes Purchase Agreement dated on April 29, 2008. The Company and the Investors
rescinded the conversion of the principal amount ($5,000,000) under the First
Note into 4,065,040 shares of Common Stock and repaid the First Note in full. At
the Rescission and Subscription Closing, the Company issued to the Investors,
4,065,040 shares of Common Stock at the price of $1.23 per share for an
aggregate purchase price of $5,000,000.
During
the quarter ended June 30, 2008, the Company issued 3,278,259 shares of its
Common Stock to one of the Company’s shareholders who paid $4,032,258 cash to
the Company during the quarter ended June 30, 2008. This purchase was part of an
investment by the shareholder entered into in November 2007 to purchase the
shares at $1.23 per share.
18.
STATUTORY RESERVES
Pursuant
to the new corporate law of the PRC effective January 1, 2006, the Company is
now only required to maintain one statutory reserve by appropriating from its
after-tax profit before declaration or payment of dividends. The statutory
reserve represents restricted retained earnings.
Surplus Reserve
Fund
The
Company is required to transfer 10% of its net income, as determined under PRC
accounting rules and regulations, to a statutory surplus reserve fund until such
reserve balance reaches 50% of the Company’s registered capital.
The
surplus reserve fund is non-distributable other than during liquidation and can
be used to fund previous years’ losses, if any, and may be utilized for business
expansion or converted into share capital by issuing new shares to existing
shareholders in proportion to their shareholdings or by increasing the par value
of the shares currently held by them, provided that the remaining reserve
balance after such issuance is not less than 25% of the registered
capital.
Common Welfare
Fund
The
common welfare fund is a voluntary fund that the Company can elect to transfer
5% to 10% of its net income to this fund. This fund can only be utilized on
capital items for the collective benefit of the Company’s employees, such as
construction of dormitories, cafeteria facilities, and other staff welfare
facilities. This fund is non-distributable other than upon
liquidation.
19.
CONTINGENCIES
The
Company’s operations in the PRC are subject to specific considerations and
significant risks not typically associated with companies in the North America
and Western Europe. These include risks associated with, among others, the
political, economic and legal environments and foreign currency exchange. The
Company’ s results may be adversely affected by changes in governmental policies
with respect to laws and regulations, anti-inflationary measures, currency
conversion and remittance abroad, and rates and methods of taxation, among other
things.
The
Company’s sales, purchases and expenses transactions are denominated in RMB and
all of the Company’s assets and liabilities are also denominated in RMB. The RMB
is not freely convertible into foreign currencies under the current law. In
China, foreign exchange transactions are required by law to be transacted only
by authorized financial institutions. Remittances in currencies other than RMB
may require certain supporting documentation in order to affect the
remittance.
20.
COMMITMENTS
Zhangzhi Steel New 1080 m3
blast furnace TRT Power Generator Project
On
November 11, 2007, the Company entered a Project General Contractor agreement
with an independent contractor under contemplation to construct a 1080 cubic
meter blast furnace for the third phase of Zhangzhi TRT project which was
originally signed on June 22, 2006. The total contract price is approximately
$4,375,000 (RMB 30,000,000); the Company has paid approximately $2,625,000 (RMB
18,000,000) for the purchase of equipment. This project is expected to produce
45,000,000 KW/h annual energy output upon completion.
Shenwei Cement Pure Low
Temperature Waste Heat Power Generateor Project
In
November 2007, the Company signed a cooperative agreement with Shenwei Group for
a Cement Waste Heat Power Generator Project. The Company will build two sets of
12MW pure low temp cement waste heat power generator systems for its two
2500 tons per day cement manufacturing line in Jin Yang and 5,000 T/D
cement manufacturing line in Tong Chuan. During the first quarter of 2008, the
Company has finished equipment bidding process, selecting the equipment, and
commenced construction of the systems (See Note 5). Total investment will be
approximately 93 MM RMB with estimated annual power generated capacity of 180 MM
KWH once the two systems are put into operation. The Company will use the BOT
(build, operate, transfer) model to build and operate the systems. The operation
period will be 5 years. During the operation period, Shenwei Group will pay the
Company the monthly electricity fee based on the actual power generated by the
systems at 0.4116 RMB per KWH as agreed.
21.
RESTATEMENT OF FINANCIAL STATEMENTS
The
financial statements for the date at June 30, 2008 and for the six and
three months ended June 30, 2008 were restated to reflect the
following:
|
1.
|
Reclassification of current tax
payable to deferred tax of liability of $357,767 on sales-type leases as
the Company did not separately record the deferred tax
liability.
|
|
2.
|
The Company initially recorded
the rescission of the first $5,000,000 convertible note and cross receipt
transactions as the settlement of the note and the reacquisition of the
BCF (Note 15). The Company’s management has now concluded that
in substance the transaction resulted in the conversion of the first
$5,000,000 note into common stock and based on substance over form, should
have been accounted for as such. Accordingly, in accordance
with EITF 00-27, the remaining BCF of $3,472,603 at the date of conversion
has been expensed.
|
|
3.
|
Reclassification of interest
expense from interest income for the three months ended June 30, 2008. The
reclassification did not have an impact on the results of operations for
the three months ended June 30,
2008.
|
|
4.
|
The Company originally recorded
the employee stock options expense for those options that had vested up to
the cancellation date. The Company’s management has now concluded
that the option subsequently issued on August 4, 2008 was a modification
of the options cancelled and forfeited on June 25, 2008.
Accordingly, the Company recorded the difference between the fair values
of the options before and after the modification date as incremental cost
and amortized such cost including the unamortized grant date fair value
over the new vesting period. No adjustment has been made
for the incremental cost in the six and three months ended June 30, 2008
as the effect to net income was not
material.
|
All the
restatement adjustments did not have an impact to the statement of cash flows
except the reclassification within the operating activities.
