Item 7. Management’s Discussion and Analysis
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
You should read the following discussion and analysis of our financial condition and results of operations together with “Selected Consolidated Financial Data” and our financial statements and the related notes appearing elsewhere in this annual report. In addition to historical information, this discussion and analysis contains forward-looking statements that involve risks, uncertainties and assumptions. See “Cautionary Note Concerning Forward-Looking Statements.” Our actual results may differ materially from those discussed below. Factors that could cause or contribute to such differences include, but are not limited to, those identified below, and those discussed in “Risk Factors” included elsewhere in this annual report.. All amounts in this annual report are in U.S. dollars, unless otherwise noted.
Agreement of Merger with Alberton
On October 27, 2020, we entered into an Agreement and Plan of Merger (the “Merger Agreement”) among us; the Alberton Acquisition Corporation (“Alberton”), and Alberton Merger Subsidiary, Inc., a wholly-owned subsidiary of Alberton, as Merger Sub. Merger Sub was formed for the sole purpose of the proposed merger with us. Under the Merger Agreement, Merger Sub was to have been merged with and into us, and we would continue as the surviving corporation and as a wholly-owned subsidiary of Alberton and our shareholders would receive stock in Alberton. In April 2022, we terminated the Merger Agreement pursuant to the terms of the Merger Agreement. In connection with the Merger Agreement, we made loans to Alberton in the total amount of $1,664,446.66 and we made loans to the Alberton’s sponsor in the total amount of $651,369.01. Although the loans are payable by Alberton and Alberton’s sponsor as a result of the termination of the Merger Agreement, because we are not able to collect any of the outstanding principal amount such loans, we recognized an expense in the full amount of these loans, along with capitalized merger costs, which together totaled approximately $3.4 million, in the year ended December 31, 2022.
Initial Public Offering
On February 27, 2024, we sold 4,500,000 shares of common stock, at a price of $4.00 per share in our initial public offering. The gross proceeds of the offering were $18 million, prior to deducting the underwriting discounts, commissions and offering expenses payable by the Company. In addition, we granted the underwriters a 45-day option to purchase an additional 675,000 shares of common stock at the initial public offering price, less underwriting discounts and commissions, to cover over-allotments. On March 5, 2024, the underwriters purchased 539,950 shares of common stock upon the partial exercise of the over-allotment option. Net proceeds received by us from our initial public offering, including the partial exercise of the over-allotment option, were approximately $18.6 million. We are using the proceeds of our initial public offering for working capital and other corporate purposes.
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Reverse Stock Split
On July 15, 2022, we effected a 0.59445-for-one reverse stock split and, in connection with the reverse stock split, we reduced our authorized common stock from 500,000,000 shares to 297,225,000 shares. All share and per share information in this annual report retroactively reflects the reverse stock split.
Overview
We are an integrated solar and renewable energy company. A solar energy system retains the direct current (DC) electricity from the sun and converts it to alternating current (AC) electricity that can be used to power residential homes and commercial businesses. We were founded in 2008 to engage in the solar business in the United States and, following our acquisition of Chengdu ZHTH and ZHPV, we commenced operations in China.
Our United States operations primarily consist of the sale and installation of photovoltaic and battery backup systems for residential and commercial customers, and sales of LED systems and services to government and commercial users. Prior to 2020, we also financed the purchase of solar equipment from us. Since early 2020, because we did not have the capital to support such operations, we suspended making loans to our solar customers, and we are not currently financing the purchase of solar systems and we do not anticipate engaging in such activities in the near future, if at all. Our finance revenue reflects revenue earned on our current portfolio, with no new loans having been added since early 2020.
Our business in China is conducted through our subsidiaries, primarily ZHTH and ZHPV, and their subsidiaries. Our China operations consist primarily of identifying and procuring solar farm projects for resale to third parties and performing EPC services primarily for solar farm projects. Our China operations did not generate any revenue for the years ended December 31, 2023 and December 31, 2022. Our China segment last generated revenue for the year ended December 31, 2021, substantially all of which was generated in the second quarter of the year.
