LBTI Lithium and Boron Technology Inc (CE)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2019 (UNAUDITED) AND DECEMBER 31, 2018

1. ORGANIZATION AND DESCRIPTION OF BUSINESS

Lithium & Boron Technology, Inc., (the “Company” or “Lithium Tech”), formerly known as SmartHeat, Inc. (“SmartHeat”), was incorporated August 4, 2006, in the State of Nevada. The Company currently produces boric acid in the People Republic of China (“PRC”) and plans to expand its manufacturing facilities to produce lithium carbonate for the electric vehicle battery market in China. The Company has collaborated with a director to develop a prototype production line that can produce boric acid and lithium carbonate from local brines pool and may also initiate production of lithium carbonate from existing ore deposits it purchases from an affiliated mining company.

The Company formerly sold plated heat exchangers and heat pumps and sold these operations on September 30, 2019 recording them as discontinued operations.

On December 31, 2018 (the “Closing Date”), the Company entered into and closed a Share Exchange Agreement and Plan of Reorganization, as amended on January 24 2019 (the “Share Exchange Agreement”) with Mid-Heaven Sincerity International Resources Investment Co., Ltd (Mid-heaven BVI) and its shareholders Mao Zhang, Jian Zhang, and Ying Zhao, constituting all the shareholders of Mid-heaven BVI (the “Mid-heaven Shareholders”). Pursuant to the terms of the Share Exchange Agreement, the shareholders of Mid-Heaven BVI delivered all of the issued and outstanding shares of capital stock of Mid-Heaven BVI to the Company, for 106,001,971 shares of the Company’s Common Stock. Mid-heaven BVI, through two subsidiaries, Qinghai Mid-Heaven Sincerity Technology Co., Ltd (“Sincerity”) and Qinghai Mid-Heaven Sincerity Salt-Lake R&D Co., Ltd (“Salt-Lake”) owns 100% of Qing Hai Mid-Heaven Boron & Lithium Technology Company, Ltd. (“Qinghai Technology”).

The Acquisition was structured as a tax-free reorganization. As a result of the share exchange agreement, Mid-heaven BVI’s shareholders own approximately 57% of the combined company.  For accounting purposes, the transaction was accounted for as a reverse acquisition of the Company by Mid-heaven BVI.

The main operating entity, Qinghai Technology was incorporated December 18, 2018. The business of Qinghai Technology was carved out of the business of Qinghai Zhongtian Boron & Litium Mining Co., Ltd (“Qinghai Mining”) on December 20, 2018. Qinghai Mining was founded March 6, 2001 and engaged in manufacture and wholesale of boric acid and related compounds for industrial and consumer usage. Qinghai Technology obtains its raw material minerals exclusively from Qinghai Mining and currently processes boric acid by crushing and processing ore. 

On September 30, 2019, Heat HP, Inc. and Heat PHE, Inc, wholly owned subsidiaries of the Company, sold all of their respective equity interests in Jinhui, SmartHeat Investment, SmartHeat Trading, SmartHeat Pump and Heat Exchange for $353. The equity interests were sold to individuals and businesses located in the PRC. Each subsidiary was sold for nominal cash consideration as below and, as the transactions were structured as purchases of equity interests, the subsidiary companies retained all liabilities when purchased. Heat HP, Inc. and Heat PHE, Inc. did not have any operations and mainly serve the purpose as holding companies.

SmartHeat Jinhui (Beijing) Energy Technology Ltd - 100 RMB ($15)

SmartHeat (China) Investment Ltd - 400 RMB ($56)

SmartHeat (Shanghai) Trading Co., Ltd - 400 RMB ($56)

SmartHeat (Shenyang) Heat Pump Technology Co., Ltd - 400 RMB ($56)

SanDeKe Co., Ltd - 600 RMB ($85)

SmartHeat Heat Exchange Equipment Co - 600 RMB ($85)

On October 23, 2019, the Company filed a certificate of amendment to its certificate of incorporation to change its name from “Smartheat, Inc.” to “Lithium & Boron Technology, Inc.” to better reflect the operations of the Company. The name change became effective October 23, 2019.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

The consolidated financial statements (“CFS”) were prepared in accordance with accounting principles generally accepted in the United States of America (“US GAAP”).

The CFS include the financial statements of the Company and its subsidiaries. All significant intercompany transactions and balances were eliminated in consolidation.

