The following discussion of the reasons for the Stock Sale contains a number of forward-looking statements that reflect the current views of the Company with respect to future events that may have an effect on its financial performance. There can be no assurance that the benefits of the transaction considered by the Board of Directors will be achieved through completion of the Stock Sale. See “Risk Factors.” Forward-looking statements are subject to risks and uncertainties. Actual results and outcomes may differ materially from the results and outcomes discussed in the forward-looking statements. Cautionary statements that identify important factors that could cause or contribute to differences in results and outcomes include those discussed in “Forward-Looking Information” and “Risk Factors.”
The Company’s Board of Directors has determined that the terms of the EIPA and the Amended EIPA and the transactions contemplated by the EIPA and Amended EIPA and related agreements are advisable and in the best interests of the Company and its stockholders, and has approved the Stock Sale and the transactions contemplated by the EIPA and the Amended EIPA.
In reaching its determination, the Company’s Board of Directors considered a number of positive factors, including the following:
The Company’s Board of Directors also considered a number of potentially negative factors in its deliberations concerning the Stock Sale. The potentially negative factors considered by the Board of Directors included:
· | potential negative reaction of the investment community after announcement of the proposed Stock Sale ; |
· | cash proceeds from the Stock Sale would be insufficient to enable the Company to make a cash distribution to stockholders as a result of the Stock Sale; |
· | other risks and uncertainties discussed above under “Risk Factors.” |
The foregoing positive and negative factors together with the background of the transaction set forth above comprise the Board of Directors’ material considerations in entering into the EIPA and Amended EIPA.
The Company’s Board of Directors retained Nimbus in 2012 to act as restructuring advisor. Nimbus assisted the Company by retaining third party advisors to conduct a market canvas for lenders, soliciting purchasers for our Company or its assets, obtaining third party financing, and conducting the stalking horse process. Nimbus also advised our Board of Directors with respect to the restructuring efforts. The Board of Directors did not ask a transaction adviser to deliver a “fairness opinion” at the time that the EIPA was executed confirming that the consideration to be paid by the Buyers is fair from a financial point of view to the Company’s stockholders; however, the EIPA and Amended EIPA provides that the Closing would occur only after completing a stalking horse auction process and the effectiveness of the transaction cannot take place without a favorable fairness opinion delivered to the Buyers and the Company as to the effectiveness of the transaction. A fairness opinion regarding the proposed Stock Sale will not be completed and available for review by stockholders prior to the shareholder meeting and vote. The Board of Directors reached such a conclusion independently and determined that, under the circumstances, the Stock Sale was in the best interests of the Company’s stockholders and at the time of the effectiveness of the transaction would occur only if such fairness opinion were obtained. In the Board of Director’s judgment, it was difficult to value a business that had been losing money and that needed an infusion of cash to expand its selling area if it were to regain profitability, particularly when a significant portion of its assets were intangibles and the businesses were burdened by guarantees that were difficult to quantify. The Company had been searching for an equity investment for 15 months without success. Moreover, even in the event that such cash infusion could be found, it was not certain that such cash infusion would be sufficient to increase sales, whether or not such sales would be profitable, and, if generated, whether or not the profits from such increased sales would be sufficient to return the Company to profitability. For this reason, the Board relied on an initial auction process followed by a stalking horse bidding process and a continuing right to terminate the EIPA and the Amended EIPA until stockholder approval and a fairness opinion to the effect that the sale of the remaining 60% of the Target Companies (constituting all of our remaining equity interests in the Target Companies) is fair to the stockholders of the Company from a financial point of view are obtained. The Company’s Board of Directors also determined that the costs of obtaining such additional “fairness opinion,” from a transaction adviser or any other third party used in connection with its decision, would be disproportionately higher than any corresponding benefit that would be realized by obtaining such an opinion prior to the stockholders’ vote. By deferring receipt of a fairness opinion after the stockholders’ vote but before effectiveness of the transaction, the Company was able to defer the expenditure of funds related to the fairness opinion until after, and only if, shareholder approval is obtained and the Board was able to hold this event as a condition to the effectiveness of the transaction in the event that a better proposal could be identified. The Company mandated that the transaction be structured as a stock sale to minimize tax liabilities and so that all liabilities related to the Target Companies, including the subsidiaries’ debt for borrowed money, would transfer to Buyers. Based on the factors listed above, the Board of Directors determined that a sale of stock would likely return the greatest value to the Company, and that no other alternatives had the likelihood of achieving success in meeting the Company’s goals, including allocation of proceeds to our Heat Pump segment. The Board of Directors also considered that the sale of the Heat Pump segment would not provide sufficient working capital to return our PHE segment to profitability. There can be no assurance that the per share market price of the Company’s Common Stock following the Stock Sale will equal or exceed the price or prices at which the Common Stock has recently If the Stock Sale is not completed, the Board of Directors will explore what, if any, alternatives are available for the future of the Company. The Board of Directors does not believe, however, that there are viable alternatives to the Stock Sale. The foregoing discussion of these factors is not meant to be exhaustive, but includes the material factors considered by the Board of Directors. The Board of Directors did not quantify or attach any particular weight to the various factors that they considered in reaching their determination that the terms of the Stock Sale are fair to and in the best interests of the Company and its stockholders. Rather, the Board of Directors viewed its recommendation as being based upon its business judgment in light of the Company’s financial position and the totality of the information presented and considered, and the overall effect of the Stock Sale on the stockholders of the Company compared to continuing the business of the Company as is or seeking other potential parties to effect an investment in or other business combination or acquisition transaction with the Company.
Regulatory Matters
Other than the change in registration of ownership which must be filed and accepted by the State Administration for Industry and Commerce of China, the Company is not aware of any regulatory or governmental approvals required to complete the Stock Sale.
Use of Proceeds
A subsidiary of Heat PHE, and not the Company’s stockholders, will receive all of the net proceeds from the Stock Sale. Following the Stock Sale, the Company’s Board of Directors plans to explore strategic alternatives to deploy the proceeds of the Stock Sale, which may include expansion of our heat pump business in the United States, Europe and China future acquisitions, a merger with another company, or other actions to redeploy capital. It is unlikely, however, that the Company will make a distribution of cash to our stockholders.
Although the Board of Directors and management have had preliminary discussions regarding potential uses of our capital following the Stock Sale, the Board of Directors intends to continue to review anticipated liabilities and potential strategic uses of capital in connection with the continuation of the Company as a going concern. Accordingly, we cannot specify with certainty the amount of net proceeds, if any, we will use for any particular use or the timing in respect thereof. Consequently, you should not vote in favor of the Stock Sale based upon any assumptions regarding the amount or timing of any potential usages of capital or distributions to stockholders.
Appraisal Rights Under Nevada law, the Company’s stockholders do not have appraisal rights as a result of the Stock Sale.
Votes Required for the Stock Sale
The affirmative vote of the holders of a majority of the outstanding shares of the Company’s Common Stock as of the Record Date is required to approve the Stock Sale.
THE COMPANY’S BOARD OF DIRECTORS RECOMMENDS A VOTE FOR THE APPROVAL OF THE STOCK SALE. PRINCIPAL PROVISIONS OF THE EQUITY INTEREST PURCHASE AGREEMENT
The following describes the principal provisions of the Amended EIPA. The text of the EIPA and the Amended EIPA are respectively attached as Annex A andAnnex B to, and is incorporated by reference into, this proxy statement.Proxy Statement. You are encouraged to carefully read the EIPA in its entirety. Capitalized terms in the following descriptions have the meanings set forth in the EIPA.
The Amended EIPA provides that the Buyers will purchase what might be deemed under Nevada law to be substantially all of our assets:
Divested Interests
Under the EIPA, the Buyers initially purchased 40% of the equity interests (the “First 40% Interest”) of the following entities (collectively referred to as “Target Companies”):
· | Taiyu (Shenyang) Energy, organized in the People’s Republic of China (“Taiyu”); | · | Siping Beifang Energy Technology Co., Ltd., organized in the People’s Republic of China (“Siping”); | · | Shenyang Energy Equipment Co. Ltd., incorporated in the People’s Republic of China (“Shenyang”); | · | Hohot Ruicheng Technology Co., Ltd., organized in the People’s Republic of China (“Ruicheng”); | · | Urumchi XinRui Technology Limited Liability Company, organized in the People’s Republic of China (“XinRui”). |
Under the terms of the Amended EIPA, the Buyers must purchase the remaining 60% of the Target Companies (constituting all of our remaining equity interests in the Target Companies) (the “Second 60% Interest”) on or prior to December 31, 2014.
Consideration
The purchase price received by Heat PHE, Inc. for the First 40% Interest was RMB 5,000,000.
The purchase price to be received by Heat PHE, Inc. for the Second 60% Interest (the controlling interest) is RMB 8,500,000 plus the forgiveness and release of intercompany debt owed to the Target Companies at the close of the Company’s fiscal year ending 2014. Change of Registration
· | Heat PHE, Inc. will cause Target Companies to file the applicable registration change with the State Administration for Industry and Commerce. |
· | Target Companies will pay all costs related to the registration change. The taxes incurred from the transfer of the equity interests shall be undertaken by each tax obligor, respectively. |
Representations and Warranties
Heat PHE, Inc. made the following representations and warranties:
· | The equity interests in Target Companies is “as is” without any other representations, warranties or covenants except as provided in the Amended EIPA. |
· | Heat PHE, Inc. has good and marketable title to the equity interests of Target Companies, free and clear of all encumbrances, subject to liens incurred by Heat PHE, Inc. pursuant to the Credit and Security Agreement between the Company and Northtech Holdings, Inc., dated July 27, 2012, as amended, and subject to any transfer requirements in the People’s Republic of China. |
· | Heat PHE, Inc. is duly organized and validly existing under the laws of the State of Nevada, and Target Companies are registered under the proper governmental authorities as required under the laws of the People’s Republic of China. |
· | Heat PHE, Inc. has the full right, power and authority to enter into the EIPA and to perform all of its obligations thereunder. |
· | The execution and performance of the Amended EIPA will not breach any other signed material contract or agreement to which Heat PHE, Inc. is a party. |
· | The representative who has executed the Amended EIPA on behalf of Heat PHE, Inc. has been duly authorized to execute this Agreement. |
The Buyers made the following representations and warranties:
· | Buyers are a group of individual citizens of the People’s Republic of China. |
· | Buyers have the full right, power and authority to enter into the Amended EIPA and to perform all of their obligations hereunder. |
· | The execution of the Amended EIPA does not breach any other signed material contract or Agreement to which Buyers are a party. |
· | The representative of Buyers who has executed the Amended EIPA are duly authorized to execute the Amended EIPA. |
· | Buyers have been given full opportunity to review all documents requested to evaluate the transaction and acknowledge that they have been given sufficient information to make the investment decision in Target Companies. Buyers acknowledge that the sale of Target Companies is “as is.” |
Conditions Precedent
The effectiveness of the transaction is subject to the following conditions precedent:
· | Approval by a majority of the Company’s stockholders present and voting and |
· | Receipt by the Board of a Fairness Opinion to the effect that the sale of the remaining 60% of the Target Companies (constituting all of our remaining equity interests in the Target Companies) is fair to the stockholders of the Company from a financial point of view. |
Closing
The Closing shall take place on or before December 31, 2014 electronically, or at such other place or by such other means as agreed by the Parties after the satisfaction of the conditions to closing in the Amended EIPA. At each Closing, Heat PHE, Inc. will deliver to the Buyers evidence of the transfer of the specified equity interest in the Target Companies and Buyers need to deliver to Heat PHE, Inc.’s China subsidiary, SmartHeat Heat Exchange Equipment Co. Ltd., the consideration by wire transfer of immediately available funds. At the Closing the parties shall exchange mutual releases.
If the conditions precedent have not been satisfied on or before the Closing Date, the parties have agreed that the Purchase Price and all documents required to be delivered at the Closing will be deposited in escrow to be released when the conditions have been met. In the event that the conditions are not met on or prior to March 31, 2015, either party has the right to terminate the Amended EIPA. Dispute Resolution
The Amended EIPA provides for the following method of dispute resolution:
· | The Amended EIPA is governed by the laws of the People’s Republic of China. |
· | The Parties will use good faith efforts to settle disputes by mediation before the Hong Kong International Arbitration Centre (HKIAC) under the then-current version of HKIAC’s Commercial Mediation Rules. Three mediators shall be appointed, one by Heat PHE, Inc., one by Buyers, and one who shall be selected by the Parties mutual agreement. |
· | If the mediation is concluded without the dispute being resolved, the parties may, at their option refer the dispute to arbitration at HKIAC in accordance with International Arbitration Rules. |
Accounting Treatment Following the Stock Sale, the Company’s balance sheet will no longer reflect the assets and liabilities of the Target Subsidiaries, but will instead reflect the amounts received at the Closings and the assets and liabilities of Heat HP subsidiaries, Heat PHE subsidiaries (SanDeKe Co., Ltd. and SmartHeat Heat Exchange Equipment Co., Ltd.) and the parent company.
In connection with the Stock Sale, generally accepted accounting principles requires us to restate the carrying values of the assets and liabilities of the Target Companies based upon the consideration which we are receiving in the Stock Sale. We determined that the intangible and other non-current assets of the Target Companies were fully impaired as a consequence of the Stock Sale. Accordingly, we wrote off all the non-current assets of Target Companies as of December 31, 2013. We also made a line-by-line analysis of each current asset account of the Target Companies to make sure that each asset account was recorded at fair value and that adequate reserves had been provided including reserves for accounts receivable, other receivables and prepayments, advance to suppliers and inventory. As a result of this revaluation, we have recorded a net loss, as of September 30, 2014, of $42.3 million relating to the Stock Sale. Interests of Certain Persons in the Stock Sale. Buyers consist of a group of 25 natural persons, all of whom are P.R.C. citizens, including Wen Sha, Jun Wang and Xudong Wang, managers of the Company’s subsidiaries engaged in the PHE segment of its business, and Huajun Ai and Yingkai Wang, the Company’s Corporate Secretary and Acting Chief Accountant, respectively. Huajun Ai, Wen Sha, Jun Wang and Xudong Wang are also principals in Northtech Holdings Inc. INFORMATION ABOUT SMARTHEAT INC.
BUSINESS General We are a U.S. holding company with no material assets other than the ownership interests of our foreign subsidiaries that design, manufacture and sell PHEs, heat pumps, and related systems in the People’s Republic of China (“PRC”) and Germany. A PHE is a device that transfers heat from one fluid to another fluid across large metal plates. PHE products are used in the industrial, residential and commercial sectors to make energy use more efficient and to reduce pollution by reducing the need for coal fired boilers. Our subsidiaries design, manufacture, sell and service PHEs, PHE Units, which combine PHEs with various pumps, temperature sensors, valves and automated control systems, heat meters and heat pumps for use in commercial and residential buildings. They also design, manufacture and sell spiral heat exchangers and tube heat exchangers. Their products and related systems are an increasingly important element in providing a clean technology solution to energy consumption and air pollution problems in China and are commonly used in a wide variety of industrial processes where heat transfer is required. Common applications include energy conversion for heating, ventilation and air conditioning (“HVAC”), and industrial use in petroleum refining, petrochemicals, metallurgy, food and beverage and chemical processing. Our subsidiaries sell their products under the SmartHeat and Taiyu brand names and also sell PHEs under the Sondex brand name as an authorized dealer of Sondex PHEs in China. Our History
We were incorporated in the State of Nevada on August 4, 2006, under the name Pacific Goldrim Resources, Inc., as an exploration stage corporation with minimal operations, to engage in the exploration for silver, lead and zinc. On April 14, 2008, we changed our name to SmartHeat Inc. and entered into a Share Exchange Agreement (the “Share Exchange Agreement”), to acquire Shenyang Taiyu Machinery & Electronic Equipment Co., Ltd., subsequently renamed SmartHeat Taiyu (Shenyang) Energy Technology Co., Ltd. (“Taiyu”), a privately held Sino-foreign joint venture company formed under the laws of the PRC on July 24, 2002, and engaged in the design, manufacture, sale and service of PHE products in China. The Share Exchange Agreement was entered into by SmartHeat, Taiyu and the stockholders of Taiyu. At the closing of the Share Exchange Agreement, all of the equitable and legal rights, title and interests in and to Taiyu’s share capital of Yuan 25,000,000 were exchanged for 1,850,000 shares of SmartHeat Common Stock (the “Share Exchange”). We received PRC government approval on May 28, 2008, of our subscription for 71.6% of the registered capital of Taiyu, and approval on June 3, 2009, of the transfer of the remaining 28.4% ownership of Taiyu from the original joint venture stockholders who had received shares of our Common Stock in the Share Exchange. As a result of the Share Exchange and subsequent transactions contemplated by the Share Exchange Agreement, and receipt of the above PRC government approvals, Taiyu became our wholly foreign-owned enterprise, or WFOE.
Prior to our acquisition of Taiyu, we had no interest in any property, but had the right to conduct exploration activities on 13 mineral title cells covering 27,027 hectares (66,785 acres) in the Slocan Mining Division of southeastern British Columbia, Canada. In connection with the acquisition of Taiyu, we transferred all of our pre-closing assets and liabilities (other than the obligation to pay a $10,000 fee to our audit firm) to a wholly owned subsidiary, PGR Holdings, Inc., a Nevada corporation (“SplitCo”), under the terms of an Agreement of Conveyance, Transfer and Assignment of Assets and Assumption of Obligations dated April 14, 2008. We sold all of the outstanding capital stock of SplitCo to Jason Schlombs, our former director and officer and one of our major stockholders, pursuant to a Stock Purchase Agreement dated April 14, 2008, in exchange for the return of his 250,000 shares of our Common Stock to us for cancellation. As an expansion of our business following our acquisition of Taiyu, we acquired and established strategic subsidiaries in China and Germany. On September 25, 2008, we acquired SanDeKe Co., Ltd., or SanDeKe, a Shanghai-based manufacturer of PHEs. On June 16, 2009, we completed an asset purchase transaction with Siping Beifang Heat Exchanger Manufacture Co., Ltd., or Siping Beifang, to set up a new manufacturing facility under our newly incorporated subsidiary, SmartHeat Siping Beifang Energy Technology Co., Ltd., or SmartHeat Siping. On August 14, 2009, we formed Beijing SmartHeat Jinhui Energy Technology Co., Ltd., or Jinhui, a joint venture in Beijing of which we own 52%, to provide consulting services and expand our sales of PHEs into new industries and regions of China. On April 7, 2010, we formed SmartHeat (China) Investment Co., Ltd., or SmartHeat Investment, as an investment holding company in Shenyang for our investment in and establishment of new companies and businesses in China. On April 12, 2010, SmartHeat Investment formed SmartHeat (Shenyang) Energy Equipment Co., Ltd., or SmartHeat Energy, as its wholly owned subsidiary for the research, development, manufacturing and sales of energy products. On May 6, 2010, we formed SmartHeat (Shanghai) Trading Co., Ltd., or SmartHeat Trading, through a nominee, Cleantech Holdings Inc., a British Virgin Islands company, or Cleantech Holdings, to market and expand sales of our branded products in China. Effective as of November 9, 2011, we terminated the nominee-owner relationship and acquired direct control over SmartHeat Trading. On December 2, 2010, we formed Hohhot Ruicheng Technology Co., Ltd., or Ruicheng, a joint venture in Hohhot City, China, for the design and manufacture of heat meters, of which we acquired 51% of the equity interest on January 7, 2011. On March 1, 2011, we entered into a purchase agreement to acquire 95% of the equity interests in Shenyang Bingchuan Refrigerating Machine Limited Company, a Shenyang-based state-owned heat pump manufacturer and designer subsequently renamed SmartHeat (Shenyang) Heat Pump Technology Co., Ltd., or SmartHeat Pump. On November 1, 2011, we increased the registered capital of SmartHeat Pump and thereby increased our ownership percentage to 98.8%. On March 3, 2011, we completed the acquisition of Gustrower Warmepumpen GmbH, subsequently renamed SmartHeat Deutschland GmbH, or SmartHeat Germany, a designer and manufacturer of high efficiency heat pumps in Germany, to extend our clean technology heating solutions into the rapidly growing heat pump markets in Europe and China. We subsequently transferred ownership of SmartHeat Germany to SmartHeat Pump. On April 10, 2012, we established a new joint venture named Urumchi XinRui Technology Limited Liability Company (“XinRui”), of which we acquired 46%. Our Business Segments
On August 23, 2013, the Company formed two new wholly-owned subsidiaries in the state of Nevada, Heat HP, Inc.(“Heat HP”) and Heat PHE, Inc. (“Heat PHE”), in order to reorganize the Company’s ownership structure over its subsidiaries. On August 23, 2013, the Company entered into an assignment agreement (“Assignment Agreement”)with each of Heat HP and Heat PHE which effected the reorganization. The reorganization was performed so the Company’s subsidiaries would be organized along their respective operating segments with Heat HP holding those subsidiaries that operated in the heat pumps and related products segment and Heat PHE holding those subsidiaries that operated in the plate heating equipment, meters and related products segment. The Company initially presented its financial results for the quarter ended March 31, 2013, in accordance with these operating segments and has continued segment reporting since that time.