Substantially all of our revenue for our China segment since 2020 has been generated from four projects for SPIC. At December 31, 2023 and December 31, 2022, we had $7.7 million and $8.4 million, respectively, of accounts receivable from SPIC. These receivables represent the balance of the contractual billings pursuant to the construction contracts and the unpaid portion of the equity transfer agreements pursuant to which we, in 2020 and 2021, sold to SPIC 70% controlling interests in three of the project entities and a 100% interest in the fourth project entity. SPIC is a large state-owned company in China, and we believe that it has the financial ability to meet its obligations on its contracts, including the transfer agreements relating to the four projects. Collections in China are paper-based, bureaucratic and often require in-person meetings. Travel restrictions in China due to the COVID restrictions in China prevented the kind of in-person meetings necessary to collect on the receivables from SPIC. Beginning in August 2022, our China personnel began in-person collection meetings with SPIC, and SPIC has started the payment process. We do not believe that any reserve against these accounts receivable is required at December 31, 2023. SPIC is a state-owned entity in China and is legally obligated to pay its receivables when a bill is issued. We will continue to evaluate the collectability of these receivables on an ongoing basic in connection with the preparation of our financial statements for each quarter.
Our business in China is conducted through our principal subsidiaries, ZHPV and ZHTH, and their subsidiaries. ZHTH is engaged in the business of identifying and procuring solar system projects for resale to third party developers and related services in China. After the project subsidiary acquires the permits for a solar project and obtains a contract for the sale of the project, ZHPV builds the project pursuant to an EPC contract. The subsidiary that owns the equity in the project subsidiary transfers the equity in the project subsidiary to the project owner. During 2020 and 2021, we has agreements with SPIC for the construction of four solar farm projects pursuant to which we preformed the EPC work and sold SPIC 70% of the equity in three of the project subsidiaries and 100% of the equity in the fourth, in each case, upon completion and acceptance of the project by SPIC, we transferred 70% of the equity in the project subsidiary to SPIC, retaining a 30% interest, and SPIC has a first right of refusal to purchase the 30% interest in the project subsidiary from us after the project has been in operation at full capacity for one year. As of March 31, 2024. SPIC has not exercised this right.
Unlike systems in the United States, which are installations for residential and small business users, the projects in China are generally solar farms, which are large land areas where multiple ground-mount solar tracking towers are installed.
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Effects of NEM 3.0
Net metering is a billing mechanism that credits solar energy system owners for the electricity that they add to the electricity grid. If the owner of a solar system generates more electricity than it consumes, the excess electricity is sold back to the grid. The California Public Utilities Commission has adopted the current net metering regulations, known as NEM 3.0, which became effective in April 2023. NEM 3.0 features a 75% reduction in export rates (the value of excess electricity pushed onto the grid by solar systems) from the rate set forth in the previous net metering regulations, NEM 2.0,, thereby reducing the overall savings and increasing the payback period of home solar installations. The changes under NEM 3.0, which are likely to result in reduced benefits for most residential solar users, could alter the return on investment for solar customers.
In January 2024, we laid off a portion of our employees associated with the design and installation of residential solar systems in response to a slowdown in demand after NEM 3.0 took effect in April 2023. The layoff represented approximately 25% of our residential solar system design and installation team. Approximately half of the employees who were laid off had been hired in late 2022 to help install the growing backlog of residential solar systems under contract in anticipation of NEM 3.0, and the contracts representing that backlog were completed during 2023. We may need to revise our pricing metrics to reflect the change resulting from NEM 3.0 in order for the purchase of a solar system to be economically attractive to the customer, which may result in lower prices and reduced margins. Although we anticipate the near-term impact of NEM 3.0 on residential solar contracts will be offset by commercial solar contracts for which we use third-party subcontractors to complete the installations, we cannot assure you that our overall business will not be impacted by the effects of NEM 3.0.