The interim consolidated financial information as of September 30, 2019 and for the nine and three-month periods ended September 30, 2019 and 2018 was prepared without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). Certain information and footnote disclosures, which are normally included in CFS prepared in accordance with U.S. GAAP were not included. The interim consolidated financial information should be read in conjunction with the Financial Statements and the notes thereto, included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2018, previously filed with the SEC.

In the opinion of management, all adjustments (which include all significant normal and recurring adjustments) necessary to present a fair statement of the Company’s consolidated financial position as of September 30, 2019 and December 31, 2018, its consolidated results of operations and cash flows for nine and three months ended September 30, 2019 and 2018, as applicable, were made.

Principles of Consolidation 

For the nine months ended September 30, 2019, the accompanying CFS include the accounts of the Company’s US parent, and its subsidiaries Heat HP and Heat PHE, and their subsidiaries SanDeKe, Jinhui, SmartHeat Investment, SmartHeat Trading, SmartHeat Pump, and Heat Exchange; and Mid-heaven BVI and its subsidiaries, Sincerity, Salt-Lake and Qinghai Technology, which are collectively referred to as the “Company.” For the nine months ended September 30, 2018, the accompanying CFS consist of the accounts of Mid-heaven BVI and its subsidiaries, Sincerity, Salt-Lake and Qinghai Technology as a result of reverse merger of SmartHeat with Mid-heaven BVI. All significant intercompany accounts and transactions were eliminated in consolidation.

Noncontrolling Interest 

The Company follows 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.

Use of Estimates

In preparing financial statements in conformity with US 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

The Company considers all highly liquid investments with an original maturity of three months or less to be cash equivalents.  

The following table presents in US dollars (“USD”) the amount of cash and equivalents held by the Company as of September 30, 2019 and December 31, 2018, respectively, based on the jurisdiction of deposit. The Company’s US parent holds cash and equivalents in US bank accounts denominated in USD.

Accounts and Retentions Receivable, net

The Company maintains 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 Company had allowance of nil and $1.78 million at September 30, 2019 and December 31, 2018. At September 30, 2019, Qinghai Technology had $0.27 million accounts receivable with aging over one-year, the Mining company agreed to take the full responsibility of payment if these accounts receivable cannot be collected.

At September 30, 2019 and December 31, 2018, the Company had retentions receivable from customers for product quality assurance of nil and $0.14 million. The retention rate varied from 5% to 20% of the sales price with variable terms from three 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 Company had allowance for these retentions of nil and $0.14 million at September 30, 2019 and December 31, 2018.

Advances to Suppliers, net

The Company makes advances to certain vendors to purchase raw material, tools and equipment for production. The advances are interest-free and unsecured. As of September 30, 2019 and December 31, 2018, the Company had allowance for advances to suppliers of nil and $2.16 million.

Inventories, net

Inventories are stated at the lower of cost or net realizable value with cost determined on a weighted-average basis. Management compares the cost of inventories with the net realizable value and an allowance is made to write down inventories to market value, if lower.

In July 2015, the FASB issued ASU 2015-11, “Inventory (Topic 330) - Simplifying the Measurement of Inventory,” which requires that inventory within the scope of the guidance be measured at the lower of cost or net realizable value. Net realizable value is the estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. The Company adopted ASU 2015-11 effective January 1, 2017 and it did not have a material effect on the Company’s CFS. 

Property and Equipment, net

Property and equipment are stated at cost, net of accumulated depreciation. Expenditures for maintenance and repairs are expensed as incurred; major additions, repairs and betterments that significantly extend original useful lives or improve productivity are capitalized and depreciated over the period benefited. 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 3% - 10% salvage value and estimated lives as follows: 

Depreciation of plant, property and equipment attributable to manufacturing is capitalized as part of inventories, and expensed to cost of sales when inventories are sold. 

Impairment of Long-Lived Assets

Long-lived assets, which include tangible assets, such as property 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, but at least annually.

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. Based on its review, the Company believes that, as of September 30, 2019 and December 31, 2018, there was no significant impairments of its long-lived assets.

Research and Development Costs

Research and development (“R&D”) costs are expensed as incurred and included in general and administrative (“G&A”) expenses. These costs primarily consist of cost of materials used, salaries paid for the Company’s development department and fees paid to third parties. R&D costs for the nine months ended September 30, 2019 and 2018 were $554 and $43,191, respectively. R&D costs for the three months ended September 30, 2019 and 2018 were $465 and $2,132, respectively.