The
following table presents the effects of the restatement adjustment on the
accompanying consolidated balance sheet for the date at June 30,
2008:
Consolidate Balance Sheet at June 30, 2008
|
|
As
Previously
Reported
|
|
|
Restated
|
|
|
Net
Adjustment
|
|
|
|
|
|
|
|
|
|
|
|
Tax
payable
|
|
$ |
855,615 |
|
|
$ |
497,848 |
|
|
$ |
(357,767 |
) |
Deferred
tax liability, net
|
|
$ |
- |
|
|
$ |
357,767 |
|
|
$ |
357,767 |
|
Total
liabilities
|
|
$ |
16,383,426 |
|
|
$ |
16,383,426 |
|
|
$ |
- |
|
Additional
paid in capital
|
|
$ |
30,251,407 |
|
|
$ |
33,724,010 |
|
|
$ |
3,472,603 |
|
Accumulated
deficit
|
|
$ |
(5,051,418 |
) |
|
$ |
(8,524,021 |
) |
|
$ |
(3,472,603 |
) |
Total
stockholders’ equity
|
|
$ |
28,991,477 |
|
|
$ |
28,991,477 |
|
|
$ |
- |
|
The
following table presents the effects of the restatement adjustment on the
accompanying consolidated statement of operations for the six months ended June
30, 2008:
|
|
As
Previously
|
|
|
|
|
|
Net
|
|
Consolidated
Statement of Operations and Comprehensive loss
|
|
Reported
|
|
|
Restated
|
|
|
Adjustment
|
|
|
|
|
|
|
|
|
|
|
|
Interest
expense
|
|
$ |
(1,191,781 |
) |
|
$ |
(4,664,384 |
) |
|
$ |
(3,472,603 |
) |
Total
non-operating expenses
|
|
$ |
(1,256,777 |
) |
|
$ |
(4,729,380 |
) |
|
$ |
(3,472,603 |
) |
Loss
before income taxes
|
|
$ |
(837,022 |
) |
|
$ |
(4,309,625 |
) |
|
$ |
(3,472,603 |
) |
Net
Loss
|
|
$ |
(1,205,576 |
) |
|
$ |
(4,678,179 |
) |
|
$ |
(3,472,603 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive
loss
|
|
$ |
(95,101 |
) |
|
$ |
(3,567,704 |
) |
|
$ |
(3,472,603 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
Loss per common share — basic
|
|
$ |
(0.04 |
) |
|
$ |
(0.17 |
) |
|
$ |
(0.13 |
) |
Net
Loss per common share — diluted
|
|
$ |
(0.04 |
) |
|
$ |
(0.17 |
) |
|
$ |
(0.13 |
) |
The
following table presents the effects of the restatement adjustment on the
accompanying consolidated statement of operations for the three months ended
June 30, 2008:
|
|
As
Previously
|
|
|
|
|
|
Net
|
|
Consolidated
Statement of Operations and Comprehensive loss
|
|
Reported
|
|
|
Restated
|
|
|
Adjustment
|
|
|
|
|
|
|
|
|
|
|
|
Interest
income
|
|
$ |
758,124 |
|
|
$ |
14,846 |
|
|
$ |
(743,278 |
) |
Interest
expenses
|
|
$ |
(1,191,781 |
) |
|
$ |
(3,921,106 |
) |
|
$ |
(2,729,325 |
) |
Total
non-operating expenses
|
|
$ |
(503,469 |
) |
|
$ |
(3,976,072 |
) |
|
$ |
(3,472,603 |
) |
Loss
before income taxes
|
|
$ |
(56 |
) |
|
$ |
(3,472,659 |
) |
|
$ |
(3,472,603 |
) |
Net
Loss
|
|
$ |
(317,636 |
) |
|
$ |
(3,790,239 |
) |
|
$ |
(3,472,603 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive
(loss) income
|
|
$ |
718,114 |
|
|
$ |
(2,754,489 |
) |
|
$ |
(3,472,603 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
Loss per common share — basic
|
|
$ |
(0.01 |
) |
|
$ |
(0.12 |
) |
|
$ |
(0.11 |
) |
Net
Loss per common share — diluted
|
|
$ |
(0.01 |
) |
|
$ |
(0.12 |
) |
|
$ |
(0.11 |
) |
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 Securities and Exchange Commission (collectively the “Filings”)
contain or may contain forward-looking statements and information that are based
upon beliefs of, and information currently available to, Company’s management as
well as estimates and assumptions made by Company’s management. Readers are
cautioned not to place undue reliance on these forward-looking statements, which
are only predictions and speak only as of the date hereof. When used in the
filings, the words “anticipate”, “believe”, “estimate”, “expect”, “future”,
“intend”, “plan”, or the negative of these terms and similar expressions as they
relate to Company or Company’s management identify forward-looking statements.
Such statements reflect the current view of Company with respect to future
events and are subject to risks, uncertainties, assumptions, and other factors
(including the risks contained in the section of operations and results of
operations, 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
Company believes that the expectations reflected in the forward-looking
statements are reasonable, 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 quarterly 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 “Exchange
Rates” below for information concerning the exchange rates at which Renminbi
(“RMB”) were translated into US Dollars (“USD”) at various pertinent dates and
for pertinent periods.
OVERVIEW
OF BUSINESS BACKGROUND
China
Recycling Energy Corporation (the “Company” or “CREG”) (formerly China Digital
Wireless, Inc.) was incorporated on May 8, 1980, under the laws of the State of
Colorado. On September 6, 2001, the Company re-domiciled its state of
incorporation from Colorado to Nevada. The Company, through its subsidiary
Shanghai TCH Data Technology Co., Ltd. (“TCH”), is doing the business of selling
and leasing energy saving equipment. The businesses of mobile phone distribution
and provision of pager and mobile phone value-added information services were
discontinued in 2007. On March 8, 2007, the Company changed its name to “China
Recycling Energy Corporation”.