Under the Assignment Agreement with Heat HP, the Company agreed to transfer, and in the case of indirectly owned subsidiaries, cause to be transferred, to Heat HP the following subsidiaries of the Company:
Heat HP | SmartHeat (China) Investment Co., Ltd. | SmartHeat (Shenyang) Heat Pump Technology Co., Ltd. | SmartHeat Deutschland GmbH | SmartHeat (Shanghai) Trading Co., Ltd. | Beijing SmartHeat Jinhui Energy Technology Co., Ltd. |
Under the Assignment Agreement with Heat PHE, the Company agreed to transfer, and in the case of indirectly owned subsidiaries, cause to be transferred, to Heat PHE the following subsidiaries of the Company:
Heat PHE | SmartHeat Taiyu (Shenyang) Energy Technology Co., Ltd. | SanDeKe Co., Ltd. | SmartHeat (Shenyang) Energy Equipment Co., Ltd. | SmartHeat Siping Beifang Energy Technology Co., Ltd. | Hohhot Ruicheng Technology Co., Ltd. |
Our Corporate Structure
Our corporate structure as of the date of this report is set forth in the following diagram. SanDeKe and SmartHeat Investment are WFOEs authorized by their respective business licenses to operate our businesses in China. SmartHeat Deutschland GmbH is wholly owned by Heat HP Inc. We own 52%, 30.6% and 27.6%, respectively, of the equity interests in our PRC-based joint venture companies, Jinhui, Ruicheng and XinRui. SmartHeat Energy is a wholly owned subsidiary of SmartHeat Investment. Taiyu owns 98.8% of the equity interests of SmartHeat Pump. Prior to November 9, 2011, we had no direct ownership interest in SmartHeat Trading; instead, we controlled and were entitled to 100% of the profit or loss of SmartHeat Trading under contractual arrangements. Effective as of November 9, 2011, we terminated the nominee-owner relationship and acquired direct control over SmartHeat Trading. *On August 23, 2013, SmartHeat entered into Assignments agreements with each of Heat HP and Heat PHE in order to reorganize the structure of its subsidiaries. Under the Assignment Agreements SmartHeat agreed to be transfer, and in the case of indirectly owned subsidiaries, cause to be transferred, certain subsidiaries to each of Heat HP and Heat PHE. Further, under the Assignment Agreements, SmartHeat agreed to cause its directly and indirectly owned subsidiaries to record these transfers with the applicable government agency in the People’s Rpublic of China, and in the case of SmartHeat Germany, in Germany. The restructured entity is reflected above after giving effect to the sale of 40% of the Company’s ownership interests in SmartHeat Taiyu (Shenyang) Energy; SmartHeat Siping Beifang Energy Technology Co., Ltd.; SmartHeat (Shenyang) Energy Equipment Co. Ltd.; Hohot Ruicheng Technology Co., Ltd.; and Urumchi XinRui Technology Limited Liability Company on December 31, 2014.
(1) We hold through 98.8% of the equity interest in SmartHeat Pump, with the remaining 1.2% of the equity interest held by Shenyang Economic and Technological Development Zone State-owned Assets Management Co., Ltd.
(2) We control 52% of Jinhui pursuant to a joint venture agreement entered into with the minority owner, Beijing Jun Tai Heng Rui Investment Consultancy Co. Ltd.
(3) We control 30.6% of Ruicheng pursuant to a joint venture agreement entered into with the minority owners, Hohhot Chengfa Heating Co. Ltd. and Beijing Taiyu Huineng Machinery and Electronic Equipment Co. Ltd. and our sale of 40% of our equity interests to the Chinese buying group. (4) What about XinRui? Please disclose.
Form of Proxy Card
FINANCIAL STATEMENTS The Company’s consolidated financial statements and financial statements schedules can be found in the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2014 which are available at www.sec.gov and in the amended and restated Annual Report on Form 10-K for the fiscal year ended December 31, 2013 attached hereto as Annex B. Additionally, the following pro forma financial statements of the Company are included on the pages indicated at the end of this proxy statement:Proxy Statement: | Page | | F-1 | | F-2 | | F-3 | | F-4 | | F-5 | | F-6 | | F-7 | | F-8 | | F-22 | | F-23 | | F-24 | | F-25 |
BASIS OF UNAUDITED PRO FORMA FINANCIAL INFORMATION On December 30, 2013, the Company, closed the transaction contemplated by the Equity Interest Purchase Agreement, dated October 10, 2013, whereby the buyers purchased 40% of the Company’s equity interests in the following PHE segment subsidiaries: SmartHeat Taiyu (Shenyang) Energy; SmartHeat Siping Beifang Energy Technology Co., Ltd.; SmartHeat (Shenyang Energy Equipment) Co. Ltd.; Hohot Ruicheng Technology Co., Ltd.; and Urumchi XinRui Technology Limited Liability Company (collectively, the “Target Companies”). The purchase price was RMB 5,000,000. Hohot Ruicheng Technology Co., Ltd. was 51% owned and Urumchi XinRui Technology Limited Liability Company (“XinRui”) was 46% owned by SmartHeat US parent company prior to 40% equity interest sell. On November 28, 2014, the Company entered into an Amended and Restated EIPA, which amended and restated the EIPA dated October 10, 2013 between the Company and the buyers. Under the terms of the Amended EIPA, the buyers have agreed to purchase the remaining 60% of the Company’s equity interests in the Target Companies effective as of December 31, 2014 (the “Closing Date”). The purchase price for the remaining 60% consists of: (i) consideration of RMB8.5 million and (ii) the forgiveness of all net indebtedness owing to the Target Companies by SmartHeat and each of its other subsidiaries as of December 31. As of September 30, 2014, the Company evaluated it is highly probably the shareholders will approve the additional 60% equity sale, and accordingly, the pro forma consolidated financial statements reflecting the total of 100% equity interest sale of Target Companies were presented as following.set forth below..
The transaction will result in an expected a loss of $42.31 million from the sale of the 100% equity interest of the sold entities, consisting of a $50.15 million loss on sale resulting from the difference of the total selling price and the net assets of sold entities, netted off with the $7.84 million the forgiveness of all net indebtedness owing to the sold entities by SmartHeat and each of its other subsidiaries. The loss is not reflected in the unaudited pro forma statements of operations because it is a material non-recurring charge directly related to the transaction that will be included in our results within the 12 months after the transaction. The following unaudited pro forma consolidated statements of operations present SmartHeat Inc. for the nine months ended September 30, 2014 and for the year ended December 31, 2013, as if the 100% equity sale occurred on January 1, 2013 and 2014, respectively, for the purpose of the statements of operations. The accompanying unaudited pro forma consolidated balance sheet presents the accounts of SmartHeat Inc. as if the 100% equity sale occurred on September 30, 2014. SMARTHEAT INC. AND SUBSIDIARIES UNAUDITED PRO FORMA CONSOLIDATED BALANCE SHEET REFLECTING THE SALE OF CERTAIN ENTITIES OF HEAT PHE SEGMENT | | AS OF SEPTEMBER 30, 2014 | | | | Company Historical (1) | | | Sales of PHE segment (2) | | | Pro Forma adjustments | | | Company Pro Forma | | | | | | | | | | | | | | | | | ASSETS | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | CURRENT ASSETS | | | | | | | | | | | | | | | Cash & equivalents | | $ | 13,601,346 | | | $ | 10,008,529 | | | $ | - | | | | | $ | 3,592,817 | | Restricted cash | | | 479,157 | | | | 413,593 | | | | | | | | | | 65,564 | | Accounts receivable, net | | | 15,946,417 | | | | 18,652,098 | | | | 3,314,754 | | a, b | | | | 609,073 | | Retentions receivable, net | | | 1,725,941 | | | | 1,681,569 | | | | | | | | | | 44,372 | | Advances to suppliers, net | | | 7,127,768 | | | | 5,317,381 | | | | | | | | | | 1,810,387 | | Other receivables (net), prepayments and deposits | | | 2,912,935 | | | | 26,903,367 | | | | 26,549,898 | | a, b | | | | 2,559,466 | | Inventories, net | | | 55,684,495 | | | | 47,481,292 | | | | | | | | | | 8,203,203 | | Taxes receivable | | | 464,364 | | | | 413,629 | | | | | | | | | | 50,735 | | Notes receivable - bank acceptances | | | 1,429,395 | | | | 1,232,727 | | | | | | | | | | 196,668 | | | | | | | | | | | | | | | | | | | | | Total current assets | | | 99,371,818 | | | | 112,104,185 | | | | | | | | | | 17,132,286 | | | | | | | | | | | | | | | | | | | | | NONCURRENT ASSETS | | | | | | | | | | | | | | | | | | | Long term investment | | | 9,851 | | | | - | | | | (9,851 | ) | b | | | | - | | Restricted cash | | | 254,807 | | | | 254,807 | | | | | | | | | | - | | Construction in progress | | | 54,906 | | | | 54,906 | | | | | | | | | | - | | Property and equipment, net | | | 2,045,669 | | | | 728,406 | | | | | | | | | | 1,317,263 | | Intangible assets, net | | | 608,652 | | | | - | | | | | | | | | | 608,652 | | | | | | | | | | | | | | | | | | | | | Total noncurrent assets | | | 2,973,885 | | | | 1,038,119 | | | | | | | | | | 1,925,915 | | | | | | | | | | | | | | | | | | | | | TOTAL ASSETS | | $ | 102,345,703 | | | $ | 113,142,304 | | | | | | | | | $ | 19,058,201 | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | LIABILITIES AND STOCKHOLDERS' EQUITY | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | CURRENT LIABILITIES | | | | | | | | | | | | | | | | | | | Accounts payable | | $ | 8,345,423 | | | $ | 8,058,552 | | | $ | 1,459,301 | | a, b | | | $ | 1,746,172 | | Advance from customers | | | 3,617,924 | | | | 2,624,354 | | | | | | | | | | 993,570 | | Taxes payable | | | 53,892 | | | | 16,304 | | | | | | | | | | 37,588 | | Accrued liabilities and other payables | | | 17,292,178 | | | | 31,031,535 | | | | 19,178,125 | | a, b | | | | 5,438,768 | | Notes payable - bank acceptances | | | - | | | | - | | | | | | | | | | - | | Loans payable | | | 18,832,200 | | | | 18,832,200 | | | | | | | | | | - | | | | | | | | | | | | | | | | | | | | | Total current liabilities | | | 48,141,617 | | | | 60,562,945 | | | | | | | | | | 8,216,097 | | | | | | | | | | | | | | | | | | | | | CREDIT LINE PAYABLE | | | 2,449,335 | | | | - | | | | | | | | | | 2,449,335 | | | | | | | | | | | | | | | | | | | | | LONG-TERM LOAN | | | 2,112,962 | | | | 2,112,962 | | | | | | | | | | - | | | | | | | | | | | | | | | | | | | | | DEFERRED TAX LIABILITY | | | 78,543 | | | | - | | | | | | | | | | 78,543 | | | | | | | | | | | | | | | | | | | | | COMMITMENTS AND CONTINGENCIES | | | | | | | | | | | | | | | | | | | | | | �� | | | | | | | | | | | | | STOCKHOLDERS' EQUITY | | | | | | | | | | | | | | | | | | | Common stock | | | 6,783 | | | | - | | | | | | | | | | 6,783 | | Paid-in capital | | | 87,265,460 | | | | 59,341,363 | | | | 49,652,165 | | b | | | | 77,576,262 | | Statutory reserve | | | 5,389,057 | | | | 4,608,375 | | | | | | | | | | 780,682 | | Accumulated other comprehensive income | | | 8,348,727 | | | | 6,785,859 | | | | (0 | ) | a | | | | 1,562,868 | | Accumulated deficit | | | (72,338,929 | ) | | | (40,940,279 | ) | | | (40,434,788 | ) | b | | | | (71,833,438 | ) | | | | | | | | | | | | | | | | | | | | Total Company stockholders' equity | | | 28,671,098 | | | | 29,795,318 | | | | | | | | | | 8,093,156 | | | | | | | | | | | | | | | | | | | | | NONCONTROLLING INTEREST | | | 20,892,148 | | | | 20,671,079 | | | | | | | | | | 221,069 | | | | | | | | | | | | | | | | | | | | | TOTAL EQUITY | | | 49,563,246 | | | | 50,466,397 | | | | - | | | | | | 8,314,225 | | | | | | | | | | | | | | | | | | | | | TOTAL LIABILITIES AND EQUITY | | $ | 102,345,703 | | | $ | 113,142,304 | | | $ | - | | | | | $ | 19,058,201 | |
(1) Source: unaudited financial statements of SmartHeat Inc. as of September 30, 2014, as filed in the Form 10-Q filed with the SEC on December 19, 2014. | (2) Source: unaudited financial statements of disposed entities of SmartHeat Inc. as of September 30, 2014 and December 31, 2013, as included in this proxy. | (a) To reflect the effect of forgiveness of all net indebtedness owing to Target Companies by SmartHeat Inc and each of its other subsidiaries. | (b) To reflect the sale of 100% equity interest in Target companies. |
SMARTHEAT INC. AND SUBSIDIARIES UNAUDITED PRO FORMA CONSOLIDATED STATEMENT OF OPERATIONS REFLECTING THE SALE OF CERTAIN ENTITIES OF HEAT PHE SEGMENT | | NINE MONTHS ENDED SEPTEMBER 30, 2014 | | | | Company Historical (1) | | | Sales of PHE segment (2) | | | Pro Forma adjustments | | | Company Pro Forma | | | | | | | | | | | | | | | | | Net sales | | $ | 20,599,124 | | | $ | 17,549,811 | | | $ | 1,066,469 | | a | | | $ | 4,115,782 | | Cost of goods sold | | | 18,790,453 | | | | 16,696,776 | | | | 1,066,469 | | a | | | | 3,160,146 | | | | | | | | | | | | | | | | | | | | | Gross loss | | | 1,808,671 | | | | 853,035 | | | | - | | | | | | 955,636 | | | | | | | | | | | | | | | | | | | | | Operating expenses | | | | | | | | | | | | | | | | | | | Selling | | | 4,848,177 | | | | 3,627,023 | | | | | | | | | | 1,221,154 | | General and administrative | | | 6,199,365 | | | | 2,799,480 | | | | | | | | | | 3,399,885 | | Provision for bad debts | | | (2,988,346 | ) | | | (3,115,176 | ) | | | | | | | | | 126,830 | | Provision for advance to supplier | | | 122,518 | | | | 98,253 | | | | | | | | | | 24,265 | | | | | | | | | | | | | | | | | | | | | Total operating expenses | | | 8,181,714 | | | | 3,409,580 | | | | - | | | | | | 4,772,134 | | | | | | | | | | | | | | | | | | | | | Loss from operations | | | (6,373,043 | ) | | | (2,556,545 | ) | | | - | | | | | | (3,816,498 | ) | | | | | | | | | | | | | | | | | | | | Non-operating income (expenses) | | | | | | | | | | | | | | | | | | | Investment loss | | | (16,889 | ) | | | - | | | | | | | | | | (16,889 | ) | Interest income | | | 125,482 | | | | 109,090 | | | | | | | | | | 16,392 | | Interest expense | | | (1,300,872 | ) | | | (1,154,288 | ) | | | | | | | | | (146,584 | ) | Financial expense | | | (318,222 | ) | | | (229,560 | ) | | | | | | | | | (88,662 | ) | Gain on issuance of stock | | | 70,000 | | | | - | | | | | | | | | | 70,000 | | Foreign exchange transaction gain | | | 3,661 | | | | 3,658 | | | | | | | | | | 3 | | Other income, net | | | 715,950 | | | | 111,056 | | | | | | | | | | 604,894 | | | | | | | | | | | | | | | | | | | | | Total non-operating expenses, net | | | (720,890 | ) | | | (1,160,044 | ) | | | - | | | | | | 439,154 | | | | | | | | | | | | | | | | | | | | | Loss before income tax | | | (7,093,933 | ) | | | (3,716,589 | ) | | | - | | | | | | (3,377,344 | ) | Income tax expense | | | 63,309 | | | | - | | | | | | | | | | 63,309 | | | | | | | | | | | | | | | | | | | | | Net loss before noncontrolling interest | | | (7,157,242 | ) | | | (3,716,589 | ) | | | - | | | | | | (3,440,653 | ) | Less: loss attributable to noncontrolling interest | | | (1,449,088 | ) | | | (1,423,456 | ) | | | | | | | | | (25,632 | ) | | | | | | | | | | | | | | | | | | | | Net loss to SmartHeat Inc. | | | (5,708,154 | ) | | | (2,293,133 | ) | | | - | | | | | | (3,415,021 | ) | | | | | | | | | | | | | | | | | | | | Basic and diluted weighted average shares outstanding | | | 6,490,176 | | | | | | | | | | | | | | 6,490,176 | | | | | | | | | | | | | | | | | | | | | Basic and diluted loss per share | | $ | (0.88 | ) | | | | | | | | | | | | $ | (0.53 | ) |
(1) Source: unaudited financial statements of SmartHeat Inc. as of and for nine months ended September 30, 2014, as filed in the Form 10-Q filed with the SEC on December 19, 2014. (2) Source: unaudited financial statements of disposed entities of SmartHeat Inc. for the nine months ended September 30, 2014 and 2013, as included in this proxy. (a) To add back the inter-company sales between disposed entities and other subsidiaries of SmartHeat Inc. (b) The transaction will result in an expected a loss of $42.31 million from the 100% equity interest sale of the sold entities consisting of a $50.15 million loss on sale resulting from the difference of the total selling price and the net assets of sold entities, netted off with the $7.84 million the forgiveness of all net indebtedness owing to the sold entities by SmartHeat and each of its other subsidiaries. The loss is not reflected in the unaudited pro forma statements of operations because it is a material non-recurring charge directly related to the transaction that will be included in our results within the 12 months after the transaction. SMARTHEAT INC. AND SUBSIDIARIES UNAUDITED PRO FORMA CONSOLIDATED STATEMENT OF OPERATIONS REFLECTING THE SALE OF CERTAIN ENTITIES OF HEAT PHE SEGMENT | | YEAR ENDED DECEMBER 31, 2013 | | | | Company Historical (1) | | | Sales of PHE segment (2) | | | Pro Forma adjustments | | | Company Pro Forma | | | | | | | | | | | | | | | | | Net sales | | $ | 44,709,526 | | | $ | 38,915,416 | | | $ | 1,974,163 | | a | | | $ | 7,768,273 | | Cost of goods sold | | | 40,401,380 | | | | 35,659,348 | | | | 1,974,163 | | a | | | | 6,716,195 | | | | | | | | | | | | | | | | | | | | | Gross profit (loss) | | | 4,308,146 | | | | 3,256,068 | | | | - | | | | | | 1,052,078 | | | | | | | | | | | | | | | | | | | | | Operating expenses | | | | | | | | | | | | | | | | | | | Selling | | | 6,864,059 | | | | 5,084,636 | | | | | | | | | | 1,779,423 | | General and administrative | | | 10,400,323 | | | | 5,582,360 | | | | | | | | | | 4,817,963 | | Long-lived assets impairment | | | 13,730,849 | | | | 13,730,849 | | | | | | | | | | - | | Impairment of long term investment | | | 908,084 | | | | - | | | | - | | | | | | 908,084 | | Provision for bad debts | | | 27,240,939 | | | | 24,638,062 | | | | | | | | | | 2,602,877 | | Provision for advance to supplier | | | (593,838 | ) | | | (682,973 | ) | | | | | | | | | 89,135 | | | | | | | | | | | | | | | | | | | | | Total operating expenses | | | 58,550,416 | | | | 48,352,934 | | | | - | | | | | | 10,197,482 | | | | | | | | | | | | | | | | | | | | | Loss from operations | | | (54,242,270 | ) | | | (45,096,866 | ) | | | - | | | | | | (9,145,404 | ) | | | | | | | | | | | | | | | | | | | | Non-operating income (expenses) | | | | | | | | | | | | | | | | | | | Investment income (loss) | | | 153,237 | | | | - | | | | | | | | | | 153,237 | | Interest income | | | 159,972 | | | | 79,704 | | | | | | | | | | 80,268 | | Interest expense | | | (1,816,456 | ) | | | (1,758,210 | ) | | | | | | | | | (58,246 | ) | Financial expense | | | (249,681 | ) | | | (73,567 | ) | | | | | | | | | (176,114 | ) | Foreign exchange transaction gain | | | (9,495 | ) | | | (9,478 | ) | | | | | | | | | (17 | ) | Loss on sale of equity interest | | | (842,491 | ) | | | - | | | | | | | | | | (842,491 | ) | Other income, net | | | 1,314,945 | | | | 470,730 | | | | | | | | | | 844,215 | | | | | | | | | | | | | | | | | | | | | Total non-operating expenses, net | | | (1,289,969 | ) | | | (1,290,821 | ) | | | - | | | | | | 852 | | | | | | | | | | | | | | | | | | | | | Loss before income tax | | | (55,532,239 | ) | | | (46,387,687 | ) | | | - | | | | | | (9,144,552 | ) | Income tax expense (benefit) | | | (50,657 | ) | | | 26,725 | | | | | | | | | | (77,382 | ) | | | | | | | | | | | | | | | | | | | | Net loss before noncontrolling interest | | | (55,481,582 | ) | | | (46,414,412 | ) | | | - | | | | | | (9,067,170 | ) | Less: loss attributable to noncontrolling interest | | | (5,812,244 | ) | | | (5,798,050 | ) | | | | | | | | | (14,194 | ) | | | | | | | | | | | | | | | | | | | | Net loss to SmartHeat Inc. | | | (49,669,338 | ) | | | (40,616,362 | ) | | | - | | | | | | (9,052,976 | ) | | | | | | | | | | | | | | | | | | | | Basic and diluted weighted average shares outstanding | | | 5,870,111 | | | | | | | | | | | | | | 5,870,111 | | | | | | | | | | | | | | | | | | | | | Basic and diluted loss per share | | $ | (8.46 | ) | | | | | | | | | | | | $ | (1.54 | ) |