Effects of COVID-19 Pandemic
The United States Center for Disease Control announced that the COVID-19 public health emergency ended in May 2023, with the result that the COVID restrictions in the United States are no longer in effect and restrictions have been terminated worldwide. We believe our United States operations are not, and have not since mid-2022 been, materially affected by COVID. However, the effects of China’s zero tolerance policy with respect to COVID-19, which is no longer in effect, has impaired our ability to negotiate both new contracts with and payment schedules with State Power Investment Corporation Guizhou Jinyuan Weining Energy Co., Ltd. (“SPIC”), a state-owned entity which has been the only customer for our China segment since 2020, with the result that we have no pending agreement with SPIC and we are continuing to negotiate payment of outstanding receivables from SPIC.
Inflation and Supply Chain Issues
Prior to mid-to-late 2021, our business was not impacted by inflation or supply chain issues. With the recent inflationary pressures combined with the world-wide supply chain issues, our business is subject to the inflationary and we were subject to supply chain issues that were affecting many domestic and foreign companies, and we expect that the inflationary pressures will continue to affect our ability to sell our products, the price at which can sell products in both the United States and China and our gross margin in both the United States and China. To the extent that we are not able to raise our prices or to the extent that we cannot accurately project our costs when we set our prices, our gross margin and the results of our operations will be impacted.
Polysilicon is an essential raw material in the production of solar power products, principally solar panels. The costs of silicon wafers and other silicon-based raw materials have accounted for a large portion of the costs associated with solar panels. Although the price of silicon had declined in recent years, increases in the price of polysilicon have resulted in increases in the price of wafers, leading to increases in our costs. Due to the volatile market prices, we cannot assure you that the price of polysilicon will remain at its current levels particularly in view of inflationary pressures and supply chain issues, especially if the global solar power market gains its growth momentum. Moreover, in the event of an industry-wide shortage of polysilicon, we may experience late or non-delivery from suppliers and it may be necessary for us to purchase silicon raw materials of lower quality that may result in lower efficiencies and reduce its average selling prices and revenues. We currently are able to obtain the raw material we request, although the prices pay are increasing as a result of the inflationary pressures.
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The inflationary pressures that are affecting us are not unique to our industry, and relate to the cost of raw materials, labor costs generally and the price at which we can sell our products. Because solar energy can be seen as a way to provide a homeowner with relief from the increasing utility prices for electricity, the market for solar systems generally, and our business specifically, has enabled us to sell more solar systems. Thus, the effects of inflation may also affect the marketability of our solar systems to residential users. In our United States segment, our revenue from solar systems increased from $40.6 million for the year ended December 31, 2022 to $50.5 million for the year ended December 31, 2023 and from $27.5 million in the year ended December 31, 2021 to $40.6 million for the year ended December 31, 2022. Our cost of revenue per watt of solar systems, which makes up approximately 80% of our costs, increased approximately 10% during the year ended December 31, 2023 compared to the same period in 2022, but decreased approximately 3% during 2022 compared to 2021 primarily due to our ability to acquire solar panels in bulk during the second half of 2022 at a cost more favorable than in 2021. In the third quarter of 2022, we were able to obtain panels at a lower cost and our cost per revenue per watt of solar systems for 2022 was equal to our cost per revenue per watt in the 2021. There is no assurance we can continue to source panels at favorable prices. We have increased the price of solar system installations in our United States segment to offset the increase in cost in 2023 and during the first half of 2022. Although we do not have any data as to the effect of higher utility costs on purchases of solar systems, it has been our experience during the years ended December 31, 2023 and 2022 that, as inflationary pressures are increasing the cost of electricity generally, our domestic business has grown as homeowners are seeking alternatives to what they see as high utility bills. As a result, we have been able to increase our prices, which reduced the effect of increased cost of raw materials and the general increase in overhead costs. However, the changes in NEM 3.0 did not affect our business in 2023 as we believe homeowners purchased solar systems in anticipation of NEM 3.0, and our residential business is feeling the effects of the reduced value seen as a result of NEM 3.0. Our gross margin from United States operations increased from 16.7% for the year ended December 31, 2022 to 21% for the year ended December, 2023 and decreased from 19.8% for the year ended December 31, 2021 to 16.7% for the year ended December 31, 2022 as a result of the increase in the cost of raw materials. The effect of increased costs on our margin was reduced because we were able to increase prices. However, competitive factors limit the amount we can increase our prices, but our price increases reduced what would otherwise have been a decline in gross margin for the year ended December 31, 2023, and, if our prices are too high, the residential customer may not see the value of installing a solar system. We are seeking to reduce the effect of increased prices in raw materials by purchasing in greater quantities. However, to the extent inflation continues or increases, we may not be able to raise prices sufficiently to prevent a significant decline in our gross margins and the results of our operations.