On June
23, 2004, the Company entered into a stock exchange agreement with Sifang
Holdings Co. Ltd. (“Sifang Holdings”) and certain shareholders. Pursuant to the
stock exchange agreement, the Company issued 13,782,636 shares of its common
stock in exchange for a 100% equity interest in Sifang Holdings, making Sifang
Holdings a wholly owned subsidiary of the Company. Sifang Holdings was
established under the laws of the Cayman Islands on February 9, 2004 for the
purpose of holding a 100% equity interest in Shanghai TCH Data Technology Co.,
Ltd. (“TCH”). TCH was established as a foreign investment enterprise in Shanghai
under the laws of the People’s Republic of China (the “PRC”) on May 25, 2004.
Since January 2007, the Company has gradually phased out and substantially
scaled down most of its business of mobile phone distribution and provision of
pager and mobile phone value-added information services. In the first and second
quarters of 2007, the Company did not engage in any substantial transactions or
activity in connection with these businesses. On May 10, 2007, the Company
ceased and discontinued the businesses related to mobile phones and pagers.
These businesses are reflected in continuing operations for all periods
presented based on the criteria for discontinued operations prescribed by
Statement of Financial Accounting Standards (“SFAS”) No. 144, “Accounting for
the Impairment or Disposal of Long-Lived Assets”.
On
February 1, 2007, the Company’s subsidiary, TCH entered into two TRT Project
Joint-Operation Agreements (“Joint-Operation Agreement”) with Xi’an Yingfeng
Science and Technology Co., Ltd. (“Yingfeng”). Yingfeng is a joint stock company
registered in Xi’an, Shaanxi Province, the PRC, and engages in the business of
designing, installing, and operating TRT systems and sales of other renewable
energy products. TRT is an electricity generating system that utilizes the
exhaust pressure and heat produced in the blast furnace of a steel mill to
generate electricity. In October 2007, the Company terminated the
Joint-Operation Agreement with Yingfeng and became fully entitled to the rights,
titles, benefits and interests in the TRT Projects.
On
September 21, 2007, the Company’s subsidiary, TCH changed its name to “Shanghai
TCH Energy Technology Co., Ltd.”.
CRITICAL
ACCOUNTING POLICIES AND ESTIMATES
Our
management's discussion and analysis of our financial condition and results of
operations are based on our consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States. The preparation of these financial statements requires us to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and the disclosure of contingent assets and liabilities at the date
of the financial statements as well as the reported net sales and expenses
during the reporting periods. On an ongoing basis, we evaluate our estimates and
assumptions. We base our estimates on historical experience and on various other
factors that we believe are reasonable under the circumstances, the results of
which form the basis for making judgments about the carrying value of assets and
liabilities that are not readily apparent from other sources. Actual results may
differ from these estimates under different assumptions or
conditions.
While our
significant accounting policies are more fully described in Note 2 to our
consolidated financial statements, we believe that the following accounting
policies are the most critical to aid you in fully understanding and evaluating
this management discussion and analysis.
Basis
of presentation
These
accompanying consolidated financial statements have been prepared in accordance
with generally accepted accounting principles in the United States of America
(“US GAAP”) and pursuant to the rules and regulations of the Securities and
Exchange Commission (“SEC”) for annual financial statements.
Basis
of consolidation
The
consolidated financial statements include the accounts of CREG and, its
subsidiaries, Sifang Holdings, TCH, and TCH’s newly incorporated subsidiaries
Xi'an TCH Energy Tech Co., Ltd. (Xi’an TCH) and Xingtai Huaxin Energy Tech Co.,
Ltd. (Huaxin). Xi’an TCH and Huaxin engage in the same business with TCH.
Substantially all of the Company's revenues are derived from the operations of
TCH and its subsidiaries, which represent substantially all of the Company’s
consolidated assets and liabilities. 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 consist
primarily of accounts receivable and other receivables. The Company does not
require collateral or other security to support these receivables. The Company
conducts periodic reviews of its clients' financial condition and customer
payment practices to minimize collection risk on accounts
receivable.
The
operations of the Company are located in the PRC. Accordingly, the Company's
business, financial condition, and results of operations may be influenced by
the political, economic, and legal environments in the PRC, as well as by the
general state of the PRC economy.
Inventory
Inventory
is valued at the lower of cost or market. Cost of work in progress and finished
goods comprises direct material cost, direct production cost and an allocated
portion of production overheads.
Property
and Equipment
Property
and equipment are stated at cost, net of accumulated depreciation. Expenditures
for maintenance and repairs are expensed as incurred; additions, renewals and
betterments are capitalized. When property and equipment are retired or
otherwise disposed of, the related cost and accumulated depreciation are removed
from the respective accounts, and any gain or loss is included in operations.
Depreciation of property and equipment is provided using the straight-line
method over the estimated lives ranging from 5 to 20 years as
follows:
Building
|
20
years
|
Vehicle
|
2 -
5 years
|
Office
and Other Equipment
|
2 -
5 years
|
Software
|
2 -
3 years
|
Sales-type
leasing and related revenue recognition
The
Company invests and leases TRT systems to Xingtai and Zhangzhi. The Company will
transfer all benefits, risks and ownership of the TRT systems to Xingtai and
Zhangzhi at the end of each lease term. The Company’s investment in these
projects is recorded as Sales-type leases in accordance with SFAS No. 13,
“Accounting for Leases” and its various amendments and interpretations. The
sales and cost of goods sold is recognized at the point of sale. The investment
in sales-type leases consists of the sum of the total minimum lease payments
receivable less unearned interest income. Unearned interest income is amortized
to income over the lease term as to produce a constant periodic rate of return
on the net investment in the lease.
Foreign
Currency Translation and Comprehensive Income (Loss)
The
Company’s functional currency is the Renminbi (“RMB”). For financial reporting
purposes, RMB has been translated into United States dollars (“USD”) as the
reporting currency. Assets and liabilities are translated at the exchange rate
in effect at the balance sheet date. Revenues and expenses are translated at the
average rate of exchange prevailing during the reporting period. Translation
adjustments arising from the use of different exchange rates from period to
period are included as a component of stockholders' equity as “Accumulated other
comprehensive income”. Gains and losses resulting from foreign currency
transactions are included in income. There has been no significant fluctuation
in exchange rate for the conversion of RMB to USD after the balance sheet
date.