Income Taxes

Income taxes are accounted for using an asset and liability method. Under this method, deferred income taxes are recognized for the tax consequences in future years of differences between the tax bases of assets and liabilities and their financial reporting amounts at each period end based on enacted tax laws and statutory tax rates, applicable to the periods in which the differences are expected to affect taxable income. Valuation allowances are established, when necessary, to reduce deferred tax assets to the amount expected to be realized.

The Company follows ASC Topic 740, which prescribes a more-likely-than-not threshold for financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. ASC Topic 740 also provides guidance on recognition of income tax assets and liabilities, classification of current and deferred income tax assets and liabilities, accounting for interest and penalties associated with tax positions, accounting for income taxes in interim periods, and income tax disclosures.

Under the provisions of ASC Topic 740, when tax returns are filed, it is likely that some positions taken would be sustained upon examination by the taxing authorities, while others are subject to uncertainty about the merits of the position taken or the amount of the position that would be ultimately sustained. The benefit of a tax position is recognized in the financial statements in the period during which, based on all available evidence, management believes it is more likely than not that the position will be sustained upon examination, including the resolution of appeals or litigation processes, if any. Tax positions taken are not offset or aggregated with other positions. Tax positions that meet the more-likely-than-not recognition threshold are measured as the largest amount of tax benefit that is more than 50% likely of being realized upon settlement with the applicable taxing authority. The portion of the benefits associated with tax positions taken that exceeds the amount measured as described above is reflected as a liability for unrecognized tax benefits in the accompanying balance sheets along with any associated interest and penalties that would be payable to the taxing authorities upon examination. Interest associated with unrecognized tax benefits is classified as interest expense and penalties are classified in selling, general and administrative expenses in the statement of income.  At September 30, 2019 and December 31, 2018, the Company did not take any uncertain positions that would necessitate recording a tax related liability.  

Revenue Recognition

In May 2014 the FASB issued Accounting Standards Update (ASU) No. 2014-09, Revenue from Contracts with Customers (Topic 606), which supersedes all existing revenue recognition requirements, including most industry specific guidance. This new standard requires a company to recognize revenues when it transfers goods or services to customers in an amount that reflects the consideration that the company expects to receive for those goods or services. The FASB subsequently issued the following amendments to ASU No. 2014-09 that have the same effective date and transition date: ASU No. 2016-08, Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations; ASU No. 2016-10, Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing; ASU No. 2016-12, Revenue from Contracts with Customers (Topic 606): Narrow-Scope Improvements and Practical Expedients; and ASU No. 2016-20, Technical Corrections and Improvements to Topic 606, Revenue from Contracts with Customers. The Company adopted these amendments with ASU 2014-09 (collectively, the new revenue standards).

The new revenue standards became effective for the Company January 1, 2018, and were adopted using the modified retrospective method. The adoption of the new revenue standards as of January 1, 2018 did not change the Company’s revenue recognition as the majority of its revenues continue to be recognized when the customer takes control of its product. As the Company did not identify any accounting changes that impacted the amount of reported revenues with respect to its product revenues, no adjustment to retained earnings was required upon adoption.

Under the new revenue standards, the Company recognizes revenues when its customer obtains control of promised goods or services, in an amount that reflects the consideration which it expects to receive for those goods. The Company recognizes revenues following the five step model prescribed under ASU No. 2014-09: (i) identify contract(s) with a customer; (ii) identify the performance obligations in the contract; (iii) determine the transaction price; (iv) allocate the transaction price to the performance obligations in the contract; and (v) recognize revenues when (or as) we satisfy the performance obligation.

Revenues from product sales are recognized when the customer obtains control of the Company’s product, which occurs typically upon delivery to the customer. Sales and purchases are recorded net of VAT collected and paid as the Company acts as an agent for the government. VAT taxes are not affected by the income tax holiday.

Deferred Income

Deferred income consists primarily of government grants and subsidies for supporting the Company’s technology innovation and transformation of boric acid, lithium and magnesium sulfate projects. The Company uses most of the subsidies to purchase machinery and equipment. Deferred income is amortized to revenue (other income) over the life of the assets for which the grant and subsidy was used for. Subsidies for declared project fund require government inspection to ensure proper use of the funds for the designated project.