Compensation costs per employee for sales, marketing and administrative personnel in our United States segment increased approximately 16% for the year ended December 31, 2023 compared to the year ended December 31, 2022, and approximately 12% during the year ended December 31, 2022 compared to 2021 in response to the increased cost of retaining and attracting talent, and such costs may continue to increase as labor costs in California continue to increase as a result of the inflationary pressures. In addition, to the extent that inflationary pressure affects our cost of revenue and general overhead, we may face the choice of raising prices to try and maintain our margins or reduce or maintain our price structure to generate business. In addition, to the extent that inflationary pressure affects our cost of revenue and general overhead, we may face the choice of raising prices to try and maintain our margins or reduce or maintain our price structure to meet competition which would resulting in a lower gross margin and a drop in operating income. Supply chain issues have caused us to periodically stock up on components such as solar panels and battery systems to ensure an adequate supply to meet expected demand, putting pressure on our cash flow. We do not believe that the supply chain issues that affected our operations in prior periods are currently affecting us. We cannot assure you that such delays and increased costs will not affect our business in the future.
Our China segment has felt the effects of both inflation and supply chain issues. Our China segment had a 0% gross margin for the year ended December 31, 2021 because our cost of revenue for one of our projects with SPIC was significantly adjusted as a result of the unanticipated increase in costs particularly the solar panel costs which resulted in a significant adjustment in cost during the period which could not be passed on to SPIC, which essentially reversed the profit that was recognized in 2020 for the project. We did not generate any revenue for our China segment for the years ended December 31, 2023 and 2022 and 2024 through the date of this annual report. Since the second quarter of 2020, the prices of the solar panels in China have been increasing due to the tight supply in the local market We cannot assure you that, if we are able to negotiate contracts with SPIC or any other purchaser, that we will be able to accurately price our costs, with the risk that, if we incur unanticipated inflationary and supply side costs, we may recognize a loss on the projects.
We are seeking to address the inflationary pressures by seeking to cut overhead expenses where possible and raising prices to levels that we believe are both competitive and attractive to customers in view of the increases in utility prices in California and maintaining an inventory of raw materials to enable us to better price our products. We believe that the proceeds of our initial public offering will provide us with funding to assist us in dealing with the effects of inflation on our business.
Transfer of Funds between our United States and China segments.
Our equity structure is a direct holding structure, that is, we directly control our U.S. subsidiaries and our subsidiaries in our China segment including: (i) Golden SolarMax Finance. Co. Ltd, a PRC subsidiary, (ii) SolarMax Technology Holdings (Hong Kong) Limited, a Hong Kong subsidiary which directly holds SolarMax Technology (Shanghai) Co., Ltd, a PRC subsidiary (together with its subsidiaries thereunder, “ZHTH”); (iii) Accumulate Investment Co., Ltd, a British Virgin Islands subsidiary which then directly holds Accumulate Investment Co., Limited, a Hong Kong subsidiary that directly holds ZHPV; a PRC subsidiary, and (iv) SolarMax Technology Holdings, a Cayman Islands subsidiary. Our business in China is conducted through ZHPV and ZHTH.