The
Company uses SFAS 130 “Reporting Comprehensive Income”. 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
The Hierarchy of Generally
Accepted Accounting Principles
In May
2008, the FASB issued SFAS No. 162, “The Hierarchy of Generally Accepted
Accounting Principles.” This Statement identifies the sources of
accounting principles and the framework for selecting the principles to be used
in the preparation of financial statements of nongovernmental entities that are
presented in conformity with generally accepted accounting principles (GAAP) in
the United States (the GAAP hierarchy). This Statement will not have an
impact on the Company’s financial statements.
Disclosures about Derivative
Instruments and Hedging Activities
In March
2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments
and Hedging Activities an amendment of FASB Statement No. 133 (“SFAS
133”). This Statement changes the disclosure requirements for derivative
instruments and hedging activities. Entities are required to provide enhanced
disclosures about (a) how and why an entity uses derivative instruments, (b) how
derivative instruments and related hedged items are accounted for under
SFAS 133 and its related interpretations, and (c) how derivative
instruments and related hedged items affect an entity’s financial position,
financial performance, and cash flows. Based on current conditions, the
Company does not expect the adoption of SFAS 161 to have a significant impact on
its results of operations or financial position.
Noncontrolling Interests in
Consolidated Financial Statements - An Amendment of ARB No.
51
In
December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in
Consolidated Financial Statements - An Amendment of ARB No. 51” (“SFAS
160”). SFAS 160 establishes new accounting and reporting standards for the
noncontrolling interest in a subsidiary and for the deconsolidation of a
subsidiary. Specifically, this statement requires the recognition of a
noncontrolling interest (minority interest) as equity in the consolidated
financial statements and separate from the parent’s equity. The amount of net
income attributable to the noncontrolling interest will be included in
consolidated net income on the face of the income statement. SFAS 160 clarifies
that changes in a parent’s ownership interest in a subsidiary that do not result
in deconsolidation are equity transactions if the parent retains its controlling
financial interest. In addition, this statement requires that a parent recognize
a gain or loss in net income when a subsidiary is deconsolidated. Such gain or
loss will be measured using the fair value of the noncontrolling equity
investment on the deconsolidation date. SFAS 160 also includes expanded
disclosure requirements regarding the interests of the parent and its
noncontrolling interest. SFAS 160 is effective for fiscal years, and interim
periods within those fiscal years, beginning on or after December 15, 2008.
Based on current conditions, the Company does not expect the adoption of SFAS
160 to have a significant impact on its results of operations or financial
position.
Business
Combinations
In
December 2007, the FASB issued SFAS No. 141 (Revised 2007), Business
Combinations (“SFAS 141R”). SFAS 141R will significantly change the
accounting for business combinations. Under SFAS 141R, an acquiring entity will
be required to recognize all the assets acquired and liabilities assumed in a
transaction at the acquisition-date fair value with limited exceptions. SFAS
141R will change the accounting treatment for certain specific items,
including:
|
·
|
Acquisition costs will be
generally expensed as
incurred;
|
|
·
|
Noncontrolling interests
(formerly known as “minority interests” - see SFAS 160 discussion above)
will be valued at fair value at the acquisition
date;
|
|
·
|
Acquired contingent liabilities
will be recorded at fair value at the acquisition date and subsequently
measured at either the higher of such amount or the amount determined
under existing guidance for non-acquired
contingencies;
|
|
·
|
In-process research and
development will be recorded at fair value as an indefinite-lived
intangible asset at the acquisition
date;
|
|
·
|
Restructuring costs associated
with a business combination will be generally expensed subsequent to the
acquisition date; and
|
|
·
|
Changes in deferred tax asset
valuation allowances and income tax uncertainties after the acquisition
date generally will affect income tax
expense.
|
SFAS 141R
also includes a substantial number of new disclosure requirements. SFAS 141R
applies prospectively to business combinations for which the acquisition date is
on or after the beginning of the first annual reporting period beginning on or
after December 15, 2008. Earlier adoption is prohibited. Accordingly, since
we are a calendar year-end company we will continue to record and disclose
business combinations following existing GAAP until January 1, 2009. We
expect SFAS 141R will have an impact on accounting for business combinations
once adopted but the effect is dependent upon acquisitions at that
time.
Employers’ Accounting for
Defined Benefit Pension and Other Postretirement Plans, an Amendment of FASB
Statements No. 87, 88, 106, and 132R
In
September 2006, the FASB issued SFAS No. 158, “Employers’ Accounting for Defined
Benefit Pension and Other Postretirement Plans, an Amendment of FASB Statements
No. 87, 88, 106, and 132R (“SFAS 158”), which requires employers to recognize
the underfunded or overfunded status of a defined benefit postretirement plan as
an asset or liability in its statement of financial position and to recognize
changes in the funded status in the year in which the changes occur through
accumulated other comprehensive income. Additionally, SFAS 158 requires
employers to measure the funded status of a plan as of the date of its year-end
statement of financial position. The new reporting requirements and related new
footnote disclosure rules of SFAS 158 are effective for fiscal years ending
after December 15, 2006. We adopted the provisions of SFAS 158 for the year end
2006, and the effect of recognizing the funded status in accumulated other
comprehensive income was not significant. The new measurement date requirement
applies for fiscal years ending after December 15, 2008.
Accounting for Nonrefundable
Advance Payments for Goods or Services Received for use in Future Research and
Development Activities
In June
2007, the FASB issued FASB Staff Position No. EITF 07-3, “Accounting for
Nonrefundable Advance Payments for Goods or Services Received for use in Future
Research and Development Activities” (“FSP EITF 07-3”), which addresses whether
nonrefundable advance payments for goods or services that used or rendered for
research and development activities should be expensed when the advance payment
is made or when the research and development activity has been
performed. Management is currently evaluating the effect of this
pronouncement on financial statements.