Cost of Sales

Cost of sales (“COS”) consists primarily of material costs and direct labor and manufacturing overhead attributable to the production of the products. Write-down of inventory to lower of cost or net realizable value is also recorded in COS. 

Unearned Revenue

The Company records payments received from customers in advance of their orders as unearned revenue. These orders normally are delivered (usually within one month) based upon contract terms and customer demand. 

Concentration of Credit Risk

Cash includes cash on hand and demand deposits in accounts maintained within China. Balances at financial institutions within China are not covered by insurance. The Company has not experienced any losses in such accounts.

Certain other financial instruments, which subject the Company to concentration of credit risk, consist of accounts and other receivables. The Company does not require collateral or other security to support these receivables. The Company conducts periodic reviews of its customers’ financial condition and customer payment practices to minimize collection risk on accounts receivable.

The operations of the Company are located primarily in China. Accordingly, the Company’s business, financial condition and results of operations may be influenced by the political, economic and legal environments in China, as well as by the general state of the PRC economy.

Statement of Cash Flows

In accordance with FASB ASC Topic 230, “Statement of Cash Flows,” cash flows from the Company’s operations are calculated based upon the local currencies. As a result, amounts shown on the statement of cash flows may not necessarily agree with changes in the corresponding asset and liability on the balance sheet.

Basic and Diluted Earnings (Loss) per Share (EPS)

Basic EPS is computed by dividing income available to common shareholders by the weighted average number of common shares outstanding for the period. Diluted EPS is computed similarly, except that the denominator is increased to include the number of additional common shares that would have been outstanding if the potential common shares had been issued and if the additional common shares were dilutive. Diluted EPS are based on the assumption that all dilutive convertible shares and stock options were converted or exercised. Dilution is computed by applying the treasury stock method. Under this method, options and warrants are assumed to have been exercised at the beginning of the period (or at the time of issuance, if later), and as if funds obtained thereby were used to purchase common stock at the average market price during the period. 

Foreign Currency Translation and Comprehensive Income (Loss)

The accounts of the US parent company are maintained in USD. The functional currency of the Company’s China subsidiaries is the Chinese Yuan Renminbi (“RMB”). The accounts of the China subsidiaries were translated into USD in accordance with FASB ASC Topic 830, “Foreign Currency Matters.” According to FASB ASC Topic 830, 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 FASB ASC Topic 220, “Comprehensive Income.”

Fair Value (“FV”) of Financial Instruments

Certain of the Company’s financial instruments, including cash and equivalents, accrued liabilities and accounts payable, carrying amounts approximate their FV due to their short maturities. FASB ASC Topic 825, “Financial Instruments,” requires disclosure of the FV of financial instruments held by the Company. The carrying amounts reported in the balance sheets for current liabilities each qualify as financial instruments and are a reasonable estimate of their FV because of the short period of time between the origination of such instruments and their expected realization and the current market rate of interest.

Fair Value Measurements and Disclosures

ASC Topic 820, “Fair Value Measurements and Disclosures,” defines FV, and establishes a three-level valuation hierarchy for disclosures of FV measurement that enhances disclosure requirements for FV measures. The three levels are defined as follow:

As of September 30, 2019 and December 31, 2018, the Company did not identify any assets and liabilities that are required to be presented on the balance sheet at FV. 

Leases

On January 1, 2019, the Company adopted ASU  No. 2016-02, Leases (Topic 842) (ASU 2016-02), as amended, which supersedes the lease accounting guidance under Topic 840, and generally requires lessees to recognize operating and financing lease liabilities and corresponding right-of-use (ROU) assets on the balance sheet for all leases with terms longer than 12 months and to provide enhanced disclosures surrounding the amount, timing and uncertainty of cash flows arising from leasing arrangements. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the income statement. A modified retrospective transition approach is required for lessees for capital and operating leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements, with certain practical expedients available. The Company concluded the adoption of this ASU did not have a material impact on the Company’s CFS since the Company does not have any lease that is longer than 12 months. 

Segment Reporting

FASB ASC Topic 280, “Segment Reporting,” requires use of the “management approach” model for segment reporting. The management approach model is based on the way a company’s management organizes segments within the company for making operating decisions and assessing performance. Reportable segments are based on products and services, geography, legal structure, management structure, or any other manner in which management disaggregates a company. Management determined the Company’s operations constitute a single reportable segment in accordance with ASC 280. The Company currently operates in one business and industry segment: manufacture and sale of boric acid.