(1) Source: audited financial statements of SmartHeat Inc. as of and for the year ended December 31, 2013, as filed in the Form 10-K/A filed with the SEC on October 24, 2014. | (2) Source: unaudited financial statements of disposed entities of SmartHeat Inc. for the year ended December 31, 2013 and 2012, as included in this proxy. | (a) To add back the inter-company sales between disposed entities and other subsidiaries of SmartHeat Inc. |
The table below reconciles the intercompany pro forma adjustments in the Company’s pro forma balance sheet related to other receivables (net), prepayments and deposits in the amount of $26,549,898, and accrued liabilities and other payables in the amount of $19,178,125, with the related party amount disclosed in Note 6 for $22,229,046 and Note 12 for $16,240,198 in the historical financial statements of the Target Companies as of September 30, 2014. Other receivables of Target Companies | | $ | 16,240,198 | | Elimination of other payables of remaining entities to Target Companies | | | 22,229,046 | | Pro forma adjustment to include receivable RMB 8.5 million selling price for additional 60% equity sale | | | 1,381,552 | | Waiver of receivables of remaining entities from Target Companies per selling agreement of the forgiveness of all net indebtedness owing to Target Companies by SmartHeat and each of its other subsidiaries | | | (12,917,038 | ) | Exchange rate difference for Taiyu due to US parent company | | | (383,860 | ) | Total pro forma adjustments for other receivables | | $ | 26,549,898 | |
Other payables of Target Companies | | $ | 22,229,046 | | Elimination of other receivables of remaining entities from Target Companies | | | 16,240,198 | | Waiver of payables of remaining entities to Target Companies per selling agreement of the forgiveness of all net indebtedness owing to Target Companies by SmartHeat and each of its other subsidiaries | | | (19,291,119 | ) | Total pro forma adjustments for other payables | | $ | 19,178,125 | |
SMARTHEAT TAIYU (SHENGYANG) ENERGY TECHNOLOGY CO., LTDSMARTHEAT SIPING BEIFANG ENERGY TECHNOLOGY CO., LTDSMARTHEAT (SHENGYANG) ENERGY EQUIPMENT CO., LTDCONSOLIDATED AND COMBINED BALANCE SHEETS | | September 30, 2014 | | | December 31, 2013 | | ASSETS | | | | | | | | | | | | | | CURRENT ASSETS | | | | | | | Cash & equivalents | | $ | 10,008,529 | | | $ | 9,283,788 | | Restricted cash | | | 413,593 | | | | 2,345,258 | | Accounts receivable, net | | | 18,652,098 | | | | 14,822,112 | | Retentions receivable, net | | | 1,681,569 | | | | 4,141,585 | | Advances to suppliers, net | | | 5,317,381 | | | | 4,848,270 | | Other receivables (net), prepayments and deposits | | | 26,903,367 | | | | 26,344,942 | | Inventories, net | | | 47,481,292 | | | | 48,787,876 | | Taxes receivable | | | 413,629 | | | | 968,124 | | Notes receivable - bank acceptances | | | 1,232,727 | | | | 2,529,954 | | | | | | | | | | | Total current assets | | | 112,104,185 | | | | 114,071,909 | | | | | | | | | | | NONCURRENT ASSETS | | | | | | | | | Restricted cash | | | 254,807 | | | | 123,398 | | Construction in progress | | | 54,906 | | | | - | | Property and equipment, net | | | 728,406 | | | | - | | Intangible assets, net | | | - | | | | 10,320,173 | | | | | | | | | | | Total noncurrent assets | | | 1,038,119 | | | | 10,443,571 | | | | | | | | | | | TOTAL ASSETS | | $ | 113,142,304 | | | $ | 124,515,480 | | | | | | | | | | | LIABILITIES AND STOCKHOLDERS' EQUITY | | | | | | | | | | | | | | | | | | CURRENT LIABILITIES | | | | | | | | | Accounts payable | | $ | 8,058,552 | | | $ | 7,474,235 | | Advance from customers | | | 2,624,354 | | | | 1,875,894 | | Taxes payable | | | 16,304 | | | | 130,379 | | Accrued liabilities and other payables | | | 31,031,535 | | | | 30,938,077 | | Notes payable - bank acceptances | | | - | | | | 2,590,025 | | Loans payable | | | 18,832,200 | | | | 24,462,299 | | | | | | | | | | | Total current liabilities | | | 60,562,945 | | | | 67,470,909 | | | | | | | | | | | LONG-TERM LOAN | | | 2,112,962 | | | | 2,132,231 | | | | | | | | | | | STOCKHOLDERS' EQUITY | | | | | | | | | | | | | | | | | | Paid-in capital | | | 59,341,363 | | | | 59,341,363 | | Statutory reserve | | | 4,608,375 | | | | 4,608,375 | | Accumulated other comprehensive income | | | 6,785,859 | | | | 7,517,274 | | Accumulated deficit | | | (40,940,279 | ) | | | (38,647,146 | ) | | | | | | | | | | Total Companies stockholders' equity | | | 29,795,318 | | | | 32,819,866 | | | | | | | | | | | NONCONTROLLING INTEREST | | | 20,671,079 | | | | 22,092,474 | | | | | | | | | | | TOTAL EQUITY | | | 50,466,397 | | | | 54,912,340 | | | | | | | | | | | TOTAL LIABILITIES AND EQUITY | | $ | 113,142,304 | | | $ | 124,515,480 | |
SMARTHEAT TAIYU (SHENGYANG) ENERGY TECHNOLOGY CO., LTDSMARTHEAT SIPING BEIFANG ENERGY TECHNOLOGY CO., LTDSMARTHEAT (SHENGYANG) ENERGY EQUIPMENT CO., LTDCONSOLIDATED AND COMBINED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS | | NINE MONTHS ENDED SEPTEMBER 30, | | | THREE MONTHS ENDED SEPTEMBER 30, | | | | 2014 | | | 2013 | | | 2014 | | | 2013 | | | | | | | | | | | | | | | Net sales | | $ | 17,549,811 | | | $ | 23,659,163 | | | $ | 7,791,218 | | | $ | 11,667,900 | | Cost of goods sold | | | 16,696,776 | | | | 21,642,798 | | | | 5,099,090 | | | | 12,592,994 | | | | | | | | | | | | | | | | | | | Gross profit (loss) | | | 853,035 | | | | 2,016,365 | | | | 2,692,128 | | | | (925,094 | ) | | | | | | | | | | | | | | | | | | Operating expenses | | | | | | | | | | | | | | | | | Selling | | | 3,627,023 | | | | 3,372,933 | | | | 893,967 | | | | 1,061,706 | | General and administrative | | | 2,799,480 | | | | 3,483,464 | | | | 953,410 | | | | (3,217,877 | ) | Provision for bad debts | | | (3,115,176 | ) | | | 21,244,272 | | | | 573,646 | | | | 9,205,242 | | Provision for advance to supplier | | | 98,253 | | | | (787,119 | ) | | | 14,513 | | | | 57,606 | | | | | | | | | | | | | | | | | | | Total operating expenses | | | 3,409,580 | | | | 27,313,550 | | | | 2,435,536 | | | | 7,106,677 | | | | | | | | | | | | | | | | | | | Income (loss) from operations | | | (2,556,545 | ) | | | (25,297,185 | ) | | | 256,592 | | | | (8,031,771 | ) | | | | | | | | | | | | | | | | | | Non-operating income (expenses) | | | | | | | | | | | | | | | | | Interest income | | | 109,090 | | | | 36,827 | | | | 54,277 | | | | 13,926 | | Interest expense | | | (1,154,288 | ) | | | (1,253,961 | ) | | | (382,295 | ) | | | (496,350 | ) | Financial expense | | | (229,560 | ) | | | (60,489 | ) | | | (1,725 | ) | | | (11,194 | ) | Foreign exchange transaction gain | | | 3,658 | | | | (6,612 | ) | | | (1,892 | ) | | | (9,957 | ) | Other income (expense), net | | | 111,056 | | | | 432,257 | | | | (23,200 | ) | | | 154,413 | | | | | | | | | | | | | | | | | | | Total non-operating expenses, net | | | (1,160,044 | ) | | | (851,978 | ) | | | (354,835 | ) | | | (349,162 | ) | | | | | | | | | | | | | | | | | | Loss before income tax | | | (3,716,589 | ) | | | (26,149,163 | ) | | | (98,243 | ) | | | (8,380,933 | ) | Income tax expense | | | - | | | | 13,041 | | | | - | | | | 13,041 | | | | | | | | | | | | | | | | | | | Net loss before noncontrolling interest | | | (3,716,589 | ) | | | (26,162,204 | ) | | | (98,243 | ) | | | (8,393,974 | ) | Less: Loss attributable to noncontrolling interest | | | (1,423,456 | ) | | | (27,727 | ) | | | (11,248 | ) | | | 9,541 | | | | | | | | | | | | | | | | | | | Net loss to SmartHeat Inc. - disposed entities | | | (2,293,133 | ) | | | (26,134,477 | ) | | | (86,995 | ) | | | (8,403,515 | ) | | | | | | | | | | | | | | | | | | Other comprehensive item | | | | | | | | | | | | | | | | | Foreign currency translation gain (loss) attributable to SmartHeat Inc. | | | (731,415 | ) | | | 1,944,429 | | | | (207,140 | ) | | | 398,713 | | | | | | | | | | | | | | | | | | | Foreign currency translation gain (loss) attributable to noncontrolling interest | | | 2,061 | | | | 17,644 | | | | (7,295 | ) | | | 4,153 | | | | | | | | | | | | | | | | | | | Comprehensive loss attributable to SmartHeat Inc. | | $ | (3,024,548 | ) | | $ | (24,190,048 | ) | | $ | (294,135 | ) | | $ | (8,004,802 | ) | | | | | | | | | | | | | | | | | | Comprehensive income (loss) attributable to noncontrolling interest | | $ | (1,421,395 | ) | | $ | (10,083 | ) | | $ | (18,543 | ) | | $ | 13,694 | |
SMARTHEAT TAIYU (SHENGYANG) ENERGY TECHNOLOGY CO., LTDSMARTHEAT SIPING BEIFANG ENERGY TECHNOLOGY CO., LTDSMARTHEAT (SHENGYANG) ENERGY EQUIPMENT CO., LTDCONSOLIDATED AND COMBINED STATEMENTS OF CASH FLOWS | | NINE MONTHS ENDED SEPTEMBER 30, | | | | 2014 | | | 2013 | | | | | | | | | CASH FLOWS FROM OPERATING ACTIVITIES: | | | | | | | Loss including noncontrolling interest | | $ | (3,716,589 | ) | | $ | (26,162,204 | ) | Adjustments to reconcile loss including noncontrolling interest to net cash used in operating activities: | | | | | | | | | Depreciation and amortization | | | 147,501 | | | | 1,095,889 | | Provision for bad debts | | | (3,115,176 | ) | | | 21,244,272 | | Provision for inventory impairment | | | 2,260,728 | | | | 4,330,689 | | Provision for advance to suppliers | | | 98,253 | | | | (787,119 | ) | Changes in warranty reserves | | | 113,430 | | | | 59,564 | | Loss (gain) on disposal of fixed assets | | | (46,322 | ) | | | 18,910 | | (Increase) decrease in assets and liabilities: | | | | | | | | | Accounts receivable | | | 4,269,970 | | | | (1,575,682 | ) | Retentions receivable | | | 212,841 | | | | 269,255 | | Advances to suppliers | | | (611,770 | ) | | | (3,683,056 | ) | Other receivables, prepayments and deposits | | | (3,708,185 | ) | | | (4,445,342 | ) | Inventories | | | (1,394,038 | ) | | | (1,095,858 | ) | Taxes receivable | | | 432,973 | | | | (1,774,316 | ) | Accounts payable | | | (1,916,969 | ) | | | 192,251 | | Advance from customers | | | (2,198,360 | ) | | | 529,868 | | Accrued liabilities and other payables | | | 2,781,784 | | | | 2,651,967 | | | | | | | | | | | Net cash used in operating activities | | | (6,389,929 | ) | | | (9,130,912 | ) | | | | | | | | | | CASH FLOWS FROM INVESTING ACTIVITIES: | | | | | | | | | Change in restricted cash | | | 1,780,000 | | | | (1,073,370 | ) | Cash received from assets disposal | | | 19,527 | | | | - | | Government refund of land use right | | | 10,318,287 | | | | - | | Acquisition of property & equipment | | | (751,068 | ) | | | (555,363 | ) | Construction in progress | | | (27,798 | ) | | | - | | Notes receivable | | | 1,275,837 | | | | 1,601,508 | | | | | | | | | | | Net cash provided by (used in) investing activities | | | 12,614,785 | | | | (27,225 | ) | | | | | | | | | | CASH FLOWS FROM FINANCING ACTIVITIES: | | | | | | | | | Proceeds from short-term loans | | | 21,590,797 | | | | 13,269,466 | | Repayment on short-term loans | | | (27,006,080 | ) | | | (12,243,555 | ) | | | | | | | | | | Net cash provided by (used in) financing activities | | | (5,415,283 | ) | | | 1,025,911 | | | | | | | | | | | EFFECT OF EXCHANGE RATE CHANGE ON CASH & EQUIVALENTS | | | (84,832 | ) | | | 231,522 | | | | | | | | | | | NET INCREASE (DECREASE) IN CASH & EQUIVALENTS | | | 724,741 | | | | (7,900,704 | ) | | | | | | | | | | CASH & EQUIVALENTS, BEGINNING OF PERIOD | | | 9,283,788 | | | | 14,291,095 | | | | | | | | | | | CASH & EQUIVALENTS, END OF PERIOD | | $ | 10,008,529 | | | $ | 6,390,391 | | | | | | | | | | | Supplemental cash flow data: | | | | | | | | | Income tax paid | | $ | - | | | $ | 706,913 | | Interest paid | | $ | 1,357,639 | | | $ | 1,253,961 | |
SMARTHEAT TAIYU (SHENGYANG) ENERGY TECHNOLOGY CO., LTD SMARTHEAT SIPING BEIFANG ENERGY TECHNOLOGY CO., LTD SMARTHEAT (SHENGYANG) ENERGY EQUIPMENT CO., LTD NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS SEPTEMBER 30, 2014 AND DECEMBER 31, 2013 (UNAUDITED) 1. ORGANIZATION AND DESCRIPTION OF BUSINESS
SmartHeat Taiyu (Shenyang) Energy Technology Co., Ltd. (“Taiyu”), is engaged in the design, manufacture, sale and servicing of plate heat exchange (“PHE”) products in China, Taiyu merged with SmartHeat Inc. (“SmartHeat”) on April 14, 2008. SmartHeat Siping Beifang Energy Technology Co., Ltd. (“SmartHeat Siping”), was incorporated on June 12, 2009 by SmartHeat, and is engaged in manufacture of PHEs. SmartHeat (Shenyang) Energy Equipment Co., Ltd. (“SmartHeat Energy”), was incorporated on April 12, 2010 by one of SmartHeat’s subsidiary - SmartHeat (China) Investment Co., Ltd. (“SmartHeat Investment”), and is engaged in research, development, manufacturing and sales of energy products. Hohhot Ruicheng Technology Co., Ltd. (“Ruicheng”), is a joint venture with 51% invested by SmartHeat on January 7, 2011, and is engaged in the design and manufacture of heat meters. Urumchi XinRui Technology Limited Liability Company (“XinRui”), is a joint venture with 46% invested by SmartHeat in April 2012, and is engaged in research and development, production and selling of heat meters and automatic control of heat supply network (collectively, the “Companies”).
On August 23 2013, SmartHeat formed two new wholly-owned subsidiaries in the State of Nevada, Heat HP Inc., and HEAT PHE Inc. On August 23, 2013, SmartHeat Inc., the Companies United States parent company entered into Assignment Agreements with Heat HP Inc. and Heat PHE Inc., respectively. Under the Assignment Agreements, SmartHeat agreed to transfer 100% of its right, title and interest in certain subsidiaries to Heat HP Inc. and Heat PHE Inc. The reorganization was performed so SmartHeat’s subsidiaries would be organized along their respective operating segments with Heat HP holding those subsidiaries that operated in the heat pumps and related products segment and Heat PHE holding those subsidiaries that operated in the plate heating equipment, meters and related products segment.
After the assignment and prior to the 40% equity interest sale of Taiyu, SmartHeat Siping, SmartHeat Energy, Ruicheng and XinRui on December 30, 2013, Heat PHE Inc., owned 100% of Taiyu, SmartHeat Siping, SmartHeat Energy and 51% of Hohhot Ruicheng, and SmartHeat owned 46% of XinRui.
On December 30, 2013, SmartHeat closed the transaction contemplated by the Equity Interest Purchase Agreement (“EIPA”) dated October 10, 2013, whereby the buyers purchased 40% of the equity interests in Taiyu, SmartHeat Siping, SmartHeat Energy, Ruicheng and XinRui. The purchase price was RMB 5,000,000.
On November 28, 2014, SmartHeat entered into an Amended and Restated EIPA, which amended and restated the EIPA dated October 10, 2013 between SmartHeat and the buyers. Under the terms of the Amended EIPA, the buyers have agreed to purchase the remaining 60% of SmartHeat’s equity interests in the Companies effective as of December 31, 2014 (the “Closing Date”). The purchase price for the remaining 60% consists of: (i) consideration of RMB8.5 million and (ii) the forgiveness of all net indebtedness owing to the Companies by SmartHeat and each of its other subsidiaries as of December 31, 2014 subject to termination provisions as set forth in EIPA. The transaction resulted in an expected a loss of $42.31 million from the 100% equity interest sale of the sold entities consisting of a $50.15 million loss on sale resulting from the difference of the total selling price and the net assets of sold entities, netted off with the $7.84 million the forgiveness of all net indebtedness owing to the sold entities by SmartHeat and each of its other subsidiaries. The effectiveness of the transaction is subject to the following conditions: (i) approval of SmartHeat’s shareholders and (ii) receipt by the Board of Directors (“BOD” or the “Board”) of SmartHeat of an opinion that the purchase and sale transaction is fair to the shareholders of SmartHeat from a financial point of view. The parties will execute a mutual release to be delivered at the closing which will provide, in part, for the Companies to forgive all net indebtedness from SmartHeat and all of its other subsidiaries. In the event that the conditions are not met prior to December 31, 2014, the consideration and all documents will be deposited into escrow and released when the conditions have been satisfied; provided that if the conditions are not satisfied on or before March 31, 2015, either party may terminate the Amended EIPA and the funds and documents will be returned to the depositing party. The buyers consist of a group of 25 natural persons, all of whom are P.R.C. citizens, including Wen Sha, Jun Wang and Xudong Wang, managers of the SmartHeat’s subsidiaries engaged in the PHE segment of its business, and Huajuan Ai and Yingkai Wang, the SmartHeat’s Corporate Secretary and Acting Chief Accountant, respectively. Huajuan Ai, Wen Sha, Jun Wang and Xudong Wang are also principals in Northtech Holdings Inc. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Basis of Presentation The unaudited consolidated financial statements were prepared in accordance with generally accepted accounting principles in the United States of America (“U.S. GAAP”).