RESULTS
OF OPERATIONS
Comparison
of Six Months Ended June 30, 2008 and June 30, 2007
The
following table sets forth the results of our operations for the periods
indicated as a percentage of net sales:
|
|
2008 (Restated)
|
|
|
2007
|
|
Six Months Ended
June 30
|
|
$
|
|
|
% of Sales
|
|
|
$
|
|
|
% of Sales
|
|
Sales
|
|
|
2,616,416 |
|
|
|
|
|
|
4,781,163 |
|
|
|
|
Sales
of products
|
|
|
- |
|
|
|
- |
|
|
|
4,781,163 |
|
|
|
100 |
% |
Rental
income
|
|
|
2,616,416 |
|
|
|
100 |
% |
|
|
- |
|
|
|
- |
|
Cost
of sales
|
|
|
(1,832,609 |
) |
|
|
70 |
% |
|
|
(3,677,818 |
) |
|
|
77 |
% |
Cost
of products
|
|
|
- |
|
|
|
- |
|
|
|
(3,677,818 |
) |
|
|
77 |
% |
Rental
expense
|
|
|
(1,832,609 |
) |
|
|
70 |
% |
|
|
- |
|
|
|
- |
|
Gross
profit
|
|
|
783,807 |
|
|
|
30 |
% |
|
|
1,103,345 |
|
|
|
23 |
% |
Interest
income on sales-type lease
|
|
|
1,139,727 |
|
|
|
44 |
% |
|
|
198,386 |
|
|
|
4 |
% |
Total
operating income
|
|
|
1,923,534 |
|
|
|
74 |
% |
|
|
1,301,731 |
|
|
|
27 |
% |
Total
Operating expenses
|
|
|
(1,503,779 |
) |
|
|
57 |
% |
|
|
(343,543 |
) |
|
|
7 |
% |
Income
from operation
|
|
|
419,755 |
|
|
|
16 |
% |
|
|
958,188 |
|
|
|
20 |
% |
Total
non-operating income (expenses)
|
|
|
(4,729,380 |
) |
|
|
(181 |
)
% |
|
|
208,918 |
|
|
|
4 |
% |
Income
(loss) before income tax
|
|
|
(4,309,625 |
) |
|
|
(165 |
)
% |
|
|
1,167,106 |
|
|
|
24 |
% |
Income
tax expense
|
|
|
(368,498 |
) |
|
|
14 |
% |
|
|
(211,593 |
) |
|
|
4 |
% |
Minority
interest
|
|
|
(56 |
) |
|
|
0 |
% |
|
|
- |
|
|
|
|
|
Income
from operations of discontinued component
|
|
|
- |
|
|
|
|
|
|
|
23,105 |
|
|
|
0.5 |
% |
Net
income (loss)
|
|
|
(4,678,179 |
) |
|
|
(179 |
)
% |
|
|
978,618 |
|
|
|
20 |
% |
SALES. Net sales for the six
months ended June 30, 2008 were $2.62 million while our net sales for the six
months ended June 30, 2007, were approximately $4.78 million, a decrease in
revenues of $2.16 million. The decrease was due to changing of our business type
during the first six months of 2007. We discontinued our mobile phone business
and commenced selling and manufacturing of energy saving equipment during the
first six months of 2007. We sell our equipment through sales-type leasing.
Sales and cost of sales are recorded at the time of leasing, the interest income
of which is part of our revenue source in additional to sales revenue. We sold
one TRT system through sales-type leasing during the first six months of 2007
while we had interest income of $1.14 million from sales-type leasing and rental
income from leasing out two power generating systems for the first six months of
2008.
COST OF SALES. Cost of sales
for the six months ended June 30, 2008 was $1.83 million while our cost of sales
for the same period of 2007, was approximately $3.68 million, a decrease of
$1.85 million. The decrease in cost of sales is attributed to changing our
business type from a mobile phone business to manufacturing, selling and leasing
the energy saving equipment in the first six months of 2007. We leased two power
generating systems under one-year, non-cancellable leases with options to renew
at a favorable price during the six months ended June 30, 2008. We paid the
lease payment in full and leased them out for higher monthly rental income under
one-year, non-cancellable lease.
GROSS PROFIT. Gross profit
was $0.78 million for the six months ended June 30, 2008 as compared to $1.10
million for the same period of 2007, representing gross margins of approximately
30% and 23% for the six months ended June 30, 2008 and 2007, respectively.
The increase in our gross profit was mainly due to a decreased cost of sales
derived from changing our business type from a mobile phone business to
manufacturing, selling and leasing the energy saving equipment in the first six
months of 2007. We sold one TRT system through sales-type leasing with gross
profit recognized during the first six months of 2007, while we had interest
income from sales-type leasing and rental income for the first six months of
2008.
OPERATING EXPENSES. Operating
expenses consisted of selling, general and administrative expenses totaling
approximately $1.50 million for the six months ended June 30, 2008 as compared
to $0.34 million for the same period of 2007, an increase of approximately $1.16
million or 338%. This increase was mainly due to the compensation expense of
approximately $630,000 related to the fair value of the options to employees
that was vested during the first six months of 2008 to the date of cancellation
of the options and increased payroll, marketing and traveling expense due to the
expansion of our business.
NET INCOME (LOSS). Our net
income (loss) for the six months ended June 30, 2008 was $(4,678,179) as
compared to $978,618 net income for the same period of 2007, a decrease of $5.65
million. This decrease in net income was mainly due to interest expense on our
amortized beneficial conversion feature for the convertible note of
approximately $4.68 million and compensation expense of the fair value of stock
options of $0.63 million for the first six months of 2008. The convertible note
was repaid on June 25, 2008 and all the vested and non-vested options were
modified on June 25, 2008.