New Accounting Pronouncements

In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments-Credit Losses (Topic 326), which requires entities to measure all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. This replaces the existing incurred loss model and is applicable to the measurement of credit losses on financial assets measured at amortized cost. This guidance is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2022. Early application will be permitted for all entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. The Company is currently evaluating the impact that the standard will have on its CFS.

In January 2017, the FASB issued ASU No. 2017-04, Simplifying the Test for Goodwill Impairment. The guidance removes Step 2 of the goodwill impairment test, which requires a hypothetical purchase price allocation. A goodwill impairment will now be the amount by which a reporting unit’s carrying value exceeds its fair value, not to exceed the carrying amount of goodwill. The guidance should be adopted on a prospective basis for the annual or any interim goodwill impairment tests beginning after December 15, 2019. Early adoption is permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017. The Company is currently evaluating the impact of adopting this standard on its CFS.

In June 2018, the FASB issued ASU 2018-07, "Compensation — Stock Compensation (Topic 718): Improvements to Nonemployee Share-Based Payment Accounting," which expands the scope of ASC 718 to include share-based payment transactions for acquiring goods and services from non-employees. An entity should apply the requirements of ASC 718 to non-employee awards except for specific guidance on inputs to an option pricing model and the attribution of cost. The amendments specify that ASC 718 applies to all share-based payment transactions in which a grantor acquires goods or services to be used or consumed in a grantor's own operations by issuing share-based payment awards. The new guidance is effective for SEC filers for fiscal years, and interim reporting periods within those fiscal years, beginning after December 15, 2019 (i.e., January 1, 2020, for calendar year entities). Early adoption is permitted. The Company is evaluating the effects of the adoption of this guidance and currently believes it will impact the accounting of the share-based awards granted to non-employees.

4. NOTES RECEIVABLE – BANK ACCEPTANCES

The Company sold goods to its customers and received notes (bank acceptances) from them in lieu of payments. These bank acceptances were issued by customers to the Company and would be honored by the applicable bank. The Company may hold a bank acceptance until the maturity for full payment, have the bank acceptance cashed out from the bank at a discount at an earlier date, or transfer the bank acceptance to its vendors in lieu of payment for their own obligations. As of September 30, 2019 and December 31, 2018, the Company had notes receivable of $270,162 and $111,473, respectively; and at September 30, 2019, the Company had $1.36 million notes receivable that were endorsed to its vendors, in lieu of payment. The Company was contingently liable for these notes receivable until it is paid or matured.

Advances to unrelated third-party companies were short-term unsecured advances. 

Advances to employees were short-term loans to employees and advances for business trips and related expenses, with no interest, payable upon demand.

Depreciation for the nine months ended September 30, 2019 and 2018 was $235,286 and $245,489, respectively.

Depreciation for the three months ended September 30, 2019 and 2018 was $76,141 and $78,024, respectively.

7. CONSTRUCTION IN PROGRESS (“CIP”)

As of September 30, 2019 and December 31, 2018, the Company had CIP of $1,613,546 and $1,662,847, respectively. The CIP was mainly for Test and Experimental Plant I, which does not have any production currently; the Company intends to transform the plant as a pilot plant for pure boric acid and lithium carbonate production. However, the CIP was delayed due to the Company is waiting for the installation and connection of the natural gas pipeline by the authority as a result of implementing the Coal-to-Gas conversion project by the authority for environmental protection purpose.

Advances from third parties were short term, non-interest-bearing and due on demand. 

At September 30, 2019 and December 31, 2018, other mainly was dividend payable to Northtech of $375,000 and $300,000, respectively.

As of September 30, 2019 and December 31, 2018, the Company had $0 and $291,410, respectively, for the government subsidy for Magnesium-rich waste liquid high value utilization project, and was recorded as other payable; during the three months ended September 30, 2019, the Company completed the project and passed the government’s inspection, the Company reclassified $65,000 equipment cost of this government subsidy payable to deferred income and amortizes it over 10 years, and reclassified $0.22 million subsidy payable as other income.