In the opinion of management, all adjustments (which include normal recurring adjustments) necessary to present a fair statement of the Companies consolidated and combined financial position as of September 30, 2014, its consolidated and combined results of operations and cash flows for the nine and three months ended September 30, 2014 and 2013, as applicable, were made. The interim results of operations are not necessarily indicative of the operating results for the full fiscal year or any future periods. Principles of Consolidation
The accompanying unaudited consolidated and combined financial statements include the accounts of Taiyu, SmartHeat Siping, and SmartHeat Shenyang Energy, which are collectively referred to as the “Companies.” All significant intercompany accounts and transactions were eliminated in consolidation. The Companies follow Financial Accounting Standards Board’s (“FASB”) Accounting Standards Codification (“ASC”) Topic 810, “Consolidation,” which established new standards governing the accounting for and reporting of noncontrolling interests (“NCIs”) in partially owned consolidated subsidiaries and the loss of control of subsidiaries. Certain provisions of this standard indicate, among other things, that NCIs, previously referred to as minority interests, be treated as a separate component of equity, not as a liability, as was previously the case, that increases and decreases in the parent’s ownership interest that leave control intact be treated as equity transactions rather than as step acquisitions or dilution gains or losses and that losses of a partially owned consolidated subsidiary be allocated to the NCI even when such allocation might result in a deficit balance. This standard also required changes to certain presentation and disclosure requirements. Losses attributable to the NCI in a subsidiary may exceed the NCI’s interests in the subsidiary’s equity. The excess attributable to the NCI is attributed to those interests. The NCI shall continue to be attributed its share of losses even if that attribution results in a deficit NCI balance. After the sale of 40% equity interest of Taiyu, Siping, SmartHeat Energy, Ruicheng and Xinrui on December 30, 2013, the Companies’ noncontrolling interest consisted of 40% of Taiyu, Siping and SmartHeat Energy since then. For accounting purposes net loss of Taiyu, Siping, SmartHeat Energy were not allocated to noncontrolling interest between December 30, 2013 and December 31, 2013, as the change in ownership interest may not change financial results materially between December 30, 2013 and December 31, 2013. However, the Companies performed long-lived assets impairment test for Taiyu, Siping, Shengyang Energy on December 31, 2013, and recognized $13.73 million impairment loss out of which $5.49 million allocated to noncontrolling interest on December 31, 2013. Use of Estimates In preparing the financial statements in conformity with U.S. GAAP, management makes estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the dates of the financial statements, as well as the reported amounts of revenues and expenses during the reporting period. Significant estimates, required by management, include the recoverability of long-lived assets, allowance for doubtful accounts and the reserve for obsolete and slow-moving inventories. Actual results could differ from those estimates. Cash and Equivalents For purposes of the statement of cash flows, the Companies consider all highly liquid investments with an original maturity of three months or less to be cash equivalents. As of September 30, 2014 and December 31, 2013, the Companies maintained restricted cash deposit in several bank accounts for the purposes described below. | | 2014 | | | 2013 | | | | (In millions) | | Support of performance guarantee | | $ | 0.20 | | | $ | 1.04 | | Support of bank acceptance | | | - | | | | 1.30 | | Support of letter of credit | | | 0.21 | | | | 0.008 | | Total restricted cash - current | | $ | 0.41 | | | $ | 2.35 | | Performance guarantee -- noncurrent | | $ | 0.25 | | | $ | 0.12 | |
Accounts and Retentions Receivable
The Companies maintain reserves for potential credit losses on accounts receivable. Management reviews the composition of accounts receivable and analyzes historical bad debts, customer concentrations, customer credit worthiness, current economic trends and changes in customer payment patterns to evaluate the adequacy of these reserves. Based on historical collection activity, the Companies had allowances of $37.77 million and $46.42 million at September 30, 2014 and December 31, 2013, respectively. At September 30, 2014 and December 31, 2013, the Companies had retentions receivable from customers for product quality assurance of $1.68 and $4.14 million, respectively. The retention rate varies from 5% to 20% of the sales price with variable terms from 3 to 24 months depending on the shipping date, and for PHE Units, the customer acceptance date, of the products and the number of heating seasons that the warranty period covers. The Companies had allowances of $2.21 million and $0 at September 30, 2014 and December 31, 2013, respectively.
Accounts receivable is net of unearned interest of $26,414 and $26,655 at September 30, 2014 and December 31, 2013, respectively. Unearned interest is imputed interest on accounts receivable with due dates over 1 year from the invoice date discounted at the Companies’ borrowing rate of 6.15% at December 31, 2012. The Companies did not record additional unearned interest after December 31, 2012 due to no long-term accounts receivable.
As of September 30, 2014, the Companies had accounts receivable of $3.31 million from the remaining subsidiaries of SmartHeat and accounts payable of $1.46 million to the remaining subsidiaries of SmartHeat. As of December 31, 2013, the Companies had accounts receivable of $3.45 million from the remaining subsidiaries of SmartHeat and accounts payable of $1.55 million to the remaining subsidiaries of SmartHeat.
Bad Debt Allowance
The Companies record approximately 50% of accounts receivable aged over 180 days from the payment due date and 100% accounts receivable aged over 360 days from the payment due date as bad debt allowance. Management of the Companies further analyzes each individual customer for which it was taken a bad debt allowance to further assess the likelihood of collectability. Customers which are either state-owned or have a history of support from the state, or larger companies with long operating histories, that management of the Companies believe the chance of non-payment will be remote, are excluded for the purpose of calculating bad debt allowance. Advance to Suppliers
The Companies make advances to certain vendors to purchase raw material and equipment for production. The advances are interest-free and unsecured. The Companies made allowance for bad debt against advance to supplier of $1.68 million and $1.60 million as of September 30, 2014 and December 31, 2013 respectively. Inventories
Inventories are valued at the lower of cost or market, with cost determined on a moving weighted-average basis. The difference is recorded as a cost of goods sold, if the current market value is lower than their historical cost. In addition, the Companies make an inventory impairment provision analysis at each period end for inventory held over 360 days. Cost of work in progress and finished goods comprises direct material, direct labor and an allocated portion of production overheads.
Certain raw materials, such as stainless steel products, plates, shims, gaskets, and pump valves, require longer than normal procurement periods, or “lead times,” with some procurement periods running longer than six months. To guarantee availability of raw materials for production and sales, the Companies, based on historical sale patterns, estimate and purchase material for the upcoming period. As part of inventory impairment analysis, the Companies perform an evaluation of raw materials stored over one year and not anticipated to be consumed, and an evaluation of potential impairment to the quality of these raw materials. If management anticipates that obsolete raw materials in inventory can be utilized and will be consumed within the next six months through new customer orders or substitute orders, no impairment is recorded. The Companies collect information about delayed and canceled contracts and met with affected customers to discuss their financing situation and their projections of future orders. Finished goods manufactured for delayed and canceled contracts that the Companies do not expect to be reinstated and contracts for which the Companies have been unable to find substitute customers become impaired.
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 with a 10% salvage value and estimated lives as follows: Buildings | 20 years | Vehicles | 5 years | Office equipment | 5 years | Production equipment | 5-10 years |
Land Use Rights Right to use land is stated at cost less accumulated amortization. Amortization is provided using the straight-line method over 50 years. Impairment of Long-Lived Assets
Long-lived assets, which include tangible assets, such as property, plant and equipment, goodwill and other intangible assets, are reviewed for impairment whenever events or changes in circumstances indicate the carrying amount of an asset may not be recoverable. Recoverability of long-lived assets to be held and used is measured by comparing the carrying amount of an asset to the estimated undiscounted future cash flows expected to be generated by the asset. If the carrying amount of an asset exceeds its estimated undiscounted future cash flows, an impairment charge is recognized based on the excess of the carrying amount over the fair value (“FV”) of the assets. FV generally is determined using the asset’s expected future discounted cash flows or market value, if readily determinable. The Companies evaluates intangible assets with indefinite lives for impairment annually using a two-step approach (codified in FASB ASC Topic 350). On December 30, 2013, SmartHeat closed the transaction contemplated by the EIPA dated October 10, 2013, whereby the buyers purchased 40% of SmartHeat’s equity interests in Taiyu, Siping, SmartHeat Energy, Ruicheng and XinRui for the purchase price of RMB 5,000,000 ($0.82 million) (See Note 1). The buyers had the option to purchase remaining 60% equity interest in the Companies for an additional purchase price of RMB 8.5 million. According to ASC 360-10-35, a long-lived asset (asset group) shall be tested for recoverability whenever events or changes in circumstances indicate that its carrying amount may not be recoverable. The Companies believed the following events or changes in circumstances indicated the carrying amount of their long-lived assets (asset group) may not be recoverable: 1) a current expectation that, more likely than not, a long-lived assets (asset group) will be sold or otherwise disposed of significantly before the end of its previously estimated useful life, and 2) A significant decrease in the market price of a long-lived asset (asset group). Since SmartHeat has the option to sell 100% ownership in Companies for RMB 13.5 million ($2.21 million), a significant decrease in the market price, before the end of its previously estimated useful life for their long-lived assets, the Companies therefore performed assets recoverability testing by comparing the assets estimated future undiscounted cash flows with their carrying value, and concluded the long-lived assets were not recoverable as a result of future cash flows are less than the carrying amount. The Companies further calculated the impairment loss amount by determining the fair value for the long-lived asset group and recorded a write-down (loss) for the difference between their carrying value and their fair value. Fair value is an asset’s purchase or sale price in a current transaction between willing parties. The best evidence of fair value is prices quoted in active markets, although SmartHeat has the option to sell 100% ownership in Companies for RMB 13.5 million ($2.21 million), the market prices are not available for many long-lived assets such as equipment, the Companies therefore used discounted cash flow method for estimating fair value of long-lived assets which are acceptable under ASC 360-10. Based on the evaluation, the Companies believed, as of December 31, 2013, the long-lived assets of Companies including construction in progress, property and equipment, and intangible assets were impaired for $13.73 million. Warranties The Companies offer to all customers standard warranties on its products for one or two heating seasons depending on the terms negotiated. The Companies accrue for warranty costs based on estimates of the costs that may be incurred under its warranty obligations. The warranty expense and related accrual is included in the Companies’ selling expenses and other payables respectively, and is recorded when revenue is recognized. Factors that affect the Companies’ warranty liability include the number of units sold, its estimates of anticipated rates of warranty claims, costs per claim and estimated support labor costs and the associated overhead. The Companies periodically assess the adequacy of its recorded warranty liabilities and adjusts the amounts as necessary. Activity in the Companies’ warranty reserve from January 1, 2013, to September 30, 2014, is as follows: | | 2014 | | | 2013 | | Beginning balance | | $ | 318,846 | | | $ | 282,739 | | Provisions | | | 488,986 | | | | 301,920 | | Actual costs incurred | | | (96,700 | ) | | | (265,813 | ) | Ending balance (Note 12) | | $ | 711,132 | | | $ | 318,846 | |
Research and Development Costs Research and development (“R&D”) costs are expensed as incurred and included in general and administrative expenses. These costs primarily consist of cost of materials used, salaries paid for the Companies’ development department and fees paid to third parties. R&D costs for the nine months ended September 30, 2014 and 2013, were $612,717and $322,648, respectively. R&D costs for the three months ended September 30, 2014 and 2013, were $208,800 and $84,595, respectively. Revenue Recognition The Companies’ revenue recognition policies comply with SEC Staff Accounting Bulletin (“SAB”) 104 (codified in FASB ASC Topic 605). Sales revenue is recognized when PHEs are delivered, and for PHE Units when customer acceptance occurs, the price is fixed or determinable, no other significant obligations of the Companies exist and collectability is reasonably assured. Payments received before all of the relevant criteria for revenue recognition met are recorded as unearned revenue under “Advance from customers.” The Companies’ sales generally provide for 30% of the purchase price on placement of an order, 30% on delivery, 30% upon installation and acceptance of the equipment after customer testing and 10% no later than the termination of the standard warranty period, which ranges from 3 to 24 months from the acceptance date. Due to the slowdown of the Chinese economy and tightened monetary policy, and to attract and retain customers, the Companies’ subsidiaries adjusted their contract and payment terms to permit more flexible and longer payment terms. Sales revenue is the invoiced value of goods, net of value-added tax (“VAT”). All of the Companies’ products sold in the PRC are subject to a VAT of 17% of gross sales price. This VAT may be offset by the VAT paid by the Companies on raw materials and other materials purchased in China and included in the cost of producing the Companies’ finished product. The Companies recorded VAT payable and VAT receivable net of payments in the financial statements. The Companies file VAT tax returns on line with PRC tax authorities and offsets the payables against the receivables. Sales and purchases are recorded net of VAT collected and paid as the Companies act as an agent for the government. VAT taxes are not affected by the income tax holiday. Sales returns and allowances were $0 for the nine and three months ended September 30, 2014 and 2013. The Companies do not provide a right of return, price protection or any other concessions to its customers. The Companies provide a standard warranty to all customers, which is not considered an additional service; rather, an integral part of the product’s sale. The Companies believe the existence of its standard product warranty in a sales contract does not constitute a deliverable in the arrangement and thus there is no need to apply the EITF 00-21 (codified in FASB ASC Topic 605-25) separation and allocation model for a multiple deliverable arrangement. SFAS 5 (codified in FASB ASC Topic 450) specifically addresses the accounting for standard warranties and neither SAB 104 nor EITF 00-21 supersedes SFAS 5. The Companies believe that accounting for its standard warranty pursuant to SFAS 5 does not impact revenue recognition because the cost of honoring the warranty can be reliably estimated. The Companies charge for after-sales services provided after the expiration of the warranty period, with after-sales services mainly consisting of cleaning PHEs and repairing and exchanging parts. The Companies recognize such revenue when the service is provided. For the nine months ended September 30, 2014 and 2013, revenue from after-sales services after the expiration of the warranty period was $36,303 and $7,719, respectively. For the three months ended September 30, 2014 and 2013, revenue from after-sales services after the expiration of the warranty period was $32,387 and $5,831, respectively, which was recorded in other income. Cost of Goods Sold Cost of goods sold (“COGS”) consists primarily of material costs and direct labor and manufacturing overhead that are directly attributable to the products. Write-down of inventories to the lower of cost or market is also recorded in COGS. The Companies also record inventory reserve for inventories aging over 360 days to COGS. Advance from Customers The Companies record payments received from customers in advance of their orders to advance account. These orders normally are delivered within a reasonable period of time based upon contract terms and customer demand.
Statement of Cash Flows
In accordance with SFAS No. 95, “Statement of Cash Flows,” codified in FASB ASC Topic 230, cash flows from the Companies’ operations are calculated based upon the local currencies. As a result, amounts shown on the statement of cash flows may not necessarily agree with changes in the corresponding asset and liability on the balance sheet. Foreign Currency Translation and Comprehensive Income (Loss)
The accounts of the Companies were translated into USD in accordance with SFAS No. 52, “Foreign Currency Translation” (codified in FASB ASC Topic 830). According to SFAS No. 52, all assets and liabilities were translated at the exchange rate on the balance sheet date, stockholders’ equity was translated at the historical rates and statement of operations items were translated at the average exchange rate for the period. The resulting translation adjustments are reported under other comprehensive income in accordance with SFAS No. 130, “Reporting Comprehensive Income” (codified in FASB ASC Topic 220). The RMB to USD exchange rates in effect as of September 30, 2014 and December 31, 2013, and the average exchange rates for the nine months ended September 30, 2014 and 2013 are as following. The exchange rates used in translation from RMB to USD were published by State Administration of Foreign Exchange of the People’s Republic of China (“SAFE”). | | Average Exchange Rate | | | Balance Sheet Date | | | | For the Nine Months Ended | | | Exchange Rate | | | | 9/30/14 | | | 9/30/13 | | | 9/30/14 | | | 12/31/13 | | RMB - USD | | | 6.1454 | | | | 6.2146 | | | | 6.1525 | | | | 6.0969 | |
New Accounting Pronouncements
The FASB has issued ASU No. 2014-12, Compensation - Stock Compensation, FASB ASC Topic 718, “Accounting for Share-Based Payments,” When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period. This ASU requires that a performance target that affects vesting, and that could be achieved after the requisite service period, be treated as a performance condition. As such, the performance target should not be reflected in estimating the grant date FV of the award. This update further clarifies that compensation cost should be recognized in the period in which it becomes probable that the performance target will be achieved and should represent the compensation cost attributable to the period(s) for which the requisite service has already been rendered.. The amendments in this ASU are effective for annual periods and interim periods within those annual periods beginning after December 15, 2015. Earlier adoption is permitted. The adoption of this standard is not expected to have a material impact on the Company's consolidated financial position and results of operations.
The FASB has issued ASU No. 2014-09, Revenue from Contracts with Customers. This ASU supersedes the revenue recognition requirements in Accounting Standards Codification 605 - Revenue Recognition and most industry-specific guidance throughout the Codification. The standard requires that an entity recognizes revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. This ASU is effective on January 1, 2017 and should be applied retrospectively to each prior reporting period presented or retrospectively with the cumulative effect of initially applying the ASU recognized at the date of initial application. The adoption of this standard is not expected to have a material impact on the Company’s consolidated financial position and results of operations.
In April 2014, the FASB issued ASU No. 2014-08, Presentation of Financial Statements (Topic 205) and Property, Plant and Equipment (Topic 360): Reporting Discontinued Operations and Disclosures of Disposals of an Entity. Under the new guidance, only disposals representing a strategic shift, such as a major line of business, a major geographical area or a major equity investment, should be presented as discontinued operations. The guidance will be applied prospectively to new disposals and new classifications of disposal groups as held for sale after the effective date. The guidance is effective for annual financial statements with fiscal years beginning on or after December 15, 2014 with early adoption permitted for disposals or classifications as held for sale which have not been reported in financial statements previously issued or available for issuance. The Company will adopt the guidance effective January 1, 2015. We are in the process of evaluating the impact of this standard on our consolidated financial statements and the impact is unknown at this time.
In January 2014, FASB issued, Accounting Standards Update 2014-05, Service Concession Arrangements (Topic 853). The objective of this Update is to specify that an operating entity should not account for a service concession arrangement within the scope of this Update as a lease in accordance with Topic 840, Leases. Service concession arrangements may become more prevalent in the United States as public-sector entities seek alternative ways to provide public services on a more efficient and cost-effective basis. The amendments apply to an operating entity of a service concession arrangement entered into with a public-sector entity grantor when the arrangement meets certain conditions. The amendments in this Update should be applied on a modified retrospective basis to service concession arrangements that exist at the beginning of an entity’s fiscal year of adoption. The modified retrospective approach requires the cumulative effect of applying this Update to arrangements existing at the beginning of the period of adoption to be recognized as an adjustment to the opening retained earnings balance for the annual period of adoption. The amendments are effective for a public business entity for annual periods, and interim periods within those annual periods, beginning after December 15, 2014. The adoption of this ASU will not affect the Company’s financial statements. 3. INVENTORIES
Inventories at September 30, 2014 and December 31, 2013, were as follows: | | 2014 | | | 2013 | | Raw materials | | $ | 40,682,660 | | | $ | 41,378,896 | | Work in process | | | 8,907,684 | | | | 6,216,166 | | Finished goods | | | 9,554,858 | | | | 10,684,380 | | Total | | | 59,145,202 | | | | 58,279,442 | | Inventory allowance | | | (11,663,910 | ) | | | (9,491,566 | ) | Inventories, net | | $ | 47,481,292 | | | $ | 48,787,876 | |
4. NOTES RECEIVABLE – BANK ACCEPTANCES
The Companies sold goods to its customers and received commercial notes (bank acceptance) from them in lieu of payments for accounts receivable. The Companies discounted the commercial notes with the bank or endorsed the commercial notes to vendors for payment of their own obligations or to get cash from third parties. Most of the commercial notes have a maturity of less than six months. As of September 30, 2014, the Companies were contingently liable for the notes endorsed to vendors of $0.61 million. 5. PROPERTY AND EQUIPMENT, NET
Property and equipment consisted of the following at September 30, 2014 and December 31, 2013: | | 2014 | | | 2013 | | Buildings | | $ | 4,935,178 | | | $ | 4,980,184 | | Production equipment | | | 7,276,060 | | | | 6,593,287 | | Office equipment | | | 920,639 | | | | 918,728 | | Vehicles | | | 684,576 | | | | 693,210 | | Total | | | 13,816,453 | | | | 13,185,409 | | Less: accumulated depreciation | | | (4,618,246 | ) | | | (4,638,369 | ) | Less: Impairment | | | (8,469,801) | | | | (8,547,040 | ) | Property & equipment, net | | $ | 728,406 | | | $ | - | |
Depreciation for the nine months ended September 30, 2014 and 2013 was $21,820 and $809,572, respectively. Depreciation for the three months ended September 30, 2014 and 2013 was $18,777 and $276,672, respectively.