Comparison
of Three Months Ended June 30, 2008 and June 30, 2007
The
following table sets forth the results of our operations for the periods
indicated as a percentage of net sales:
Three Months Ended June 30
|
|
2008 (Restated)
|
|
|
2007
|
|
|
|
$
|
|
|
% of Sales
|
|
|
$
|
|
|
% of Sales
|
|
Sales
|
|
|
2,616,416 |
|
|
|
|
|
|
- |
|
|
|
|
Sales
of products
|
|
|
- |
|
|
|
|
|
|
- |
|
|
|
N/A |
|
Rental
income
|
|
|
2,616,416 |
|
|
|
100 |
% |
|
|
- |
|
|
|
N/A |
|
Cost
of sales
|
|
|
(1,832,609 |
) |
|
|
70 |
% |
|
|
- |
|
|
|
N/A |
|
Cost
of products
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
N/A |
|
Rental
expense
|
|
|
(1,832,609 |
) |
|
|
70 |
% |
|
|
- |
|
|
|
N/A |
|
Gross
profit
|
|
|
783,807 |
|
|
|
30 |
% |
|
|
- |
|
|
|
N/A |
|
Interest
income on sales-type lease
|
|
|
574,775 |
|
|
|
22 |
% |
|
|
148,150 |
|
|
|
N/A |
|
Total
operating income
|
|
|
1,358,582 |
|
|
|
52 |
% |
|
|
148,150 |
|
|
|
N/A |
|
Total
Operating expenses
|
|
|
(855,169 |
) |
|
|
33 |
% |
|
|
(86,501 |
) |
|
|
N/A |
|
Income
(loss) from operation
|
|
|
503,413 |
|
|
|
19 |
% |
|
|
61,649 |
|
|
|
|
|
Total
non-operating expenses
|
|
|
(3,976,072 |
) |
|
|
(152 |
)% |
|
|
208,968 |
|
|
|
N/A |
|
Income
(loss) before income tax
|
|
|
(3,472,659 |
) |
|
|
(133 |
)% |
|
|
270,617 |
|
|
|
N/A |
|
Income
tax expense
|
|
|
(317,551 |
) |
|
|
12 |
% |
|
|
(51,436 |
) |
|
|
N/A |
|
Minority
interest
|
|
|
(29 |
) |
|
|
- |
|
|
|
- |
|
|
|
N/A |
|
Income
from operations of discontinued component
|
|
|
- |
|
|
|
- |
|
|
|
|
|
|
|
N/A |
|
Net
income (loss)
|
|
|
(3,790,239 |
) |
|
|
(145 |
%) |
|
|
219,181 |
|
|
|
N/A |
|
SALES. Net sales for the
quarter ended June 30, 2008 were $2.62 million while our net sales for the
quarter ended June 30, 2007, were nil, an increase in revenues of $2.62 million.
The increase was due to changing our business type during the first quarter of
2007. We discontinued our mobile phone business and commenced selling and
manufacturing of energy saving equipment during first quarter of 2007. We sell
our equipment through sales-type leasing. Sales and cost of sales are recorded
at the time of leasing, the interest income of which is part of our revenue
source in addition to sales revenue. We sold one TRT system through sales-type
leasing during the first quarter of 2007 which brought us only interest income
of $148,150 for the second quarter of 2007 while we had both interest income
from sales-type leasing and rental income during the second quarter ended June
30, 2008.
COST OF SALES. Cost of sales
for the quarter ended June 30, 2008 was $1.83 million while our cost of sales
for the quarter ended June 30, 2007 was nil, an increase of $1.83 million. The
increase in cost of sales attributed to changing our business type from a mobile
phone business to manufacturing, selling and leasing the energy saving equipment
in the first quarter of 2007. We leased two power generating systems under
one-year, non-cancellable leases with options to renew at favorable price during
the quarter ended June 30, 2008. We paid the lease payment in full and lease
them out for higher monthly rental income under one-year, non-cancellable
lease.
GROSS PROFIT. Gross profit
was $0.78 million for the quarter ended June 30, 2008 as compared to $0 gross
profit for the quarter ended June 30, 2007, representing gross margins of
approximately 30% and 0% for the second quarter ended 2008 and 2007,
respectively. The increase in our gross profit was mainly due to changing our
business type from a mobile phone business to manufacturing, selling and leasing
the energy saving equipment in the first quarter of 2007. We sold one TRT system
through sales-type leasing with gross profit recognized during the first quarter
of 2007 which brought us only the interest income for the second quarter ended
June 30, 2007, while we had interest income from sales-type leasing and rental
income for the second quarter of 2008.
OPERATING EXPENSES. Operating
expenses consisted of selling, general and administrative expenses totaling
approximately $855,169 for the quarter ended June 30, 2008 as compared to
$86,501 for the quarter ended June 30, 2007, an increase of approximately
$768,668 or 889%. This increase was mainly due to the compensation expense of
approximately $307,000 of the fair value of the stock options to employees that
were vested in the second quarter of 2008 through the cancellation date of June
25, 2008 and increased payroll, marketing and traveling expense due to the
expansion of our business.
NET INCOME (LOSS). Our net
income (loss) for the quarter ended June 30, 2008 was $(3,790,239) as compared
to $219,181 net income for the quarter ended June 30, 2007, a decrease of $4.01
million. This decrease in net income (loss) was mainly due to interest expense
on our amortized beneficial conversion feature for the convertible note of
approximately $4.06 million and compensation expense of the fair value of the
stock options of $307,000 for the second quarter of 2008. The convertible note
was repaid on June 25, 2008 and all the vested and non-vested options have been
modified on June 25, 2008.
LIQUIDITY
AND CAPITAL RESOURCES
Six
months ended June 30, 2008 as compared to six months ended June 30,
2007
As of
June 30, 2008, the Company had cash and cash equivalents of approximately
$7,001,594. At June 30, 2008, other current assets consisted of approximately
$22.14 million and current liabilities consisted of approximately $13.17
million, working capital amounted to $12.81 million at June 30, 2008. The ratio
of current assets to current liabilities was 1.82:1 at the period ended June 30,
2008.