As of September 30, 2019, accrued expenses mainly consisted of accrued payroll expense of $62,410 for Qinghai Technology. As of December 31, 2018, accrued expenses mainly consisted of accrued property and land rental fee of $2.38 million for SmartHeat Pump and accrued payroll of $0.38 million.

10. RELATED PARTY TRANSACTIONS

Qinghai Technology purchased raw material boron rock from Qinghai Mining (owned by three major shareholders of the Company); in addition, Qinghai Technology sometimes received no-interest short-term advances from Qinghai Mining for daily operation needs. As of September 30, 2019 and December 31, 2018, due from (to) Qinghai Mining (representing the net amount of intercompany transactions between Qinghai Technology and Qinghai Mining due to carve out) was $0.18 million and $(3.88) million, respectively, which included $54,976 net due to Qinghai Mining after the Debt Offset Agreement disclosed below. Qinghai Technology purchased of $1,113,250 and $518,870 boron ore from Qinghai Mining during the nine and three months ended September 30, 2019.

On July 1, 2019, Qinghai Technology and Qinghai Mining entered a boron ore purchase contract for a term of one year. Qinghai Mining is to supply Qinghai Technology boron ore based on Qinghai Technology’s monthly production plan at a price of RMB 62 ($8.77) per ton. The price is adjustable in the future if there is a significant fluctuation of the market price for the boron ore.

Qinghai Technology used equipment that belongs to Qinghai Province DaChaiDan ZhongTian Resources Development Co., Ltd (“Zhongtian Resources”, owned by two major shareholders of the Company) for production. The depreciation of these fixed assets had an impact on the production costs of boric acid of the Company, and was included in the Company’s cost of sales. The depreciation of these fixed assets for the nine months ended September 30, 2019 and 2018 was $25,658 and $26,533, respectively. The depreciation of these fixed assets for the three months ended September 30, 2019 and 2018 was $8,059 and $7,434, respectively. Due to Zhongtian Resources resulting from using its equipment was $25,658 and $0.11 million at September 30, 2019 and December 31, 2018, respectively.

Qinghai Technology previously purchased raw material from DaChaiDan SanXin Industrial Company Ltd (“SanXin”). The outstanding payable to SanXin at September 30, 2019 and December 31, 2018 was $0 and $0.13 million, respectively. SanXin is a non-related party company; however, Qinghai Mining assumed the payables as of December 31, 2018 that Qinghai Technology owed to SanXin under a Debt Offset Agreement between the Company, Qinghai Mining and SanXin entered into in June 2019.

Qinghai Technology sold boric acid to Qinghai Dingjia Zhixin Trading Co., Ltd (“Dingjia”, 90% owned by the son of the Company’s major shareholder). For the nine months ended September 30, 2019 and 2018, the Company’s sales to Dingjia was $112,855 and $955,087, respectively. For the three months ended September 30, 2019 and 2018, the Company’s sales to Dingjia was $17,300 and $513,973, respectively. At September 30, 2019 and December 31, 2018, outstanding receivables from (payable to) Dingjia was $(0.08) million and $4.06 million, respectively.

Qinghai Technology, Qinghai Mining, Zhongtian Resources and Dingjia entered a Debt Offset Agreement, in which, Qinghai Mining assumed the outstanding payable balance of Qinghai Technology as of December 31, 2018 to Zhongtian, and Qinghai Technology transferred the outstanding receivable balance as of December 31, 2018 from Dingjia to Qinghai Mining. With execution of the Debt Offset Agreement entered in June 2019, the Company had $54,976 net due to Qinghai Mining at December 31, 2018.

In addition, at September 30, 2019 and December 31, 2018, the Company had $456,263 and $255,233 due to another major shareholder of the Company, resulting from the certain of the Company’s operating expenses such as legal and audit fees that were paid by this major shareholder on behalf of the Company. This short term advance bore no interest, and was payable upon demand.

The following table summarized the due from (to) related parties as of September 30, 2019 and December 31, 2018, respectively:

11. DEFERRED INCOME

Deferred income consisted mainly of the government subsidy to the Company’s special projects. 