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Since prior to the reporting periods presented in this prospectus and through the date of this prospectus, no dividends, distribution or other transfers of funds have occurred between and among us and our subsidiaries, on the one hand; and our Chinese subsidiaries, on the other hand, and we have not made any dividends, distributions or other transfer of funds to our stockholders. For the foreseeable future, we intend to use any earnings for our operations. As a result, we do not expect to pay any cash dividends. To the extent that we may in the future seek to fund the business through distribution, dividends or transfer of funds among and between holding company and subsidiaries, any such transfer of funds with PRC subsidiaries is subject to PRC government regulations. The structure of cash flows within holding company and PRC subsidiaries and a summary of the applicable regulations, is as follows:
1. Within the direct holding structure, the cross-border transfer of funds between us and our PRC subsidiaries is legal and compliant with the laws and regulations of the PRC. Funds can be directly transferred to our subsidiaries including ZHPV and ZHTH, and then transferred to subordinate operating entities through ZHPV and ZHTH according to the laws and regulations of the PRC.
2. If we intend to distribute dividends from our PRC subsidiaries, either for use in our United States segment or for distribution to stockholders, we will transfer the dividends from the PRC entities to ZHPV and ZHTH in accordance with the laws and regulations of the PRC, and then ZHPV and ZHTH will transfer the dividends to their respective parent companies and then to us and, if the funds are to be paid to our stockholders as a dividend, the dividend will be distributed by us to all stockholders based on their share ownership, regardless of whether the shareholders are U.S. investors or investors in other countries or regions.
3. Our PRC subsidiaries’ ability to distribute dividends is based upon their distributable earnings. Current PRC regulations permit our PRC subsidiaries to pay dividends to their respective shareholders only out of their accumulated profits, if any, determined in accordance with PRC accounting standards and regulations. In addition, each of the PRC subsidiaries is required to set aside at least 10% of its after-tax profits each year, if any, to fund a statutory reserve until such reserve reaches 50% of each of their registered capitals. These reserves are not distributable as cash dividends.
In addition, the Enterprise Income Tax Law and its implementation rules provide that a withholding tax at a rate of 10% will be applicable to dividends payable by Chinese companies to non-PRC-resident enterprises unless reduced under treaties or arrangements between the PRC central government and the governments of other countries or regions where the non-PRC resident enterprises are tax resident. Pursuant to the tax agreement between Mainland China and the Hong Kong Special Administrative Region, the withholding tax rate in respect to the payment of dividends by a PRC enterprise to a Hong Kong enterprise may be reduced to 5% from a standard rate of 10%. However, if the relevant tax authorities determine that our transactions or arrangements are for the primary purpose of enjoying a favorable tax treatment, the relevant tax authorities may adjust the favorable withholding tax in the future. Accordingly, there is no assurance that the reduced 5% withholding rate will apply to dividends received by ours Hong Kong subsidiary from its PRC subsidiaries. This withholding tax will reduce the amount of dividends we may receive from our PRC subsidiaries.
To address persistent capital outflows and the RMB’s depreciation against the U.S. dollar in the fourth quarter of 2016, the People’s Bank of China and the State Administration of Foreign Exchange, or SAFE, have implemented a series of capital control measures in the subsequent months, including stricter vetting procedures for China-based companies to remit foreign currency for overseas acquisitions, dividend payments and shareholder loan repayments. The PRC government may continue to strengthen its capital controls and our PRC subsidiaries’ dividends and other distributions may be subject to tightened scrutiny in the future.
Foreign currency exchange regulation in the PRC is primarily governed by the Regulations on the Administration of Foreign Exchange, most recently revised by the State Council on August 5, 2008, Notice on Further Simplifying and Improving Policies of Foreign Exchange Administration Regarding Direct Investment issued by SAFE on February 13, 2015, and the Provisions on the Administration of Settlement, Sale and Payment of Foreign Exchange promulgated by People’s Bank of China on June 20, 1996. Currently, RMB is convertible for current account items, including the distribution of dividends, interest payments, trade and service-related foreign exchange transactions. Conversion of RMB for most capital account items, such as direct investment, security investment and repatriation of investment, however, is still subject to registration with the SAFE. Foreign-invested enterprises may buy, sell and remit foreign currencies at financial institutions engaged in foreign currency settlement and sale after providing valid commercial documents and, in the case of most capital account item transactions, obtaining approval from the SAFE. Capital investments by foreign enterprises are also subject to limitations, which include approvals by the NDRC, the Ministry of Construction, and registration with the SAFE.