6. OTHER RECEIVABLES, PREPAYMENTS AND DEPOSITS
Other receivables, prepayments and deposits consisted of the following at September 30, 2014 and December 31, 2013, respectively: | | 2014 | | | 2013 | | Advance to third party companies | | $ | 13,550,683 | | | $ | 10,059,572 | | Deposit for public bids of sales contracts | | | 532,415 | | | | 704,175 | | Prepayment for freight, insurance, advertisement and consulting expenses | | | 152,157 | | | | 17,446 | | Other deposits | | | 71,829 | | | | 51,724 | | Advance to employees | | | 126,271 | | | | 588,114 | | Advance to unrelated individuals | | | 77,346 | | | | - | | Advance to HP segment subsidiaries | | | 22,229,046 | | | | 21,900,731 | | Others | | | 560,225 | | | | 580,681 | | Total | | | 37,299,972 | | | | 33,902,443 | | Less: bad debt allowance | | | (10,396,605 | ) | | | (7,557,501 | ) | Other receivables (net), prepayments & deposits | | $ | 26,903,367 | | | $ | 26,344,942 | |
Advance to third parties were short-term unsecured advances to unrelated parties with payment usually due within a year and includes an advance to Siping Beifang of RMB 22.13 million ($3.60 million) that is non-interest bearing and with due date extended to September 2014.
Deposits for public bidding represented the deposits for bidding on expected contracts, which will be returned to the Companies after the bidding process is completed, usually within three to four months from the payment date. Prepayment for freight, related insurance expenses and advertisement represented prepaid shipping and freight insurance expenses for customers and is generally repaid upon customer receipt of products and prepaid advertising expense.
Other deposits mainly consisted of deposits for rents, payroll expense and utilities. Advance to employees represented short-term loans to employees and advances for business trips and related expenses. Advance to HP segment represented receivables from other subsidiaries of SmartHeat Inc., including $14.3 million receivable from Heat HP, Inc. for transferring the 98.8% ownership of SmartHeat (Shenyang) Heat Pump Technology Co., Ltd. (“SmartHeat Pump”) by Taiyu to Heat HP Inc., the transfer is not completed as of this report date. Other receivables (consisting of advance to third parties and employees, deposit for public bids and others), prepayments and deposits are reimbursed or settled within 12 months.
7. INTANGIBLE ASSETS
All land in the PRC is government-owned and cannot be sold to any individual or company. However, the government grants the user a “land use right” to use the land. Taiyu acquired land use rights during 2005 for RMB 3,549,682 ($0.44 million). In June 2009, SmartHeat Siping acquired land use rights for $3.1 million from Siping Beifang. In November 2010, SmartHeat Energy, acquired land use rights for $10.10 million. The Companies have the right to use the land for 50 years and is amortizing such rights on a straight-line basis for 50 years. SmartHeat Energy later cancelled the purchase of land use right due to the adjustments of the overall development plan of the area by the local authority. On May 21, 2014, SmartHeat Energy and Shenyang City Development and Land Resource Bureau Economy and Technology Development Office entered into an official agreement, whereby full purchase price of the land use right would be returned to SmartHeat Energy in installments within 5 days from the effective date of the official agreement. SmartHeat Energy will make the ownership change of the land use right upon receiving the refund from the local authority. SmartHeat Energy received accumulated amount of $14.89 million (RMB 91.62 million) as of September 30, 2014 and is in the process of title transfer, which is expected to complete by the end of 2014. Currently the land is used by the third party.
Intangible assets consisted of the following at September 30, 2014 and December 31, 2013, respectively: | Estimated Useful Life (In years) | | 2014 | | | 2013 | | Land use rights | 50 | | $ | 4,112,074 | | | $ | 15,167,552 | | Software | 5 | | | 294,730 | | | | 510,594 | | Total | | | | 4,406,804 | | | | 15,678,146 | | Less: accumulated amortization | | | | (598,628 | ) | | | (1,515,069 | ) | Less: Impairment | | | | (3,808,176) | | | | (3,842,904 | | Intangible assets, net | | | $ | - | | | $ | 10,320,173 | |
Amortization of intangible assets for the nine months ended September 30, 2014 and 2013, was $125,681 and $271,997, respectively. Amortization of intangible assets for the three months ended September 30, 2014 and 2013, was $0 and $89,297, respectively. Annual amortization for the next five years from September 30, 2014, is expected to be $0.
8. CONSTRUCTION IN PROGRESS
As of September 30, 2014, Siping had construction in progress of $54,906 for expanding and upgrading its production line and production equipment. Total cost for the construction is $0.98 million, and is expected to complete in June 2015. 9. MAJOR CUSTOMERS AND VENDORS
For the nine and three months ended September 30, 2014, no customers accounted for over 10% of the Companies’ total sales. For the nine months ended September 30, 2013, one customer accounted for 12% of total sales. At September 30, 2013, total receivable from this customer was $7.20 million. For the three months ended September 30, 2013, no customers accounted for over 10% of the Companies’ total sales.
For the nine months ended September 30, 2014 and 2013, no vendors accounted for over 10% of the Companies’ total purchases. For the three months ended September 30, 2014, three vendors accounted for 21%, 17%, and 17% of the Companies’ total purchases. At September 30, 2014, total payable to these vendors were $0. For the three months ended September 30, 2013, one vendor accounted for 12% of the Companies’ total purchases. At September 30, 2013, total payable to the vendor was $0.
10. TAXES RECEIVABLE
Taxes receivable consisted of the following at September 30, 2014 and December 31, 2013: | | 2014 | | | 2013 | | Income | | $ | 179,130 | | | $ | 180,764 | | Value-added | | | 233,627 | | | | 781,216 | | Other | | | 872 | | | | 6,144 | | Total | | $ | 413,629 | | | $ | 968,124 | |
11. TAXES PAYABLE
Taxes payable consisted of the following at September 30, 2014 and December 31, 2013: | | 2014 | | | 2013 | | Income | | $ | - | | | $ | - | | Value-added | | | - | | | | 99,456 | | Other | | | 16,304 | | | | 30,923 | | Total | | $ | 16,304 | | | $ | 130,379 | |
12. ACCRUED LIABILITIES AND OTHER PAYABLES Accrued liabilities and other payables consisted of the following at September 30, 2014 and December 31, 2013: | | 2014 | | | 2013 | | Advance from third parties | | $ | 3,232,832 | | | $ | 3,262,314 | | Payable to Siping Beifang | | | 2,294,927 | | | | 2,306,184 | | Payable for equipment purchase | | | 9,121 | | | | - | | Payable to employees | | | 2,025 | | | | - | | Deposit from customer | | | 2,961,235 | | | | 2,988,240 | | Refund of land use right purchased | | | 4,790,513 | | | | 4,627,270 | | Others | | | 467,220 | | | | 539,728 | | Warranty reserve (See Note 2) | | | 711,132 | | | | 318,846 | | Accrued expenses | | | 322,332 | | | | 507,196 | | Advance from HP segment subsidiaries | | | 16,240,198 | | | | 16,388,299 | | Total | | $ | 31,031,535 | | | $ | 30,938,077 | |
Advances from third parties were short-term, non-interest-bearing advances from third parties due on demand. Payable to Siping Beifang represented loans to them without interest and payable upon demand. Deposit from customer represented advance payment from a customer for SmartHeat Siping to execute the sales order; however, the customer wanted to cancel the order after SmartHeat Siping commenced manufacturing and the SmartHeat Siping refused to return the deposit claiming breach of the contract by the customer. The dispute was filed with the court and is currently docketed for trial.
Refund of land use right previously purchased represented the refund received for the land use right SmartHeat Energy purchased in November 2010. SmartHeat Energy later cancelled the purchase due to the adjustments of the overall development plan of the area by the local authority. The local government agreed to the cancellation and refunded SmartHeat Energy $4.63 million as of December 31, 2013, and was committed to refund SmartHeat Energy the remaining purchase price. On May 21, 2014, SmartHeat Energy and Shenyang City Development and Land Resource Bureau Economy and Technology Development Office entered into an official agreement, whereby full purchase price of the land use right will be returned to SmartHeat Energy in installments within 5 days from the effective date of the official agreement. SmartHeat Energy will make the ownership change of the land use right upon receiving the refund from the local authority. As of September 30, 2014, SmartHeat Energy received total of $14.89 million (RMB 91.62 million), of which, $$4.79 million was the amount received in excess of the amount paid to acquire land use right. The local government has not yet made qualitative determination about the excessed amount and until SmartHeat Energy receives any further information from the local government, the excess amount from refund of land use right is recorded as other payable. The land use right title transfer is expected to complete by the end of 2014. Currently the land is used by the third party.
Advance from HP segment represented payables to other subsidiaries of SmartHeat Inc. Others represented payables for the Companies certain construction and installation projects, and miscellaneous expenses including postage, business insurance, employee benefits, project bidding fee, and medical insurance, etc. Accrued expenses mainly consisted of accrued payroll of $0.13 million, accrued welfare, interest and utility.
13. NOTES PAYABLE – BANK ACCEPTANCES
Notes payable represented the conversion of accounts payable into notes payable, which were issued by a bank. The Companies deposited a portion of the acceptance amount into the bank as collateral. The terms of the notes range from 3-6 months and bear no interest. At September 30, 2014 and December 31, 2013, the Companies deposited $0 and $1.30 million with the bank as restricted cash for the bank issuing the notes (See note 2). The restricted cash is refundable when the notes are repaid. 14. LOANS PAYABLE
Short-Term Bank Loans
The Companies were obligated for the following short-term loans as of September 30, 2014 and December 31, 2013: | | 2014 | | | 2013 | | Subsidiary obligated | From a commercial bank in the PRC for RMB 7,200,000 entered into on February 20, 2014.The loan bore interest at 6% with maturity on February 19, 2015. | | | | | | | | | | From a commercial bank in the PRC for RMB 20,000,000 entered into on August 11, 2014. The loan bore interest at 7.2% with maturity on August 11, 2015. The loan was guaranteed by Heat Pump and SanDeKe. | | | | | | | | | | From a commercial bank in the PRC for RMB 20,000,000 entered into on August 19, 2014. The loan bore interest at 7.2% with maturity on August 19, 2015. The loan was guaranteed by Heat Pump and SanDeKe. | | | | | | | | | | From a commercial bank in the PRC for RMB 8,765,114 entered into on September 17, 2014. The loan bore interest at 7.2% with maturity on March 17, 2015. The loan was pledged by the Taiyu’s accounts receivable. | | | | | | | | | | From a commercial bank in the PRC for RMB 13,344,190 entered into on September 26, 2012. The loan bore interest at 6.16% with maturity on January 18, 2014. The loan was repaid at maturity. | | | | | | | | | | From a commercial bank in the PRC for RMB 10,000,000 entered into on November 30, 2012. The loan bore interest at 7.87% with maturity on November 22, 2014. The loan was guaranteed by Taiyu. This loan was repaid at maturity. | | | | | | | | | | From a commercial bank in the PRC for RMB 40,000,000 entered into on March 11, 2013. The loan bore interest at 6.60% with maturity on March 10, 2014. The loan was guaranteed by Siping, HeatPump and management of Chinese subsidiaries. This loan was repaid at maturity. | | | | | | | | | | From a commercial bank in the PRC for RMB 10,000,000 entered into on May 21, 2013. The loan bore interest at 6.60% with maturity on May 20, 2014. This loan was repaid at maturity. | | | | | | | | | | From a commercial bank in the PRC for RMB 5,000,000 entered into on August 29, 2013. The loan bore interest at 7.20% with maturity on August 29, 2014. The loan was guaranteed by Taiyu. This loan was repaid at maturity. | | | | | | | | | | From a commercial bank in the PRC for RMB 5,000,000 entered into on September 4, 2013. The loan bore interest at 7.20% with maturity on September 4, 2014. The loan was guaranteed by Taiyu. This loan was repaid at maturity. | | | | | | | | | | From a commercial bank in the PRC for RMB 30,000,000 entered into on August 8, 2013. The loan bore interest at 6.90% with maturity on August 7, 2014. The loan was paid in full at maturity. | | | | | | | | | | From a commercial bank in the PRC for RMB 9,900,000 entered into on September 18, 2013. The loan bore interest at 6.0% with maturity on September 17, 2014. This loan was pledged by Taiyu’s accounts receivable. This loan was repaid at maturity. | | | | | | | | | | From a commercial bank in the PRC for RMB 9,900,000 entered into on October 11, 2013. The loan bore interest at 6.0% with maturity on October 10, 2014. This loan was pledged by Taiyu’s accounts receivable. This loan was repaid at maturity. | | | | | | | | | | From a commercial bank in the PRC for RMB 16,000,000 entered into on July 10, 2013. The loan bore interest at 6.0% with maturity on January 9, 2014. This loan was pledged by Taiyu’s accounts receivable. This loan was repaid at maturity. | | | | | | | | | | From a commercial bank in the PRC for RMB 36,000,000 entered into on April 23, 2014. The loan bore interest at 7.2% with maturity on April 22, 2015. This loan was pledged by Siping, Heat Pump, SanDeKe, and two officers of the Chinese subsidiaries. | | | | | | | | | | From a commercial bank in the PRC for RMB 4,000,000 entered into on April 23, 2014. The loan bore interest at 7.2% with maturity on April 22, 2015. This loan was guaranteed by Siping, Heat Pump, SanDeKe, and two officers of the Chinese subsidiaries. | | | | | | | | | | | | | | | | | | | |
The banks sometimes require loan guarantee provided by a third party to the Companies, the third party loan guarantor was Liaoning Wugang Metal Trading Co., Ltd. (“Liaoning Wugang”), with a maximum guarantee of RMB 46 million ($7.32 million). The guarantee is for the loans entered from February 20, 2012 to August 16, 2013, with the guarantee length equal to the loan term; the guarantee service was extended for the loans entered or will be entered from September 18, 2013 to September 12, 2014 with the guarantee length equal to the loan term, the maximum guarantee amount was revised to RMB 44 million ($7.05 million). The Companies was not required to pay any guarantee fees. However, the Companies have contracted to provide similar guarantees for up to RMB 20 million ($3.18 million) to Liaoning Guorui Commercial Trading Co., Ltd. (“Guorui”). The guarantee is for the loans entered from January 12, 2012 to January 11, 2013 with the guarantee length equal to the loan term, the Companies do not require Guorui to pay any guarantee fees. The Companies did not extend the guarantee term for Guorui after January 11, 2013. These arrangements are common to the banking industry in China, and there are no other relationships between the Companies and Liaoning Wugang or Guorui, both of whom were referred to the Companies by the lending bank. As of September 30, 2014 and December 31, 2013, the Companies did not have any loan guarantees from Liaoning Wugang. Long-Term Bank Loan
Taiyu entered into a long-term loan of $2,112,962 (RMB 13 million) with China Construction Bank on November 30, 2013 with maturity on November 29, 2015. The interest rate for the loan is variable currently at 6.46%, and to be paid on the 20th of each month. This loan is guaranteed by Taiyu’s building and land.
15. DEFERRED TAX ASSET (LIABILITY)
Deferred tax asset (liability) represented differences between the tax bases and book bases of bad debt allowance and provision of inventory impairment booked by the Companies, which was not allowed per tax purpose. As of September 30, 2014 and December 31, 2013, deferred tax asset (liability) consisted of the following: | | 2014 | | | 2013 | | Deferred tax asset - current (bad debt allowance for accounts receivable) | | $ | 5,842,955 | | | $ | 7,267,745 | | Deferred tax asset - current (bad debt allowance for retention receivable) | | | 331,499 | | | | - | | Deferred tax asset - current (inventory allowance) | | | 2,286,710 | | | | 1,864,883 | | Deferred tax asset – current (allowance for other receivable) | | | 1,956,964 | | | | 1,534,723 | | Deferred tax asset – current (allowance for advance to supplier) | | | 396,653 | | | | 375,512 | | Deferred tax asset – current (reserve for warranty) | | | 39,135 | | | | 33,282 | | Deferred tax asset - noncurrent (impairment loss on long - lived assets) | | | - | | | | 3,025,845 | | Less: valuation allowance | | | (10,853,916 | ) | | | (14,101,990 | ) | Deferred tax assets, net | | $ | - | | | $ | - | |
16. INCOME TAXES
Taiyu is governed by the Income Tax Law of the PRC concerning privately-run enterprises, which are generally subject to tax at 25% on income reported in the statutory financial statements after appropriate tax adjustments. Under the Income Tax Law that became effective January 1, 2008, new high-tech enterprises given special support by the PRC government are subject to an income tax rate of 15%. Taiyu has been classified as a high-tech enterprise since 2009 and eligible for an income tax rate of 15% through 2014. Local PRC government reviews the high-tech status of such enterprises annually.
SmartHeat Siping and SmartHeat Energy are subject to the regular 25% PRC income tax rate.
The following table reconciles the statutory rates to the Companies’ effective tax (benefit) rate for the nine months ended September 30, 2014 and 2013: | | 2014 | | | 2013 | | PRC statutory benefit rates | | | (25.0 | )% | | | (25.0 | )% | Effect of tax holiday | | | 7.2 | % | | | 5.5 | % | Valuation allowance | | | 17.8 | % | | | 19.6 | % | Tax expense per financial statements | | | - | % | | | 0.1 | % |
The following table reconciles the statutory rates to the Companies’ effective tax (benefit) rate for the three months ended September 30, 2014 and 2013: | | 2014 | | | 2013 | | PRC statutory tax (benefit) rates | | | (25.0) | % | | | (25.0 | )% | Effect of tax holiday | | | 6.1 | % | | | 10.0 | % | Valuation allowance | | | 18.9 | % | | | 15.2 | % | Tax expense per financial statements | | | - | % | | | 0.2 | % |
17. STATUTORY RESERVES AND RESTRICTED NET ASSETS Relevant PRC statutory laws and regulations permit payments of dividends by the Companies to foreign holding company only out of the subsidiary’s retained earnings, if any, as determined in accordance with PRC accounting standards and regulations. The results of operations reflected in the financial statements prepared in accordance with U.S. GAAP differ from those reflected in the statutory financial statements of the Companies.
In accordance with the PRC Regulations on Enterprises with Foreign Investment and their articles of association, a foreign-invested enterprise (“FIE”) established in the PRC is required to provide certain statutory reserves, which are appropriated from net profit as reported in the FIE’s PRC statutory accounts. An FIE is required to allocate at least 10% of its annual after-tax profit to the surplus reserve until such reserve has reached 50% of its respective registered capital based on the FIE’s PRC statutory accounts. Appropriations to other funds are at the discretion of the board of directors for all FIEs. The aforementioned reserves can only be used for specific purposes and are not distributable as cash dividends. Additionally, shareholders of an FIE are required to contribute capital to satisfy the registered capital requirement of the FIE. Until such contribution of capital is satisfied, the FIE is not allowed to repatriate profits to its shareholders, unless otherwise approved by the State Administration of Foreign Exchange. Taiyu, SmartHeat Siping, and Ruicheng were established as FIEs and therefore are subject to the above-mandated restrictions on distributable profits. Additionally, in accordance with the Company Law of the PRC, a domestic enterprise is required to provide surplus reserve at least 10% of its annual after-tax profit until such reserve has reached 50% of its respective registered capital based on the enterprise’s PRC statutory accounts. A domestic enterprise is also required to provide discretionary surplus reserve, at the discretion of the board of directors, from the profits determined in accordance with the enterprise’s PRC statutory accounts. The aforementioned reserves can only be used for specific purposes and are not distributable as cash dividends. SmartHeat Energy was established as domestic enterprises and therefore is subject to the above-mentioned restrictions on distributable profits. As a result of these PRC laws and regulations that require annual appropriations of 10% of after-tax income to be set aside prior to payment of dividends as general reserve fund, the Companies are restricted in their ability to transfer a portion of their net assets to the foreign holding company as a dividend. 18. COMMITMENTS
Lease Agreements
The Companies leased offices for its sales representative in several different cities under various one-year, non-cancellable and renewable operating lease agreements. Rental expense for the nine months ended September 30, 2014 and 2013, was $157,493and $203,337, respectively. Rental expense for the three months ended September 30, 2014 and 2013, was $46,892 and $56,725, respectively.