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, 2008 and
2007:
|
|
2008
(Restated)
|
|
|
2007
|
|
Cash
provided by (used in):
|
|
|
|
|
|
|
Operating
Activities
|
|
$ |
(3,752,801
|
) |
|
$ |
4,178,452 |
|
Investing
Activities
|
|
|
(5,139,416
|
) |
|
|
(4,475,102
|
) |
Financing
Activities
|
|
|
13,958,352 |
|
|
|
36,137 |
|
Net cash
flow used in operating activities was $3.75 million in the first six months
of 2008, as compared to net cash flow provided by operating activities of $4.18
million in the first six months of 2007. The decrease in net cash inflows from
operating activities was mainly due to the net loss for the first six months of
2008 and prepaid equipment rents of approximately $9.21 million.
Net cash
flow used in investing activities was $5.14 million for the period ended June
30, 2008, as compared to net cash used in investing activities of $4.48 million
for the period ended June 30, 2007. The increase of net cash flow used in
investing activities was mainly due to the payment for construction in progress
of approximately $5.61 million for constructing a power generating system. We
will use the BOT (build, operate, transfer) model to build and operate a system
and charge the user of this system monthly electricity fees based on the actual
power generated by the systems.
Net cash
flow provided by financing activities was $13.96 million for the period ended
June 30, 2008 as compared to net cash provided by financing activities of
$36,137 for the period ended June 30, 2007. The increase of net cash flow
provided by financing activities in the first six months of 2008 was mainly due
to the issuance of common stock to an accredited investor for $5 million,
issuance of a convertible note to the same investor for $5 million, and issuance
of common stock to one of our major shareholders for $4,032,258.
We
believe we have sufficient cash to continue our current business throughout 2008
due to increased sales, interest revenue and rental income from operating
activity.
We do not
believe that inflation had a significant negative impact on our results of
operations during 2008.
Off-Balance
Sheet Arrangements
We have
not entered into any other financial guarantees or other commitments to
guarantee the payment obligations of any third parties. We have not entered into
any derivative contracts that are indexed to our shares and classified as
stockholder’s equity or that are not reflected in our consolidated financial
statements. Furthermore, we do not have any retained or contingent interest in
assets transferred to an unconsolidated entity that serves as credit, liquidity
or market risk support to such entity. We do not have any variable interest in
any unconsolidated entity that provides financing, liquidity, market risk or
credit support to us or engages in leasing, hedging or research and development
services with us.
Contractual
Obligations
Convertible Notes
Payable
On
November 16, 2007, the Company entered into a Stock and Notes Purchase Agreement
(“Purchase Agreement”) with Carlyle Asia Growth Partners III, L.P. (“CAGP”) and
CAGP III Co. Investment, L.P. (together with CAGP, the “Investors”). Under the
terms of the Purchase Agreement, the Company sold to the Investors a 10% Secured
Convertible Promissory Note in the principal amount of $5,000,000 (the “First
Note”). Additionally, the Purchase Agreement provides for two subsequent
transactions to be effected by the Company and the Investors, which include (i)
the issuance by the Company and subscription by the Investors of a total of
4,066,706 shares of common stock of Company, at the price of $1.23 per share for
an aggregate purchase price of approximately $5,000,000, and (ii) the issuance
and sale by the Company to the Investors of a 5% Secured Convertible Promissory
Note in the principal amount of $15,000,000 (the foregoing transactions,
together with sale and purchase of the First Note, are hereinafter referred to
as the “Offering”). The subsequent transactions are contingent upon the
satisfaction of certain conditions specified in the Purchase Agreement,
including entry into specified energy and recycling project contracts and the
purchase of certain energy recycling systems.
The First
Note bore interest at 10% per annum and matured on November 16, 2009. The
principal face amount of the First Note, together with any interest thereon was
convertible at the option of the holders at any time on or prior to maturity,
into shares of the Company’s common stock at an initial conversion price of
$1.23 per share (subject to anti-dilution adjustments). The First Note was
subject to mandatory conversion upon the consummation of the aforementioned
issuance and subscription of shares of the Company’s common stock under the
Purchase Agreement. As more fully described in the First Note, the obligations
of the Company under the First Note ranked senior to all other debt of the
Company.
As
collateral for the First Note, the President and a major shareholder of the
Company pledged 9,653,471 shares of the Company’s common stock held by him to
secure the First Note.
The First
Note was considered to have an embedded beneficial conversion feature (“BCF”)
because the conversion price was less than the quoted market price at the time
of the issuance. Accordingly, the BCF of $5,000,000 was recorded separately as
unamortized beneficial conversion feature based on the intrinsic value method.
The First Note was recorded in the balance sheet at face value less the
unamortized BCF. The terms for the First Note were amended on April 29, 2008 and
the First Note was repaid in full on June 25, 2008, as described
below.
On April
29, 2008, the Company entered into an Amendment to the Purchase Agreement with
the Investors (the “Amendment”). Under the terms of the Amendment, (i) the
Company issued and the Investors subscribed for 4,066,706 shares of common stock
of the Company, at $1.23 per share for an aggregate purchase price of
$5,002,048, as originally contemplated under the Agreement; (ii) the Investors
converted the principal amount under the First Note (and waived any accrued
interest thereon) into 4,065,040 shares of common stock of the Company at the
conversion price per share of $1.23, pursuant to the terms and conditions of the
First Note issued under the Agreement; (iii) the Company issued and sold to the
Investors a new 5% Secured Convertible Promissory Note in the principal amount
of $5,000,000 to the Investors (the “Second Note” and collectively with the
First Note, the “Notes”); and (iv) the Company granted to the Investors an
option to purchase a 5% Secured Convertible Promissory Note in the principal
amount of $10,000,000, exercisable by the Investors at any time within nine (9)
months following the date of the closing of the transactions contemplated by the
Amendment (the “Option Note”).