Therefore, we may experience difficulties in completing the administrative procedures necessary to obtain and remit foreign currency for the payment of dividends from our profits, if any. Furthermore, if our subsidiaries in the PRC incur debt on their own in the future, the instruments governing the debt may restrict their ability to pay dividends or make other payments.
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Years Ended December 31, 2023 and 2022
Results of Operations
The following tables set forth information relating to our operating results for the years ended December 31, 2023 and 2022 (dollars in thousands) and as a percentage of revenue:
Years ended December 31,
2023
2022
Dollars
%
Dollars
%
Revenue:
Solar energy sales (US)
$ 50,523
93.3 %
$ 40,599
90.8 %
LED sales (US)
3,055
5.7 %
3,305
7.4 %
Financing (US)
562
1.0 %
814
1.8 %
Total revenues
54,139
100.0 %
44,718
100.0 %
Cost of revenue:
Solar energy sales
40,891
75.5 %
35,093
78.5 %
LED sales
2,099
3.9 %
2,143
4.8 %
Solar farm EPC (China)
-
0.0 %
-
0.0 %
Power purchase agreements and other
-
0.0 %
-
0.0 %
Total cost of revenues
42,990
79.4 %
37,236
83.3 %
Gross profit
11,149
20.6 %
7,482
16.7 %
Operating expenses:
Sales and marketing (US)
1,158
2.1 %
1,080
2.4 %
Sales and marketing (China)
-
0.0 %
-
0.0 %
General and administrative (US)
8,789
16.3 %
12,848
28.7 %
General and administrative (China)
718
1.3 %
1,522
3.4 %
Total operating expenses
10,665
19.7 %
15,450
34.5 %
Income (loss) from operations (US)
1,202
2.2 %
(6,448 )
(14.4 )%
Income (loss) from operations (China)
(718 )
(1.2 )%
(1,522 )
(3.4 )%
Equity in income of solar project companies
864
1.6 %
494
1.1 %
Gain on debt extinguishment
27
0.0 %
1,947
4.4 %
Gain on early termination of lease
4
0.0 %
1,079
2.4 %
Interest income
69
0.1 %
62
0.1 %
Interest (expense)
(1,577 )
(2.9 )%
(1,829 )
(4.1 )%
Other income (loss), net
500
0.9 %
(615 )
(1.4 )%
Income (loss) before income taxes
371
0.7 %
(6,832 )
(15.3 )%
Income tax benefit (provision)
64
0.1 %
(41 )
(0.1 )%
Net income (loss)
435
0.8 %
(6,873 )
(15.4 )%
Currency translation adjustment
(115 )
(0.2 )%
(887 )
(2.0 )%
Comprehensive income (loss)
$ 320
0.6 %
$ (7,760 )
(17.4 )%
Revenues
Revenues for the year ended December 31, 2023 were $54.1 million, an increase of $9.4 million or 21% from $44.7 million in the year ended December 31, 2022, all of which was generated by the United States segment. The increase resulted primarily from a $9.9 million increase in solar energy and battery sales. The increase in the solar energy and battery sales in the United States segment in the year ended December 31, 2023 is attributed to the increase in the average size of systems completed coupled with the increase in the sales price per watt for smaller systems. Another factor contributing to the increase is the price per watt for systems being financed with third party lenders. The fees charged by third party lenders have increased over time and such fees are passed through to the customers, i.e., both revenue and cost increase related to the lender fees. During the year ended December 31, 2023 and 2022, our battery sales were $3.2 million and $3.4 million, respectively. Battery sales refer to the sale of batteries sold other than as a part of a solar system. During the year ended December 31, 2023, we de-emphasized battery sales as we devoted resources to the sale, installation and permitting of solar systems and we have since expanded our marketing effort for battery sales other than as part of a solar system. Financing revenue for the years ended December 31, 2023 and 2022 related to income from existing loan agreements. We have not entered into new financing agreements since 2020 because we did not have the financing to support such operations. We have no immediate plans to re-enter the business of providing financing to our customers unless we have sufficient funds for such purpose.