19. CONTINGENCIES
The Companies’ operations in the PRC are subject to specific considerations and significant risks not typically associated with companies in North America and Western Europe. These include risks associated with, among others, the political, economic and legal environments in China and foreign currency exchange. The Companies results may be adversely affected by changes in PRC government 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 Companies’ sales, purchases and expense transactions in China are denominated in RMB and all of the Companies’ assets and liabilities in China are also denominated in RMB. The RMB is not freely convertible into foreign currencies under the current PRC 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. SUBSEQUENT EVENT
On November 28, 2014, SmartHeat entered into an Amended and Restated EIPA, which amended and restated the EIPA dated October 10, 2013 between SmartHeat and the buyers. Under the terms of the Amended EIPA, the buyers have agreed to purchase the remaining 60% of SmartHeat’s equity interests in the Companies. The purchase price for the remaining 60% consists of: (i) consideration of RMB8.5 million and (ii) the forgiveness of all net indebtedness owing to the Companies by SmartHeat and each of its other subsidiaries as of December 31, 2014.
The effectiveness of the transaction is subject to the following conditions: (i) approval of its shareholders and (ii) receipt by the BOD of SmartHeat of an opinion that the purchase and sale transaction is fair to the shareholders of SmartHeat from a financial point of view. The parties will execute a mutual release to be delivered at the closing which will provide, in part, for the Companies to forgive all net indebtedness from SmartHeat and all of its other subsidiaries. In the event that the conditions are not met prior to December 31, 2014, the consideration and all documents will be deposited into escrow and released when the conditions have been satisfied; provided that if the conditions are not satisfied on or before March 31, 2015, either party may terminate the Amended EIPA and the funds and documents will be returned to the depositing party. The Companies presently intends to continue to seek competing bids to the Amended EIPA. There is no assurance that any competing bid may be found or that a definitive agreement will be negotiated with such party.
SMARTHEAT TAIYU (SHENGYANG) ENERGY TECHNOLOGY CO., LTDSMARTHEAT SIPING BEIFANG ENERGY TECHNOLOGY CO., LTDSMARTHEAT (SHENGYANG) ENERGY EQUIPMENT CO., LTDCONSOLIDATED AND COMBINED BALANCE SHEETS | | December 31, 2013 | | | December 31, 2012 | | ASSETS | | | | | | | | | | | | | | CURRENT ASSETS | | | | | | | Cash & equivalents | | $ | 9,283,788 | | | $ | 14,291,095 | | Restricted cash | | | 2,345,258 | | | | 892,904 | | Accounts receivable, net | | | 14,822,112 | | | | 32,536,975 | | Retentions receivable | | | 4,141,585 | | | | 3,655,246 | | Advances to suppliers, net | | | 4,848,270 | | | | 669,993 | | Other receivables (net), prepayments and deposits | | | 26,344,942 | | | | 27,062,518 | | Inventories, net | | | 48,787,876 | | | | 51,066,467 | | Taxes receivable | | | 968,124 | | | | - | | Notes receivable - bank acceptances | | | 2,529,954 | | | | 2,192,810 | | | | | | | | | | | Total current assets | | | 114,071,909 | | | | 132,368,008 | | | | | | | | | | | NONCURRENT ASSETS | | | | | | | | | Restricted cash | | | 123,398 | | | | - | | Retentions receivable | | | - | | | | 421,731 | | Advance to supplier for equipment | | | - | | | | 1,744,056 | | Construction in progress | | | - | | | | 1,298,841 | | Property and equipment, net | | | - | | | | 8,981,251 | | Intangible assets, net | | | 10,320,173 | | | | 14,076,547 | | | | | | | | | | | Total noncurrent assets | | | 10,443,571 | | | | 26,522,426 | | | | | | | | | | | TOTAL ASSETS | | $ | 124,515,480 | | | $ | 158,890,434 | | | | | | | | | | | | | | | | | | | | LIABILITIES AND STOCKHOLDERS' EQUITY | | | | | | | | | | | | | | | | | | CURRENT LIABILITIES | | | | | | | | | Accounts payable | | $ | 7,474,235 | | | $ | 8,202,196 | | Advance from customers | | | 1,875,894 | | | | 4,583,158 | | Taxes payable | | | 130,379 | | | | 729,138 | | Accrued liabilities and other payables | | | 30,938,077 | | | | 18,036,278 | | Notes payable - bank acceptances | | | 2,590,025 | | | | 736,698 | | Loans payable | | | 24,462,299 | | | | 26,155,437 | | | | | | | | | | | Total current liabilities | | | 67,470,909 | | | | 58,442,905 | | | | | | | | | | | LONG-TERM LOAN | | | 2,132,231 | | | | - | | | | | | | | | | | COMMITMENTS AND CONTINGENCIES | | | | | | | | | | | | | | | | | | STOCKHOLDERS' EQUITY | | | | | | | | | Paid-in capital | | | 59,341,363 | | | | 77,340,955 | | Statutory reserve | | | 4,608,375 | | | | 4,615,331 | | Accumulated other comprehensive income | | | 7,517,274 | | | | 9,985,797 | | Retained earning (accumulated deficit) | | | (38,647,146 | ) | | | 7,703,059 | | | | | | | | | | | Total Company stockholders' equity | | | 32,819,866 | | | | 99,645,142 | | | | | | | | | | | NONCONTROLLING INTEREST | | | 22,092,474 | | | | 802,387 | | | | | | | | | | | TOTAL EQUITY | | | 54,912,340 | | | | 100,447,529 | | | | | | | | | | | TOTAL LIABILITIES AND EQUITY | | $ | 124,515,480 | | | $ | 158,890,434 | |
SMARTHEAT TAIYU (SHENGYANG) ENERGY TECHNOLOGY CO., LTDSMARTHEAT SIPING BEIFANG ENERGY TECHNOLOGY CO., LTDSMARTHEAT (SHENGYANG) ENERGY EQUIPMENT CO., LTDCONSOLIDATED AND COMBINED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS) | | YEARS ENDED DECEMBER 31, | | | | 2013 | | | 2012 | | | | | | | | | Net sales | | $ | 38,915,416 | | | $ | 39,877,236 | | Cost of goods sold | | | 35,659,348 | | | | 24,603,587 | | | | | | | | | | | Gross profit | | | 3,256,068 | | | | 15,273,649 | | | | | | | | | | | Operating expenses | | | | | | | | | Selling | | | 5,084,636 | | | | 7,704,390 | | General and administrative | | | 5,582,360 | | | | 5,985,893 | | Long-lived assets impairment | | | 13,730,849 | | | | - | | Provision for bad debts | | | 24,638,062 | | | | 18,499,039 | | Provision for advance to supplier | | | (682,973 | ) | | | 2,216,156 | | | | | | | | | | | Total operating expenses | | | 48,352,934 | | | | 34,405,478 | | | | | | | | | | | Loss from operations | | | (45,096,866 | ) | | | (19,131,829 | ) | | | | | | | | | | Non-operating income (expenses) | | | | | | | | | Interest income | | | 79,704 | | | | 190,574 | | Interest expense | | | (1,758,210 | ) | | | (1,644,001 | ) | Financial expense | | | (73,567 | ) | | | (20,259 | ) | Foreign exchange transaction gain (loss) | | | (9,478 | ) | | | 5,069 | | Other income, net | | | 470,730 | | | | 1,298,210 | | | | | | | | | | | Total non-operating expenses, net | | | (1,290,821 | ) | | | (170,407 | ) | | | | | | | | | | Loss before income tax | | | (46,387,687 | ) | | | (19,302,236 | ) | Income tax expense | | | 26,725 | | | | 585,892 | | | | | | | | | | | Net loss before noncontrolling interest | | | (46,414,412 | ) | | | (19,888,128 | ) | Less: Loss attributable to noncontrolling interest | | | (5,798,050 | ) | | | (737 | ) | | | | | | | | | | Net loss to SmartHeat Inc. - disposed entities | | | (40,616,362 | ) | | | (19,887,391 | ) | | | | | | | | | | Other comprehensive item | | | | | | | | | Foreign currency translation gain (loss) attributable to SmartHeat Inc. - disposed entities | | | (2,427,319 | ) | | | 442,960 | | | | | | | | | | | Foreign currency translation gain attributable to noncontrolling interest of disposed entities | | | 18,939 | | | | 1,960 | | | | | | | | | | | Comprehensive loss attributable to SmartHeat Inc. - disposed entities | | $ | (43,043,681 | ) | | $ | (19,444,431 | ) | | | | | | | | | | Comprehensive income (loss) attributable to noncontrolling interest of disposed entities | | $ | (5,779,111 | ) | | $ | 1,223 | |
SMARTHEAT TAIYU (SHENGYANG) ENERGY TECHNOLOGY CO., LTDSMARTHEAT SIPING BEIFANG ENERGY TECHNOLOGY CO., LTDSMARTHEAT (SHENGYANG) ENERGY EQUIPMENT CO., LTDCONSOLIDATED AND COMBINED STATEMENTS OF CASH FLOWS | | YEARS ENDED DECEMBER 31, | | | | 2013 | | | 2012 | | | | | | | | | CASH FLOWS FROM OPERATING ACTIVITIES: | | | | | | | Loss including noncontrolling interest | | $ | (46,414,412 | ) | | $ | (19,888,128 | ) | Adjustments to reconcile loss including noncontrolling interest to net cash used in operating activities: | | | | | | | | | Depreciation and amortization | | | 1,458,014 | | | | 1,452,929 | | Long-lived assets impairment | | | 13,730,849 | | | | - | | Provision for bad debts | | | 24,638,062 | | | | 18,499,039 | | Provision for inventory impairment | | | 5,934,938 | | | | 208,159 | | Provision for advance to suppliers | | | (682,973 | ) | | | 2,216,156 | | Loss on disposal of fixed assets | | | 19,133 | | | | - | | Unearned interest on accounts receivable | | | 26,755 | | | | (45,244 | ) | (Increase) decrease in assets and liabilities: | | | | | | | | | Accounts receivable | | | (898,871 | ) | | | (2,921,154 | ) | Retentions receivable | | | 60,346 | | | | 5,543 | | Advances to suppliers | | | (1,645,706 | ) | | | 10,623,901 | | Other receivables, prepayments and deposits | | | (4,461,236 | ) | | | (7,681,929 | ) | Inventories | | | (2,271,248 | ) | | | (6,512,366 | ) | Accounts payable | | | 1,156,897 | | | | (4,729,599 | ) | Advance from customers | | | (2,795,259 | ) | | | 1,127,240 | | Taxes payable | | | (1,520,422 | ) | | | (286,567 | ) | Accrued liabilities and other payables | | | 11,447,934 | | | | 260,830 | | | | | | | | | | | Net cash used in operating activities | | | (2,217,199 | ) | | | (7,671,190 | ) | | | | | | | | | | CASH FLOWS FROM INVESTING ACTIVITIES: | | | | | | | | | Change in restricted cash | | | (1,518,908 | ) | | | 1,776,838 | | Acquisition of property & equipment | | | (589,621 | ) | | | (723,046 | ) | Cash paid for construction in progress | | | (1,851 | ) | | | (771,370 | ) | Cash disposed from equity interest sale | | | (399,241 | ) | | | - | | Notes receivable | | | (264,229 | ) | | | (666,355 | ) | | | | | | | | | | Net cash used in investing activities | | | (2,773,850 | ) | | | (383,933 | ) | | | | | | | | | | CASH FLOWS FROM FINANCING ACTIVITIES: | | | | | | | | | Proceeds from bank loans | | | 24,483,311 | | | | 22,400,000 | | Repayment on bank loans | | | (24,846,320 | ) | | | (9,029,703 | ) | Notes payable | | | - | | | | (2,538,661 | ) | Capital contribution | | | - | | | | 1,700,050 | | | | | | | | | | | Net cash (used in) provided by financing activities | | | (363,009 | ) | | | 12,531,686 | | | | | | | | | | | EFFECT OF EXCHANGE RATE CHANGE ON CASH & EQUIVALENTS | | | 346,751 | | | | 44,329 | | | | | | | | | | | NET (DECREASE) INCREASE IN CASH & EQUIVALENTS | | | (5,007,307 | ) | | | 4,520,892 | | | | | | | | | | | CASH & EQUIVALENTS, BEGINNING OF YEAR | | | 14,291,095 | | | | 9,770,203 | | | | | | | | | | | CASH & EQUIVALENTS, END OF YEAR | | $ | 9,283,788 | | | $ | 14,291,095 | | | | | | | | | | | Supplemental cash flow data: | | | | | | | | | Income tax paid | | $ | 720,001 | | | $ | 325,309 | | Interest paid | | $ | 1,663,459 | | | $ | 1,644,001 | |
SMARTHEAT TAIYU (SHENGYANG) ENERGY TECHNOLOGY CO., LTD SMARTHEAT SIPING BEIFANG ENERGY TECHNOLOGY CO., LTD SMARTHEAT (SHENGYANG) ENERGY EQUIPMENT CO., LTD NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS DECEMBER 31, 2013 AND 2012 (UNAUDITED) 1. ORGANIZATION AND DESCRIPTION OF BUSINESS SmartHeat Taiyu (Shenyang) Energy Technology Co., Ltd. (“Taiyu”), is engaged in the design, manufacture, sale and servicing of plate heat exchange (“PHE”) products in China, Taiyu merged with SmartHeat Inc. (“SmartHeat”) on April 14, 2008. SmartHeat Siping Beifang Energy Technology Co., Ltd. (“SmartHeat Siping”), was incorporated on June 12, 2009 by SmartHeat, and is engaged in manufacture of PHEs. SmartHeat (Shenyang) Energy Equipment Co., Ltd. (“SmartHeat Energy”), was incorporated on April 12, 2010 by one of SmartHeat’s subsidiary - SmartHeat (China) Investment Co., Ltd. (“SmartHeat Investment”), and is engaged in research, development, manufacturing and sales of energy products. Hohhot Ruicheng Technology Co., Ltd. (“Ruicheng”), is a joint venture with 51% invested by SmartHeat on January 7, 2011, and is engaged in the design and manufacture of heat meters. Urumchi XinRui Technology Limited Liability Company (“XinRui”), is a joint venture with 46% invested by SmartHeat in April 2012, and is engaged in research and development, production and selling of heat meters and automatic control of heat supply network (collectively, the “Companies”). On August 23, 2013, SmartHeat formed two new wholly-owned subsidiaries in the State of Nevada, Heat HP Inc., and HEAT PHE Inc. On August 23, 2013, SmartHeat Inc., the Companies United States parent company entered into Assignment Agreements with Heat HP Inc. and Heat PHE Inc., respectively. Under the Assignment Agreements, SmartHeat agreed to transfer 100% of its right, title and interest in certain subsidiaries to Heat HP Inc. and Heat PHE Inc. The reorganization was performed so SmartHeat’s subsidiaries would be organized along their respective operating segments with Heat HP holding those subsidiaries that operated in the heat pumps and related products segment and Heat PHE holding those subsidiaries that operated in the plate heating equipment, meters and related products segment. After the assignment and prior to the 40% equity interest sale of Taiyu, SmartHeat Siping, SmartHeat Energy, Ruicheng and XinRui on December 30, 2013, Heat PHE Inc., owned 100% of Taiyu, SmartHeat Siping, SmartHeat Energy and 51% of Hohot Ruicheng, and SmartHeat owned 46% of XinRui. On December 30, 2013, SmartHeat closed the transaction contemplated by the Equity Interest Purchase Agreement (“EIPA”) dated October 10, 2013, whereby the buyers purchased 40% of the equity interests in Taiyu, SmartHeat Siping, SmartHeat Energy, Ruicheng and XinRui. The purchase price was RMB 5,000,000. On November 28, 2014, SmartHeat entered into an Amended and Restated EIPA, which amended and restated the EIPA dated October 10, 2013 between SmartHeat and the buyers. Under the terms of the Amended EIPA, the buyers have agreed to purchase the remaining 60% of SmartHeat’s equity interests in the Companies effective as of December 31, 2014 (the “Closing Date”). The purchase price for the remaining 60% consists of: (i) consideration of RMB8.5 million and (ii) the forgiveness of all net indebtedness owing to the Companies by SmartHeat and each of its other subsidiaries as of December 31, 2014 subject to termination provisions as set forth in EIPA. The transaction resulted in an expected a loss of $42.31 million from the 100% equity interest sale of the sold entities consisting of a $50.15 million loss on sale resulting from the difference of the total selling price and the net assets of sold entities, netted off with the $7.84 million the forgiveness of all net indebtedness owing to the sold entities by SmartHeat and each of its other subsidiaries. The effectiveness of the transaction is subject to the following conditions: (i) approval of SmartHeat’s shareholders and (ii) receipt by the Board of Directors (“BOD” or the “Board”) of SmartHeat of an opinion that the purchase and sale transaction is fair to the shareholders of SmartHeat from a financial point of view. The parties will execute a mutual release to be delivered at the closing which will provide, in part, for the Companies to forgive all net indebtedness from SmartHeat and all of its other subsidiaries. In the event that the conditions are not met prior to December 31, 2014, the consideration and all documents will be deposited into escrow and released when the conditions have been satisfied; provided that if the conditions are not satisfied on or before March 31, 2015, either party may terminate the Amended EIPA and the funds and documents will be returned to the depositing party. The buyers consist of a group of 25 natural persons, all of whom are P.R.C. citizens, including Wen Sha, Jun Wang and Xudong Wang, managers of the SmartHeat’s subsidiaries engaged in the PHE segment of its business, and Huajuan Ai and Yingkai Wang, the SmartHeat’s Corporate Secretary and Acting Chief Accountant, respectively. Huajuan Ai, Wen Sha, Jun Wang and Xudong Wang are also principals in Northtech Holdings Inc. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Basis of Presentation The unaudited consolidated financial statements were prepared in accordance with generally accepted accounting principles in the United States of America (“U.S. GAAP”). In the opinion of management, all adjustments (which include normal recurring adjustments) necessary to present a fair statement of the Companies consolidated and combined financial position as of December 31, 2013 and 2012, its consolidated and combined results of operations and cash flows for the years ended December 31, 2013 and 2012, as applicable, were made. Principles of Consolidation The accompanying unaudited consolidated and combined financial statements include the accounts of Taiyu, SmartHeat Siping, and SmartHeat Shenyang Energy as of December 31, 2013; and included accounts of Taiyu, SmartHeat Siping, SmartHeat Shenyang Energy and Ruicheng (51% owned) as of December 31, 2012, which are collectively referred to as the “Companies.” All significant intercompany accounts and transactions were eliminated in consolidation. The Companies follow Financial Accounting Standards Board’s (“FASB”) Accounting Standards Codification (“ASC”) Topic 810, “Consolidation,” which established new standards governing the accounting for and reporting of noncontrolling interests (“NCIs”) in partially owned consolidated subsidiaries and the loss of control of subsidiaries. Certain provisions of this standard indicate, among other things, that NCIs, previously referred to as minority interests, be treated as a separate component of equity, not as a liability, as was previously the case, that increases and decreases in the parent’s ownership interest that leave control intact be treated as equity transactions rather than as step acquisitions or dilution gains or losses and that losses of a partially owned consolidated subsidiary be allocated to the NCI even when such allocation might result in a deficit balance. This standard also required changes to certain presentation and disclosure requirements. Losses attributable to the NCI in a subsidiary may exceed the NCI’s interests in the subsidiary’s equity. The excess attributable to the NCI is attributed to those interests. The NCI shall continue to be attributed its share of losses even if that attribution results in a deficit NCI balance. As of December 31, 2012, the Companies’ noncontrolling interest consisted of 49% of Ruicheng. After the sale of 40% equity interest of Taiyu, Siping, SmartHeat Energy, Ruicheng and Xinrui on December 30, 2013, the Companies’ noncontrolling interest consisted of 40% of Taiyu, Siping and SmartHeat Energy since then. For accounting purposes net loss of Taiyu, Siping, SmartHeat Energy were not allocated to noncontrolling interest between December 30, 2013 and December 31, 2013, as the change in ownership interest may not change financial results materially between December 30, 2013 and December 31, 2013. However, the Companies performed long-lived assets impairment test for Taiyu, Siping, Shengyang Energy on December 31, 2013, and recognized $13.73 million impairment loss out of which $5.49 million allocated to noncontrolling interest on December 31, 2013. Use of Estimates In preparing the financial statements in conformity with U.S. GAAP, management makes estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the dates of the financial statements, as well as the reported amounts of revenues and expenses during the reporting period. Significant estimates, required by management, include the recoverability of long-lived assets, allowance for doubtful accounts and the reserve for obsolete and slow-moving inventories. Actual results could differ from those estimates. Cash and Equivalents For purposes of the statement of cash flows, the Companies consider all highly liquid investments with an original maturity of three months or less to be cash equivalents. As of December 31, 2013 and 2012, the Companies maintained restricted cash deposit in several bank accounts for the purposes described below. | | 2013 | | | 2012 | | | | (In millions) | | Support of performance guarantee | | $ | 1.04 | | | $ | 0.52 | | Support of bank acceptance | | | 1.30 | | | | 0.37 | | Support of letter of credit | | | 0.01 | | | | - | | Total restricted cash - current | | $ | 2.35 | | | $ | 0.89 | | Performance guarantee -- noncurrent | | $ | 0.12 | | | $ | - | |
Accounts and Retentions Receivable The Companies maintain reserves for potential credit losses on accounts receivable. Management reviews the composition of accounts receivable and analyzes historical bad debts, customer concentrations, customer credit worthiness, current economic trends and changes in customer payment patterns to evaluate the adequacy of these reserves. Based on historical collection activity, the Companies had allowances of $46.42 million and $26.72 million at December 31, 2013 and 2012, respectively. At December 31, 2013 and 2012, the Companies had retentions receivable from customers for product quality assurance of $4.14 and $4.08 million, respectively. The retention rate varies from 5% to 20% of the sales price with variable terms from 3 to 24 months depending on the shipping date, and for PHE Units, the customer acceptance date, of the products and the number of heating seasons that the warranty period covers. The Companies had allowances of $0 at December 31, 2013 and 2012. Accounts receivable is net of unearned interest which is imputed interest on accounts receivable with due dates over 1 year from the invoice date discounted at the Companies’ borrowing rate of 6.15% at December 31, 2012. The Companies did not record additional unearned interest after December 31, 2012 due to no long-term accounts receivable.