The detail of deferred income for the Company’s special projects at September 30, 2019 is:

The detail of deferred income for the Company’s special projects at December 31, 2018 is as following:

12. SUBSIDY INCOME

Subsidy income consisted of amortization of deferred income for declared special projects and government’s general incentive fund (recorded as income upon receipt) for the nine and three months ended September 30, 2019 and 2018, respectively:

13. CONVERSION OF CREDIT LINE PAYABLE (RELATED PARTY TRANSACTION)

On June 14, 2018, the Company entered into the Sixth Amendment to the Credit and Security Agreement dated July 27, 2012, as amended, between the Company and Northtech, as described below:

In October 2017, The Company entered into negotiations with Northtech to restructure the Credit Agreement. On October 31, 2017 the Credit Line was not extended, and the parties continued negotiations.  The parties agreed that Northtech will convert all outstanding interest and principal due under the Credit Agreement into the Company's common stock at a $.065 per share, a premium of $.0649 to the 30 average closing price of the Company's common stock of $.0001 per share.  In addition, the parties agreed to reduce the maximum credit line under the Credit Agreement to $1,000,000 and extended the maturity date to December 31, 2018. Further conversion of any outstanding principal and interest under the Credit Agreement will be based on conversion price subject to a minimum of $.065 per share and a maximum of $.50 per share.

As a result of the entering into the Sixth Amendment, the Company issued Northtech 71,283,000 restricted shares of common stock (66,316,601 shares on December 28, 2018 due to the maximum limit of 75,000,000 authorized for issuance at December 31, 2018, and 4,966,399 shares on March 20, 2019). Upon the issuance of the common stock to Northtech, the total interest and principal of $4,633,395 due to Northtech was reduced to zero.

The Company recorded a 100% valuation allowance for all deferred tax assets due to the uncertainty of its realization. 

15. INCOME TAXES

The Company is subject to income taxes by entity on income arising in or derived from the tax jurisdiction in which each entity is domiciled. The Company’s PRC subsidiaries file their income tax returns online with PRC tax authorities.

The President of the United States signed H.R. 1 (the “Tax Reform”). The Tax Reform Law, effective for tax years beginning on or after January 1, 2018, except for certain provisions, resulted in changes to existing United States tax law, including various provisions that are expected to impact the Company. The Tax Reform Law reduces the federal corporate tax rate from 35% to 21% effective January 1, 2018 for the Company. The Company will continue to analyze the provisions of the Tax Reform Law to assess the impact on the Company’s CFS.

The US parent company, was incorporated in the US and has net operating losses (“NOL”) for income tax purposes, the NOL arising in tax years beginning after 2017 may reduce 80% of a taxpayer’s taxable income, and be carried forward indefinitely. The US parent Company has NOL carry forwards for income taxes of approximately $2.22 million at September 30, 2019. Management believes the realization of benefits from these losses remains uncertain due to the SU parent Company’s limited operating history and continuing losses. Accordingly, a 100% deferred tax asset valuation allowance was provided.

SanDeKe, Jinhui, SmartHeat Investment, SmartHeat Pump, SmartHeat Trading and Heat Exchange are subject to the regular 25% PRC income tax rate.

Mid-Heaven BVI is a BVI company, and there is no income tax for companies domiciled in the BVI. Sincerity and Salt-Lake are governed by the Income Tax Law of the PRC concerning privately-run enterprises, which are generally subject to tax at 25% on income reported in the statutory financial statements after appropriate tax adjustments. Mid-Heaven BVI, Sincerity and Salt-Lake do not have any operations, and are not expected to have any operations in the future.

Qinghai Technology was carved out of Qinghai Mining on December 20, 2018. However, for the nine and three months ended September 30, 2019 and 2018, Qinghai Technology and Qinghai Mining still filed a combined income tax return in PRC, which had $0 income tax due to combined taxable loss.

As a result of carving out from Qinghai Mining and operating as an independent corporation, Qinghai Technology as a standalone entity had taxable income of $707,514 and $490,704 for the nine and three months ended September 30, 2019, and taxable income $384,398 and $67,113 for the nine and three months ended September 30, 2018. Qinghai Technology used the Separate Return Method under ASC 740-10-30-27 to allocate its income tax expenses.  Under the Separate Return Method, Qinghai Technology calculated its tax provision as if it were filing its own tax return based on the pre-tax accounts.  For the nine and three months ended September 30, 2019, Qinghai Technology calculated its income tax expense of $106,127 and $73,605, respectively; for the nine and three months ended September 30, 2018, Qinghai Technology calculated its income tax expense of $57,660 and $10,067, under the Separate Return Method, and credited it to due to related party – Qinghai Mining. As a qualified business under the China Government’s strategy of Develop-the-West, from January 1, 2011 through December 31, 2012, all the qualified business including Qinghai Technology is subject to a reduced income tax rate of 15% compared to a national customary rate of 25%.  