The
Second Note bears interest at 5% per annum and matures on April 29, 2011. The
principal face amount of the Second Note, together with any interest thereon, is
convertible at the option of the holders at any time on or after March 30, 2010
(or such earlier date if the audited consolidated financial statements of the
Company for the fiscal year ending December 31, 2009 are available prior to
March 30, 2010) and prior to maturity, into shares of the Company's common stock
at an initial conversion price that is tied to the after-tax net profits of the
Company for the fiscal year ending December 31, 2009, as described in the Second
Note. The Second Note is subject to mandatory conversion upon the listing of the
Company's common stock on the National Association of Securities Dealers
Automated Quotations main-board, the New York Stock Exchange or the American
Stock Exchange. As more fully described in the Second Note, the obligations of
the Company under the Second Note shall rank senior to all other debt of the
Company.
The
Second Note and the Option Note are both secured by a security interest granted
to the Investors pursuant to the Share Pledge Agreement.
The
Second Note was not considered to have an embedded BCF because the conversion
price and convertible shares are contingent upon future net
profits.
On June
25, 2008, the Company and the Investors entered into a Rescission and
Subscription Agreement (the “Rescission”) to rescind the conversion of the First
Note and the issuance of conversion shares of Common Stock at the Second Closing
pursuant to the Amendment. The Company and the Investors rescinded the
conversion of the principal amount ($5,000,000) under the First Note into
4,065,040 shares of Common Stock, and the Investors waived accrued interest on
the First Note. Accordingly, the interest expense which had accrued on the note
has been recorded as a decrease in interest expense for the period. At the
Rescission closing, the Company repaid in full the First Note and issued to the
Investors 4,065,040 shares of Common Stock at the price of $1.23 per share for
an aggregate purchase price of $5,000,000. This was done through a
cross receipt arrangement; the amortized portion of BCF was reversed to
additional paid in stock. The Company has now concluded that in
substance the transaction resulted in the conversion of the first $5,000,000
note into common stock and that the remaining BCF of $3,472,603 at the date of
conversion should have been expensed.
Zhangzhi Steel New 1080 m3
blast furnace TRT Power Generator Project
On
November 11, 2007, the Company entered a Project General Contractor agreement
with an independent contractor under contemplation to construct a 1080 cubic
meter blast furnace for the third phase of the Zhangzhi TRT project which was
originally signed on June 22, 2006. The total contract price is approximately
$4,375,000 (RMB 30,000,000); the Company has paid approximately $2,625,000 (RMB
18,000,000) for the purchase of the equipment. This project is expected to
produce 45,000,000 KW/h annual energy output upon completion.
Item 3.
|
Quantitative and
Qualitative Disclosures About Market
Risk
|
Not
Applicable.
Item 4T.
|
Controls and
Procedures
|
At the
time that our Quarterly Report on Form 10-Q for the quarterly period ended June
30, 2008 was originally filed, our management evaluated, with the participation
of our Chief Executive Officer and Chief Financial Officer, the effectiveness of
our disclosure controls and procedures and concluded that as of the end of such
period, our disclosure controls and procedures were
effective. Disclosure controls and procedures include, without
limitation, controls and procedures designed to ensure that information required
to be disclosed by us in the reports that we file or submit under the Exchange
Act is accumulated and communicated to management, including our principal
executive and principal financial officer, or persons performing similar
functions, as appropriate to allow timely decisions regarding required
disclosure. In connection with the restatement of our financial
statements in this Quarterly Report on Form 10-Q described in the introductory
Explanatory Note, management reevaluated the effectiveness of the design and
operation of our disclosure controls and procedures as of the Evaluation Date.
Based on that reevaluation, the Chief Executive Officer and Chief Financial
Officer concluded that our disclosure controls and procedures were effective as
of the Evaluation Date.
The
Company has retained a consultant to evaluate our internal control over
financial reporting and to assist us in making improvements to the quality of
our controls, policies and procedures. The Company also intends to form an Audit
Committee of independent directors during the 2009 fiscal year to oversee the
audit and internal audit process. In addition, we are improving
supervision, education, and training of our accounting staff and continue to
search for more qualified financial personnel with experience with U.S. GAAP and
U.S. public company reporting and compliance obligations.
Changes in Internal Control Over
Financial Reporting
Other
than as noted above in this Item 4, there has been no change in our
internal control over financial reporting (as defined in Exchange Act
Rules 13a-15(f) and 15d-15(f)) that occurred during the quarter covered by
this report 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.
|
Not
applicable.
Item 2.
|
Unregistered Sales of
Equity Securities and Use of
Proceeds
|
None.
Item 3.
|
Defaults Upon Senior
Securities
|
None.
Item 4.
|
Submission of Matters
to a Vote of Security
Holders
|
None.
Item 5.
|
Other
Information
|
None.
Item 6. Exhibits
Exhibit
Number
|
|
|
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.*
|
* Filed
herewith.
SIGNATURES
Pursuant
to the requirements of the Securities Exchange Act of 1934, the registrant has
duly caused this report to be signed on its behalf by the undersigned thereunto
duly authorized.
|
CHINA
RECYCLING ENERGY CORPORATION
|
|
(Registrant)
|
|
|
|
China
Recycling Energy Corporation
|
|
|
Date:
September 28, 2009
|
By:
|
/s/ Guohua Ku
|
|
|
Guohua
Ku
|
|
|
Chairman
of the Board of Directors and Chief Executive
Officer
|
|
|
|
Date:
September 28, 2009
|
By:
|
/s/ Xinyu
Peng
|
|
|
Xinyu
Peng
|
|
|
Chief
Financial Officer and
Secretary
|
EXHIBIT
INDEX
Exhibit
Number
|
|
|
|
|
|
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.*
|
* Filed
herewith.