As of December 31, 2013, the Companies had accounts receivable of $3.45 million from the remaining subsidiaries of SmartHeat and accounts payable of $1.55 million to the remaining subsidiaries of SmartHeat. The Companies record approximately 50% of accounts receivable aged over 180 days from the payment due date and 100% accounts receivable aged over 360 days from the payment due date as bad debt allowance. Management of the Companies further analyzes each individual customer for which it was taken a bad debt allowance to further assess the likelihood of collectability. Customers which are either state-owned or have a history of support from the state, or larger companies with long operating histories, that management of the Companies believe the chance of non-payment will be remote, are excluded for the purpose of calculating bad debt allowance. Advance to Suppliers The Companies make advances to certain vendors to purchase raw material and equipment for production. The advances are interest-free and unsecured. Inventories Inventories are valued at the lower of cost or market, with cost determined on a moving weighted-average basis. The difference is recorded as a cost of goods sold, if the current market value is lower than their historical cost. In addition, the Companies make an inventory impairment provision analysis at each period end for inventory held over 360 days. Cost of work in progress and finished goods comprises direct material, direct labor and an allocated portion of production overheads. Certain raw materials, such as stainless steel products, plates, shims, gaskets, and pump valves, require longer than normal procurement periods, or “lead times,” with some procurement periods running longer than six months. To guarantee availability of raw materials for production and sales, the Companies, based on historical sale patterns, estimate and purchase material for the upcoming period. As part of inventory impairment analysis, the Companies perform an evaluation of raw materials stored over one year and not anticipated to be consumed, and an evaluation of potential impairment to the quality of these raw materials. If management anticipates that obsolete raw materials in inventory can be utilized and will be consumed within the next six months through new customer orders or substitute orders, no impairment is recorded. The Companies collect information about delayed and canceled contracts and met with affected customers to discuss their financing situation and their projections of future orders. Finished goods manufactured for delayed and canceled contracts that the Companies do not expect to be reinstated and contracts for which the Companies have been unable to find substitute customers become impaired. 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 with a 10% salvage value and estimated lives as follows: Buildings | 20 years | Vehicles | 5 years | Office equipment | 5 years | Production equipment | 5-10 years |
Land Use Rights Right to use land is stated at cost less accumulated amortization. Amortization is provided using the straight-line method over 50 years.
Impairment of Long-Lived Assets
Long-lived assets, which include tangible assets, such as property, plant and equipment, goodwill and other intangible assets, are reviewed for impairment whenever events or changes in circumstances indicate the carrying amount of an asset may not be recoverable. Recoverability of long-lived assets to be held and used is measured by comparing the carrying amount of an asset to the estimated undiscounted future cash flows expected to be generated by the asset. If the carrying amount of an asset exceeds its estimated undiscounted future cash flows, an impairment charge is recognized based on the excess of the carrying amount over the fair value (“FV”) of the assets. FV generally is determined using the asset’s expected future discounted cash flows or market value, if readily determinable. The Companies evaluates intangible assets with indefinite lives for impairment annually using a two-step approach (codified in FASB ASC Topic 350). On December 30, 2013, SmartHeat closed the transaction contemplated by the EIPA dated October 10, 2013, whereby the buyers purchased 40% of SmartHeat’s equity interests in Taiyu, Siping, SmartHeat Energy, Ruicheng and XinRui for the purchase price of RMB 5,000,000 ($0.82 million) (See Note 1). The buyers had the option to purchase remaining 60% equity interest in the Companies for an additional purchase price of RMB 8.5 million. According to ASC 360-10-35, a long-lived asset (asset group) shall be tested for recoverability whenever events or changes in circumstances indicate that its carrying amount may not be recoverable. The Companies believed the following events or changes in circumstances indicated the carrying amount of their long-lived assets (asset group) may not be recoverable: 1) a current expectation that, more likely than not, a long-lived assets (asset group) will be sold or otherwise disposed of significantly before the end of its previously estimated useful life, and 2) A significant decrease in the market price of a long-lived asset (asset group). Since SmartHeat has the option to sell 100% ownership in Companies for RMB 13.5 million ($2.21 million), a significant decrease in the market price, before the end of its previously estimated useful life for their long-lived assets, the Companies therefore performed assets recoverability testing by comparing the assets estimated future undiscounted cash flows with their carrying value, and concluded the long-lived assets were not recoverable as a result of future cash flows are less than the carrying amount. The Companies further calculated the impairment loss amount by determining the fair value for the long-lived asset group and recorded a write-down (loss) for the difference between their carrying value and their fair value. Fair value is an asset’s purchase or sale price in a current transaction between willing parties. The best evidence of fair value is prices quoted in active markets, although SmartHeat has the option to sell 100% ownership in Companies for RMB 13.5 million ($2.21 million), the market prices are not available for many long-lived assets such as equipment, the Companies therefore used discounted cash flow method for estimating fair value of long-lived assets which are acceptable under ASC 360-10. Based on the evaluation, the Companies believed, as of December 31, 2013, the long-lived assets of Companies including construction in progress, property and equipment, and intangible assets were impaired for $13.73 million. Warranties The Companies offer to all customers standard warranties on its products for one or two heating seasons depending on the terms negotiated. The Companies accrue for warranty costs based on estimates of the costs that may be incurred under its warranty obligations. The warranty expense and related accrual is included in the Companies’ selling expenses and other payables respectively, and is recorded when revenue is recognized. Factors that affect the Companies’ warranty liability include the number of units sold, its estimates of anticipated rates of warranty claims, costs per claim and estimated support labor costs and the associated overhead. The Companies periodically assess the adequacy of its recorded warranty liabilities and adjusts the amounts as necessary. Activity in the Companies’ warranty reserve from January 1, 2012, to December 31, 2013, is as follows: | | 2013 | | | 2012 | | Beginning balance | | $ | 282,739 | | | $ | 282,739 | | Provisions | | | 301,920 | | | | 271,968 | | Actual costs incurred | | | (265,813 | ) | | | (271,968 | ) | Ending balance in current liabilities (Note 12) | | $ | 318,846 | | | $ | 282,739 | |
Research and Development Costs Research and development (“R&D”) costs are expensed as incurred and included in general and administrative expenses. These costs primarily consist of cost of materials used, salaries paid for the Companies’ development department and fees paid to third parties. R&D costs for the years ended December 31, 2013 and 2012, were $1,424,438 and $1,501,953, respectively. Revenue Recognition The Companies’ revenue recognition policies comply with SEC Staff Accounting Bulletin (“SAB”) 104 (codified in FASB ASC Topic 605). Sales revenue is recognized when PHEs are delivered, and for PHE Units when customer acceptance occurs, the price is fixed or determinable, no other significant obligations of the Companies exist and collectability is reasonably assured. Payments received before all of the relevant criteria for revenue recognition met are recorded as unearned revenue under “Advance from customers.” The Companies’ sales generally provide for 30% of the purchase price on placement of an order, 30% on delivery, 30% upon installation and acceptance of the equipment after customer testing and 10% no later than the termination of the standard warranty period, which ranges from 3 to 24 months from the acceptance date. Due to the slowdown of the Chinese economy and tightened monetary policy, and to attract and retain customers, the Companies’ subsidiaries adjusted their contract and payment terms to permit more flexible and longer payment terms. Sales revenue is the invoiced value of goods, net of value-added tax (“VAT”). All of the Companies’ products sold in the PRC are subject to a VAT of 17% of gross sales price. This VAT may be offset by the VAT paid by the Companies on raw materials and other materials purchased in China and included in the cost of producing the Companies’ finished product. The Companies recorded VAT payable and VAT receivable net of payments in the financial statements. The Companies file VAT tax returns on line with PRC tax authorities and offsets the payables against the receivables. Sales and purchases are recorded net of VAT collected and paid as the Companies act as an agent for the government. VAT taxes are not affected by the income tax holiday. Sales returns and allowances were $0 for the years ended December 31, 2013 and 2012. The Companies do not provide a right of return, price protection or any other concessions to its customers. The Companies provide a standard warranty to all customers, which is not considered an additional service; rather, an integral part of the product’s sale. The Companies believe the existence of its standard product warranty in a sales contract does not constitute a deliverable in the arrangement and thus there is no need to apply the EITF 00-21 (codified in FASB ASC Topic 605-25) separation and allocation model for a multiple deliverable arrangement. SFAS 5 (codified in FASB ASC Topic 450) specifically addresses the accounting for standard warranties and neither SAB 104 nor EITF 00-21 supersedes SFAS 5. The Companies believe that accounting for its standard warranty pursuant to SFAS 5 does not impact revenue recognition because the cost of honoring the warranty can be reliably estimated. The Companies charge for after-sales services provided after the expiration of the warranty period, with after-sales services mainly consisting of cleaning PHEs and repairing and exchanging parts. The Companies recognize such revenue when the service is provided. For the years ended December 31, 2013 and 2012, revenue from after-sales services after the expiration of the warranty period was $23,336 and $233,029, respectively, which was recorded in other income. Cost of Goods Sold Cost of goods sold (“COGS”) consists primarily of material costs and direct labor and manufacturing overhead that are directly attributable to the products. Write-down of inventories to the lower of cost or market is also recorded in COGS. The Companies also record inventory reserve for inventories aging over 360 days to COGS. Advance from Customers The Companies record payments received from customers in advance of their orders to advance account. These orders normally are delivered within a reasonable period of time based upon contract terms and customer demand. In accordance with SFAS No. 95, “Statement of Cash Flows,” codified in FASB ASC Topic 230, cash flows from the Companies’ operations are calculated based upon the local currencies. As a result, amounts shown on the statement of cash flows may not necessarily agree with changes in the corresponding asset and liability on the balance sheet. Foreign Currency Translation and Comprehensive Income (Loss) The accounts of the Companies were translated into USD in accordance with SFAS No. 52, “Foreign Currency Translation” (codified in FASB ASC Topic 830). According to SFAS No. 52, all assets and liabilities were translated at the exchange rate on the balance sheet date, stockholders’ equity was translated at the historical rates and statement of operations items were translated at the average exchange rate for the period. The resulting translation adjustments are reported under other comprehensive income in accordance with SFAS No. 130, “Reporting Comprehensive Income” (codified in FASB ASC Topic 220). The RMB to USD exchange rates in effect as of December 31, 2013 and 2012, and the average exchange rates for the years ended December, 2013 and 2012 are as following. The exchange rates used in translation from RMB to USD were published by State Administration of Foreign Exchange of the People’s Republic of China (“SAFE”). | | Average Exchange Rate | | | Balance Sheet Date | | | | For the Year Ended | | | Exchange Rate | | | | 12/31/13 | | | 12/31/12 | | | 12/31/13 | | | 12/31/12 | | RMB - USD | | | 6.2142 | | | | 6.3125 | | | | 6.0969 | | | | 6.2855 | |
New Accounting Pronouncements In January 2014, FASB issued, Accounting Standards Update 2014-01, Investments—Equity Method and Joint Ventures (Topic 323), Accounting for Investments in Qualified Affordable Housing Projects. The objective of this Update is to provide guidance on accounting for investments by a reporting entity in flow-through limited liability entities that manage or invest in affordable housing projects that qualify for the low-income housing tax credit. The amendments in this Update permit reporting entities to make an accounting policy election to account for their investments in qualified affordable housing projects using the proportional amortization method if certain conditions are met. The amendments in this Update should be applied retrospectively to all periods presented. A reporting entity that uses the effective yield method to account for its investments in qualified affordable housing projects before the date of adoption may continue to apply the effective yield method for those preexisting investments. The amendments in this Update are effective for public business entities for annual periods and interim reporting periods within those annual periods, beginning after December 15, 2014. The adoption of this ASU will not affect the Companies’ financial statements. In January 2014, FASB issued, Accounting Standards Update 2014-05, Service Concession Arrangements (Topic 853). The objective of this Update is to specify that an operating entity should not account for a service concession arrangement within the scope of this Update as a lease in accordance with Topic 840, Leases. Service concession arrangements may become more prevalent in the United States as public-sector entities seek alternative ways to provide public services on a more efficient and cost-effective basis. The amendments apply to an operating entity of a service concession arrangement entered into with a public-sector entity grantor when the arrangement meets certain conditions. The amendments in this Update should be applied on a modified retrospective basis to service concession arrangements that exist at the beginning of an entity’s fiscal year of adoption. The modified retrospective approach requires the cumulative effect of applying this Update to arrangements existing at the beginning of the period of adoption to be recognized as an adjustment to the opening retained earnings balance for the annual period of adoption. The amendments are effective for a public business entity for annual periods, and interim periods within those annual periods, beginning after December 15, 2014. The adoption of this ASU will not affect the Companies’ financial statements. Inventories at December 31, 2013 and 2012, were as follows: | | 2013 | | | 2012 | | Raw materials | | $ | 41,378,896 | | | $ | 32,754,840 | | Work in process | | | 6,216,166 | | | | 9,303,262 | | Finished goods | | | 10,684,380 | | | | 12,999,188 | | Total | | | 58,279,442 | | | | 55,057,290 | | Inventory allowance | | | (9,491,566 | ) | | | (3,990,823 | ) | Inventories, net | | $ | 48,787,876 | | | $ | 51,066,467 | |
4. NOTES RECEIVABLE – BANK ACCEPTANCES The Companies sold goods to its customers and received commercial notes (bank acceptance) from them in lieu of payments for accounts receivable. The Companies discounted the commercial notes with the bank or endorsed the commercial notes to vendors for payment of their own obligations or to get cash from third parties. Most of the commercial notes have a maturity of less than six months. As of December 31, 2013, the Companies were contingently liable for the notes endorsed to vendors of $1.37 million. 5. PROPERTY AND EQUIPMENT, NET Property and equipment consisted of the following at December 31, 2013 and 2012: | | 2013 | | | 2012 | | Buildings | | $ | 4,980,184 | | | $ | 4,830,751 | | Production equipment | | | 6,593,287 | | | | 6,034,488 | | Office equipment | | | 918,728 | | | | 921,933 | | Vehicles | | | 693,210 | | | | 692,965 | | Total | | | 13,185,409 | | | | 12,480,137 | | Less: accumulated depreciation | | | (4,638,369 | ) | | | (3,498,886 | ) | Less: Impairment | | | (8,547,040) | | | | - | | Property & equipment, net | | $ | - | | | $ | 8,981,251 | |
Depreciation for the years ended December 31, 2013 and 2012 was $1,057,000 and $1,036,000, respectively. 6. OTHER RECEIVABLES, PREPAYMENTS AND DEPOSITS Other receivables, prepayments and deposits consisted of the following at December 31, 2013 and 2012, respectively: | | 2013 | | | 2012 | | Advance to third parties | | $ | 10,059,572 | | | $ | 4,813,659 | | Deposit for public bids of sales contracts | | | 704,175 | | | | 1,375,101 | | Prepayment for freight, insurance, advertisement and consulting expenses | | | 17,446 | | | | 183,099 | | Other deposits | | | 51,724 | | | | 82,929 | | Advance to employees | | | 588,114 | | | | 701,553 | | Advance to HP segment | | | 21,900,731 | | | | 20,840,202 | | Others | | | 580,681 | | | | 342,120 | | Total | | | 33,902,443 | | | | 28,338,663 | | Less: bad debt allowance | | | (7,557,501 | ) | | | (1,276,145 | ) | Other receivables (net), prepayments & deposits | | $ | 26,344,942 | | | $ | 27,062,518 | |
Advance to third parties were short-term unsecured advances to unrelated parties with payment usually due within a year and includes an advance to Siping Beifang of RMB 22.13 million ($3.63 million) that is non-interest bearing and with due date extended to the end of 2014. Deposits for public bidding represented the deposits for bidding on expected contracts, which will be returned to the Companies after the bidding process is completed, usually within three to four months from the payment date. Prepayment for freight, related insurance expenses and advertisement represented prepaid shipping and freight insurance expenses for customers and is generally repaid upon customer receipt of products and prepaid advertising expense. Other deposits mainly consisted of deposits for rents, payroll expense and utilities. Advance to employees represented short-term loans to employees and advances for business trips and related expenses. Advance to HP segment represented receivables from other subsidiaries of SmartHeat Inc, including $14.44 million receivable from Heat HP, Inc. for transferring the 98.8% ownership of SmartHeat (Shenyang) Heat Pump Technology Co., Ltd. (“SmartHeat Pump”) by Taiyu to Heat HP Inc., the transfer is not completed as of this report date. Other receivables (consisting of advance to third parties and employees, deposit for public bids and others), prepayments and deposits are reimbursed or settled within 12 months. Intangible assets consisted mainly of land use rights, trademarks, computer software, know-how technology, customer lists and covenants not to compete. All land in the PRC is government-owned and cannot be sold to any individual or company. However, the government grants the user a “land use right” to use the land. Taiyu acquired land use rights during 2005 for RMB 3,549,682 ($0.44 million). In June 2009, SmartHeat Siping acquired land use rights for $3.1 million from SipingBeifang. In November 2010, SmartHeat Energy, acquired land use rights for $10.10 million. The Companies have the right to use the land for 50 years and is amortizing such rights on a straight-line basis for 50 years.
SmartHeat Energy later cancelled the purchase of the land use right due to the adjustments of the overall development plan of the area by the local authority. On May 21, 2014, SmartHeat Energy and Shenyang City Development and Land Resource Bureau Economy and Technology Development Office entered into an official agreement, whereby full purchase price of the land use right would be returned to SmartHeat Energy in installments within five days from the effective date of the official agreement. SmartHeat Energy will make the ownership change of the land use right upon receiving the refund from the local authority. SmartHeat Energy received total amount of $14.89 million (RMB 91.62 million) as of September 30, 2014 and is in the process of title transfer, which is expected to complete by the end of 2014. Currently the land is used by the third party. Intangible assets consisted of the following at December 31, 2013 and 2012, respectively: | Estimated Useful Life (In years) | | 2013 | | | 2012 | | Land use rights | 50 | | $ | 15,167,552 | | | $ | 14,712,441 | | Software | 5 | | | 510,594 | | | | 477,173 | | Total | | | | 15,678,146 | | | | 15,189,614 | | Less: accumulated amortization | | | | (1,515,069 | ) | | | (1,113,067 | ) | Less: impairment | | | | (3,842,904 | ) | | | - | | Intangible assets, net | | | $ | 10,320,173 | | | $ | 14,076,547 | |
Amortization of intangible assets for the years ended December 31, 2013 and 2012, was $363,084 and $372,523, respectively. Annual amortization for the next five years from December 31, 2013, is expected to be $108,100 for 2014 and $0 thereafter due to fully amortization of certain intangible assets, impairment of the land use rights of Taiyu and Siping, and return of land use right of SmartHeat Energy to the government. 8. CONSTRUCTION IN PROGRESS The construction in progress at December 31, 2013 was fully impaired as described in Note 2 “Impairment of Long-Lived Assets”.