The following table reconciles the US statutory rates to the Company’s effective tax rate for the nine months ended September 30, 2019 and 2018, respectively:

The income tax expense for the nine months ended September 30, 2019 and 2018, respectively, consisted of the following:

The following table reconciles the US statutory rates to the Company’s effective tax rate for the three months ended September 30, 2019 and 2018, respectively:

The income tax expense for the three months ended September 30, 2019 and 2018, respectively, consisted of the following:

16. STATUTORY RESERVES AND RESTRICTED NET ASSETS

The Company’s ability to pay dividends primarily depends on the Company receiving funds from its subsidiaries. PRC laws and regulations permit payments of dividends by the Company’s PRC subsidiaries 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 US GAAP differ from those reflected in the statutory financial statements of the Company’s PRC subsidiaries.

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 BOD 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. Sincerity, incorporated on July 9, 2018 in China as a wholly foreign-owned enterprise (“WFOE”) with registered capital of $1.00 million, has 10 years from the incorporation date to fulfill the registered capital requirement.

Additionally, in accordance with the Company Laws 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 BOD, 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. Qinghai Technology was established as domestic enterprises and therefore are 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 Company’s PRC subsidiaries are restricted in their ability to transfer a portion of their net assets to the Company as a dividend.

17. COMMITMENTS

Capital Contribution

Sincerity with registered capital of $1.00 million and Salt-Lake incorporated in China on September 6, 2018 with registered capital of RMB 6 million ($0.88 million) have 10 years from the incorporation date to fulfill the registered capital requirement. Under PRC company law, registered capital must be used in the operations of the domestic company within its approved business scope.

18. CONTINGENCIES

The Company’s operations in the PRC are subject to specific considerations and significant risks not typically associated with companies in North America and Western Europe. These include risks associated with, among others, the political, economic and legal environments in China and foreign currency exchange. The Company’s 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 Company’s sales, purchases and expense transactions in China are denominated in RMB and all of the Company’s 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. 

19. REVERSE MERGER 

On December 31, 2018 (the "Closing Date"), the Company entered into a Share Exchange Agreement and Plan of Reorganization with Mid-heaven BVI and its shareholders Mao Zhang, Jian Zhang, and Ying Zhao, constituting all of the shareholders of Mid-heaven BVI (the “Mid-heaven Shareholders”).

Pursuant to the terms of the Agreement, the shareholders of Mid-heaven BVI delivered all of the issued and outstanding shares of capital stock of Mid-heaven BVI to the Company, for 106,001,971 shares of the Company’s Common Stock. Mid-heaven, through two subsidiaries, owns 100% of Qinghai Technology. The Acquisition was structured as a tax-free reorganization. 

As a result of the share exchange agreement, Mid-heaven BVI’s shareholders own approximately 57% of the combined company.  For accounting purposes, the transaction was accounted for as a reverse acquisition of the Company by Mid-heaven BVI.  The following unaudited pro forma consolidated results of operations for the Company and Mid-heaven BVI for the nine and three months ended September 30, 2018 presents the Company and Mid-heaven BVI’s operations as if the acquisitions occurred January 1, 2018.  The pro forma results are not necessarily indicative of the actual results that would have occurred had the acquisitions been completed as of the beginning of the periods presented, nor are they necessarily indicative of future consolidated results.

20. DISPOSAL OF SUBSIDIARIES

On September 30, 2019, Heat HP, Inc. and Heat PHE, Inc, wholly owned subsidiaries of the Company, sold all of their respective equity interests in Jinhui, SmartHeat Investment, SmartHeat Trading, SmartHeat Pump, SanDeKe and SmartHeat Exchange for $353.  The transactions were structured as purchases of equity interests, the subsidiary companies retained all liabilities when purchased.

The following table summarizes the carrying value of the assets and liabilities disposed at the closing date. The excess of the selling price over the carrying value of the net assets disposed was recorded as gain from disposal of subsidiaries of $5,666,187.

21. SUBSEQUENT EVENTS

The Company evaluated all events that occurred subsequent to September 30, 2019 through the date the CFS were issued, no material subsequent event was identified.