9. MAJOR CUSTOMERS AND VENDORS One customer accounted for 12% of total sales for the year ended December 31, 2013. At December 31, 2013, total receivable from the customer was $1,286,257. For the year ended December 31, 2012, no customers accounted for more than 10% of the Companies’ total sales. For the years ended December 31, 2013, one vendor accounted for 11% of the Companies’ total purchases. At December 31, 2013, total payable to the vendor was $0. For the year ended December 31, 2012, no vendors accounted for more than 10% of the Companies’ total purchases. Taxes receivable consisted of the following at December 31, 2013 and 2012: | | 2013 | | | 2012 | | Income | | $ | 180,764 | | | $ | - | | Value-added | | | 781,216 | | | | - | | Other | | | 6,144 | | | | - | | Total | | $ | 968,124 | | | $ | - | |
Taxes payable consisted of the following at December 31, 2013 and 2012: | | 2013 | | | 2012 | | Income | | $ | - | | | $ | 505,643 | | Value-added | | | 99,456 | | | | 62,425 | | Other | | | 30,923 | | | | 161,070 | | Total | | $ | 130,379 | | | $ | 729,138 | |
12. ACCRUED LIABILITIES AND OTHER PAYABLES Accrued liabilities and other payables consisted of the following at December 31, 2013 and 2012: | | 2013 | | | 2012 | | Advance from third parties | | $ | 3,262,314 | | | $ | - | | Payable to Siping Beifang | | | 2,306,184 | | | | 1,947,808 | | Deposit from customer | | | 2,988,240 | | | | - | | Refund of land use right purchased | | | 4,627,270 | | | | - | | Others | | | 539,728 | | | | 512,935 | | Warranty reserve (See Note 2) | | | 318,846 | | | | 282,739 | | Accrued expenses | | | 507,196 | | | | 345,194 | | Advance from HP segment | | | 16,388,299 | | | | 14,947,602 | | Total | | $ | 30,938,077 | | | $ | 18,036,278 | |
Advances from third parties were short-term, non-interest-bearing advances from third parties due on demand. Payable to Siping Beifang represented loans to them without interest and payable upon demand. Deposit from customer represented advance payment from a customer for SmartHeat Siping to execute the sales order; however, the customer wanted to cancel the order after SmartHeat Siping commenced manufacturing and the SmartHeat Siping refused to return the deposit claiming breach of the contract by the customer. The dispute was filed with the court and is currently docketed for trial. Refund of land use right previously purchased represented the partial refund received for the land use right SmartHeat Energy purchased in November 2010. SmartHeat Energy later cancelled the purchase due to the adjustments of the overall development plan of the area by the local authority. The local government agreed to the cancellation and refunded SmartHeat Energy $4.63 million as of December 31, 2013, and was committed to refund SmartHeat Energy the remaining purchase price. On May 21, 2014, SmartHeat Energy and Shenyang City Development and Land Resource Bureau Economy and Technology Development Office entered into an official agreement, whereby full purchase price of the land use right would be returned to SmartHeat Energy in installments within 5 days from the effective date of the official agreement. SmartHeat Energy received accumulated amount of $14.89 million (RMB 91.62 million) as of September 30, 2014, of which, $4.79 million received in excess of the amount paid to acquire land use right. The local government has not yet made qualitative determination about the excess amount and until such time SmartHeat Energy receives further information, the excess amount was recorded as other payable. The land use right title transfer is expected to complete by the end of 2014. Currently the land is used by the third party. Advance from HP segment represented payables to other subsidiaries of SmartHeat Inc. Others represented payables for the Companies certain construction and installation projects, and miscellaneous expenses including postage, business insurance, employee benefits, project bidding fee, and medical insurance, etc. Accrued expenses mainly consisted of accrued payroll of $0.31 million, accrued welfare, interest and utility. 13. NOTES PAYABLE – BANK ACCEPTANCES Notes payable represented the conversion of accounts payable into notes payable, which were issued by a bank. The Companies deposited a portion of the acceptance amount into the bank as collateral. The terms of the notes range from 3-6 months and bear no interest. At December 31, 2013 and 2012, the Companies deposited $1.30 million and $0.37 million with the bank as restricted cash for the bank issuing the notes (See note 2). The restricted cash is refundable when the notes are repaid. 14. LOANS PAYABLE The Companies were obligated for the following short-term loans as of December 31, 2013 and 2012: | | 2013 | | | 2012 | | Subsidiary obligated | From a commercial bank in the PRC for RMB 50,000,000 entered into on February 17, 2012.The loan bore interest at 7.872% with maturity on January 16, 2013. The loan was repaid at maturity. | | | - | | | | 7,954,817 | | Taiyu | From a commercial bank in the PRC for RMB 10,000,000 entered into on July 12, 2012. The loan bore interest at 7.87% with maturity on July 11, 2013. The loan was repaid at maturity. | | | - | | | | 1,590,963 | | Siping | From a commercial bank in the PRC for RMB 10,000,000 entered into on August 23, 2012. The loan bore interest at 6.30% with maturity on August 22, 2013. The loan was guaranteed by a third party. The loan was repaid at maturity. | | | - | | | | 1,590,963 | | Taiyu | From a commercial bank in the PRC for RMB 9,000,000 entered into on September 7, 2012. The loan bore interest at 6.3% with maturity on September 6, 2013. The loan was guaranteed by a third party. The loan was repaid at maturity. | | | - | | | | 1,431,867 | | Taiyu | From a commercial bank in the PRC for RMB 8,000,000 entered into on September 13, 2012. The loan bore interest at 6.3% with maturity on September 12, 2013. The loan was guaranteed by a third party. The loan was repaid at maturity. | | | - | | | | 1,272,771 | | Taiyu | From a commercial bank in the PRC for RMB 30,000,000 entered into on August 21, 2012. The loan bore interest at 6.6% with maturity on August 20, 2013. The loan was repaid at maturity. | | | - | | | | 4,772,890 | | Taiyu | From a commercial bank in the PRC for RMB 9,600,000 entered into on September 13, 2012. The loan bore interest at 6.6% with maturity on March 3, 2013. This loan was guaranteed by accounts receivable. The loan was repaid at maturity. | | | - | | | | 1,527,325 | | Taiyu | From a commercial bank in the PRC for RMB 13,000,000 entered into on December 12, 2011. The loan bore interest at 6.65% with maturity on October 26, 2013. This loan was pledged with Taiyu’s building and land. This loan was repaid at maturity. | | | - | | | | 2,068,252 | | Taiyu | From a commercial bank in the PRC for RMB 13,344,190 entered into on June 26, 2012. The loan bore interest at 6.16% with maturity on January 18, 2014. The loan was repaid at maturity. | | | 2,188,684 | | | | 2,354,626 | | Taiyu | From a commercial bank in the PRC for RMB 10,000,000 entered into on November 30, 2012. The loan bore interest at 7.87% with maturity on November 22, 2014. The loan was guaranteed by Taiyu. This loan was repaid at maturity. | | | 1,640,178 | | | | 1,590,963 | | Siping | From a commercial bank in the PRC for RMB 40,000,000 entered into on March 11, 2013. The loan bore interest at 6.60% with maturity on March 10, 2014. The loan was guaranteed by Siping, HeatPump and management of Chinese subsidiaries. This loan was repaid at maturity. | | | 6,560,711 | | | | - | | Taiyu | From a commercial bank in the PRC for RMB 10,000,000 entered into on May 21, 2013. The loan bore interest at 6.60% with maturity on May 20, 2014. This loan was repaid at maturity. | | | 1,640,178 | | | | - | | Taiyu | From a commercial bank in the PRC for RMB 5,000,000 entered into on August 29, 2013. The loan bore interest at 7.20% with maturity on August 29, 2014. The loan was guaranteed by Taiyu. This loan was repaid at maturity. | | | 820,089 | | | | - | | Siping | From a commercial bank in the PRC for RMB 5,000,000 entered into on September 4, 2013. The loan bore interest at 7.20% with maturity on September 4, 2014. The loan was guaranteed by Taiyu. This loan was repaid at maturity. | | | 820,089 | | | | - | | Siping | From a commercial bank in the PRC for RMB 30,000,000 entered into on August 8, 2013. The loan bore interest at 6.90% with maturity on August 7, 2014. This loan was repaid at maturity. | | | 4,920,533 | | | | - | | Taiyu | From a commercial bank in the PRC for RMB 9,900,000 entered into on September 18, 2013. The loan bore interest at 6.0% with maturity on September 17, 2014. This loan was pledged by Taiyu’s accounts receivable. This loan was repaid at maturity. | | | 1,623,776 | | | | - | | Taiyu | From a commercial bank in the PRC for RMB 9,900,000 entered into on October 11, 2013. The loan bore interest at 6.0% with maturity on October 10, 2014. This loan was pledged by Taiyu’s accounts receivable. This loan was repaid at maturity. | | | 1,623,776 | | | | - | | Taiyu | From a commercial bank in the PRC for RMB 16,000,000 entered into on July 10, 2013. The loan bore interest at 6.0% with maturity on January 9, 2014. This loan was pledged by Taiyu’s accounts receivable. This loan was repaid at maturity. | | | 2,624,285 | | | | - | | Taiyu | TOTAL | | $ | 24,462,299 | | | $ | 26,155,437 | | |
The banks sometimes require loan guarantee provided by a third party to the Companies, the third party loan guarantor was Liaoning Wugang Metal Trading Co., Ltd. (“Liaoning Wugang”), with a maximum guarantee of RMB 46 million ($7.32 million). The guarantee is for the loans entered from February 20, 2012 to August 16, 2013, with the guarantee length equal to the loan term; the guarantee service was extended for the loans entered or will be entered from September 18, 2013 to September 12, 2014 with the guarantee length equal to the loan term, the maximum guarantee amount was revised to RMB 44 million ($7.05 million). The Companies were not required to pay any guarantee fees. However, the Companies have contracted to provide similar guarantees for up to RMB 20 million ($3.18 million) to Liaoning Guorui Commercial Trading Co., Ltd. (“Guorui”). The guarantee is for the loans entered from January 12, 2012 to January 11, 2013 with the guarantee length equal to the loan term, the Companies do not require Guorui to pay any guarantee fees. The Companies did not extend the guarantee term for Guorui after January 11, 2013. These arrangements are common to the banking industry in China, and there are no other relationships between the Companies and Liaoning Wugang or Guorui, both of whom were referred to the Companies by the lending bank. As of December 31, 2013, the Companies did not have any loan guarantees from Liaoning Wugang. Long-Term Bank Loan Taiyu entered into a long-term loan of $2.13 million (RMB 13 million) with China Construction Bank on November 30, 2013 with maturity on November 29, 2015. The interest rate for the loan is variable currently at 6.46%, and to be paid on the 20th of each month. This loan is guaranteed by Taiyu’s building and land. 15. DEFERRED TAX ASSET (LIABILITY) Deferred tax asset (liability) represented differences between the tax bases and book bases of bad debt allowance and provision of inventory impairment booked by the Companies, which was not allowed per tax purpose. As of December 31, 2013 and 2012, deferred tax asset (liability) consisted of the following: | | 2013 | | | 2012 | | Deferred tax asset - current (bad debt allowance) | | $ | 7,267,745 | | | $ | 4,215,753 | | Deferred tax asset - current (inventory allowance) | | | 1,864,883 | | | | 598,623 | | Deferred tax asset – current (allowance for other receivable) | | | 1,534,723 | | | | 227,910 | | Deferred tax asset – current (allowance for advance to supplier) | | | 375,512 | | | | 333,851 | | Deferred tax asset – current (reserve for warranty) | | | 33,282 | | | | - | | Deferred tax asset - noncurrent (impairment loss on long - lived assets) | | | 3,025,845 | | | | - | | Less: valuation allowance | | | (14,101,990 | ) | | | (5,376,137 | ) | Deferred tax assets, net | | $ | - | | | $ | - | |
Taiyu is governed by the Income Tax Law of the PRC concerning privately-run enterprises, which are generally subject to tax at 25% on income reported in the statutory financial statements after appropriate tax adjustments. Under the Income Tax Law that became effective January 1, 2008, new high-tech enterprises given special support by the PRC government are subject to an income tax rate of 15%. Taiyu has been classified as a high-tech enterprise since 2009 and eligible for an income tax rate of 15% through 2014. Local PRC government reviews the high-tech status of such enterprises annually. SmartHeat Siping and SmartHeat Energy and Ruicheng are subject to the regular 25% PRC income tax rate. The following table reconciles the statutory rates to the Companies’ effective tax (benefit) rate for the years ended December 31, 2013 and 2012: | | 2013 | | | 2012 | | PRC statutory tax (benefit) rates | | | (25.0 | )% | | | (25.0 | )% | Effect of tax holiday | | | 5.4 | % | | | 8.5 | % | Others | | | (0.3 | )% | | | (0.3 | )% | Valuation allowance | | | 20.0 | % | | | 19.9 | % | Tax expense per financial statements | | | 0.1 | % | | | 3.1 | % |
17. STATUTORY RESERVES AND RESTRICTED NET ASSETS Relevant PRC statutory laws and regulations permit payments of dividends by the Companies to foreign holding company only out of the subsidiary’s retained earnings, if any, as determined in accordance with PRC accounting standards and regulations. The results of operations reflected in the financial statements prepared in accordance with U.S. GAAP differ from those reflected in the statutory financial statements of the Companies. In accordance with the PRC Regulations on Enterprises with Foreign Investment and their articles of association, a foreign-invested enterprise (“FIE”) established in the PRC is required to provide certain statutory reserves, which are appropriated from net profit as reported in the FIE’s PRC statutory accounts. An FIE is required to allocate at least 10% of its annual after-tax profit to the surplus reserve until such reserve has reached 50% of its respective registered capital based on the FIE’s PRC statutory accounts. Appropriations to other funds are at the discretion of the board of directors for all FIEs. The aforementioned reserves can only be used for specific purposes and are not distributable as cash dividends. Additionally, shareholders of an FIE are required to contribute capital to satisfy the registered capital requirement of the FIE. Until such contribution of capital is satisfied, the FIE is not allowed to repatriate profits to its shareholders, unless otherwise approved by the State Administration of Foreign Exchange. Taiyu, SmartHeat Siping, and Ruicheng were established as FIEs and therefore are subject to the above-mandated restrictions on distributable profits. Additionally, in accordance with the Company Law of the PRC, a domestic enterprise is required to provide surplus reserve at least 10% of its annual after-tax profit until such reserve has reached 50% of its respective registered capital based on the enterprise’s PRC statutory accounts. A domestic enterprise is also required to provide discretionary surplus reserve, at the discretion of the board of directors, from the profits determined in accordance with the enterprise’s PRC statutory accounts. The aforementioned reserves can only be used for specific purposes and are not distributable as cash dividends. SmartHeat Energy was established as domestic enterprises and therefore is subject to the above-mentioned restrictions on distributable profits. As a result of these PRC laws and regulations that require annual appropriations of 10% of after-tax income to be set aside prior to payment of dividends as general reserve fund, the Companies are restricted in their ability to transfer a portion of their net assets to the foreign holding company as a dividend. The Companies had net other income, of $470,730 and $1,298,210 for the years ended December 31, 2013 and 2012, respectively. The net other income for the year ended December 31, 2013 mainly consisted of net profits from selling of raw material. The net other income for 2012 mainly consisted of net profits from selling of raw material of $781,400; net profits from after-sales services of $177,600, and a government subsidy of $263,800. The Companies leased offices for its sales representative in several different cities under various one-year, non-cancellable and renewable operating lease agreements. Rental expense for the years ended December 31, 2013 and 2012, was $144,328 and $186,574, respectively. Certain of the Companies bank loans were guaranteed for repayment by a third party. The guarantee term is same as the loan term and the Companies are not required to pay for this guarantee service as the Companies provides the same guarantee service to loans of the third party. As of December 31, 2013 and 2012, the Companies signed a contract to provide guarantees of up to RMB 20 million ($3.18 million) in loans for the third party (See Note 14 – Loans Payable). The Companies’ operations in the PRC are subject to specific considerations and significant risks not typically associated with companies in North America and Western Europe. These include risks associated with, among others, the political, economic and legal environments in China and foreign currency exchange. The Companies results may be adversely affected by changes in PRC government 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 Companies’ sales, purchases and expense transactions in China are denominated in RMB and all of the Companies’ assets and liabilities in China are also denominated in RMB. The RMB is not freely convertible into foreign currencies under the current PRC law. In China, foreign exchange transactions are required by law to be transacted only by authorized financial institutions. Remittances in currencies other than RMB may require certain supporting documentation in order to affect the remittance.
21. SUBSEQUENT EVENT
On November 28, 2014, SmartHeat entered into an Amended and Restated EIPA, which amended and restated the EIPA dated October 10, 2013 between SmartHeat and the buyers. Under the terms of the Amended EIPA, the buyers have agreed to purchase the remaining 60% of SmartHeat’s equity interests in the Companies. The purchase price for the remaining 60% consists of: (i) consideration of RMB8.5 million and (ii) the forgiveness of all net indebtedness owing to the Companies by SmartHeat and each of its other subsidiaries as of December 31, 2014.
The effectiveness of the transaction is subject to the following conditions: (i) approval of its shareholders and (ii) receipt by the BOD of SmartHeat of an opinion that the purchase and sale transaction is fair to the shareholders of SmartHeat from a financial point of view. The parties will execute a mutual release to be delivered at the closing which will provide, in part, for the Companies to forgive all net indebtedness from SmartHeat and all of its other subsidiaries. In the event that the conditions are not met prior to December 31, 2014, the consideration and all documents will be deposited into escrow and released when the conditions have been satisfied; provided that if the conditions are not satisfied on or before March 31, 2015, either party may terminate the Amended EIPA and the funds and documents will be returned to the depositing party. The Companies presently intends to continue to seek competing bids to the Amended EIPA. There is no assurance that any competing bid may be found or that a definitive agreement will be negotiated with such party. PROPOSAL NUMBER 2 ADJOURNMENTS OF THE SPECIAL MEETING At the Special Meeting, stockholders will be asked to vote on a proposal to adjourn the Special Meeting to another date, time or place, if deemed necessary in the judgment of the proxy holders, for the purpose of soliciting additional proxies to vote in favor of Proposal 1. Any adjournment of the Special Meeting may be made without notice, other than by the announcement made at the Special Meeting, if the majority of those shares present at the meeting, in person or represented by proxy, and entitled to vote thereon approve the adjournment proposal. However, if, after the adjournment, the Board of Directors fixes a new record date for the adjourned meeting, a new notice of the adjourned meeting shall be given to each stockholder of record on the new record date entitled to vote at the adjourned meeting. If we adjourn the Special Meeting to a later date, we will transact the same business and, unless we must fix a new record date, only the stockholders who were eligible to vote at the original meeting will be permitted to vote at the adjourned meeting. Required Vote
You may vote “FOR” or “AGAINST” the following resolution, or you may “ABSTAIN.” Approval of this proposal requires the affirmative “FOR” vote of a majority of the shares present in person or represented by proxy at the Special Meeting and entitled to vote thereon. If you elect to “ABSTAIN,” the abstention has the same effect as a vote “AGAINST.” Unless marked to the contrary, proxies received will be voted “FOR” the approval of the adjournment of the Special Meeting, if necessary, to solicit additional proxies if there are not sufficient votes in favor of Proposal 1.
Recommendation
The Board of Directors recommends a vote “FOR” the approval of the approval of the adjournment of the Special Meeting, if necessary, to solicit additional proxies if there are not sufficient votes in favor of Proposal 1. As of the date of this Proxy Statement, there are no other matters that we intend to present, or have reason to believe others will present, at the Special Meeting. If, however, other matters properly come before the Special Meeting, the accompanying proxy authorizes the persons named as proxies or their substitutes to vote on such matters as they determine appropriate.
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