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During the years ended December 31, 2023 and 2022 and continuing through the date of this annual report, we did not generate any revenue in the China segment because there are no projects under construction. As a result of the strict lockdown in China through the end of 2022 resulting from the resurgence of the pandemic, we have not been able to negotiate new contracts with SPIC since the completion of the last project in June 2021. Because we currently do not have any projects under contract for our China segment, we have neither revenue nor cost of revenue for our China segment for the years ended December 31, 2023 and 2022.
Revenue increased $9.4 million, or 21%, to $54.1 million in the year ended December 31, 2023 from $44.7 million in the year ended December 31, 2022. We deployed 11.1 MW on 1,368 completed systems during the year ended December 31, 2023, compared with 9.4 MW on 1,174 systems during the year ended December 31, 2022, an increase of 18% in wattages. On average, solar revenue per watt was $4.25 in the year ended December 31, 2023 compared to $3.95 in the year ended December 31, 2022, a 8% increase primarily as a result of the increase in the prices of panels and inverters from a year ago, as well as a significant increase in third party lender fees which were priced into the system price for customers who finance the purchase of their systems through our third party lenders. Solar revenue per watt represents the revenue generated during the period from sales of solar systems (excluding battery sales) divided by the wattage installed during the period. Our LED revenue decreased by $250,000, or 8%, to $3.1 million for the year ended December 31, 2023 from $3.3 million for the year ended December 31, 2022, primarily resulting from the decrease in the number of LED projects. LED revenues include LED product sales and LED consulting revenues and are expected to continue to fluctuate based on the number of LED projects awarded which is based on the bidding process and specific customer purchase requirements and timing. The revenue trend from our LED business is therefore not as consistent as our solar business, and LED revenue tends to fluctuate period to period. Our revenue for the year ended December 31, 2023 and 2022 includes finance-related revenues of $562,000 and $814,000, respectively, from our portfolio of solar loans provided to our customers, the decrease, which is expected, reflects the pay down and pay off of customer loans over time since we are not making new loans. Since early 2020, because we did not have the capital to support such operations, we suspended making loans to our solar customers but may resume lending if we have sufficient funds, including from the proceeds of our initial public offering.
Cost of revenue and gross profit
During the year ended December 31, 2023 and 2022, our China operations did not have any cost of revenue since it did not have any projects under construction during both periods.
Cost of revenue for our United States segment increased 15% from $37.2 million in the year ended December 31, 2022 to $43.0 million in the year ended December 31, 2023, primarily as a result of the corresponding increase in revenue in the United States segment. Gross margin for the United States segment increased to 21% for the year ended December 31, 2023 from 17% a year ago, primarily as result of the sales price rising faster than the increase in the unit cost of revenue. The improvement of the gross profit for the year ended December 31, 2023 also reflects a one-time net credit to revenue in the of approximately $435,000 from customer deposits related to solar projects cancelled by customers and customer service projects completed for which revenues should have been recognized in past periods, as well as a one-time credit to cost of revenue of approximately $650,000 related to the over-accrual of accrued warranty liability. We had no cost of revenue with respect to interest income on customer loans. Our China segment had no revenue and no cost of revenue for the year ended December 31, 2023 and 2022.
Our overall gross margin for the year ended December 31, 2023 was 21% compared to 17% in the year ended December 31, 2022, primarily as a result of our ability to increase the sales price commensurate with the continued rising costs of materials, higher sale commissions and increased rates of third party lenders, and partially offset by higher selling prices, in the year ended December 31, 2023. The improvement in the gross margin is also due to a one-time net credit to revenue in the United States segment of approximately $435,000 related to customer deposits for which revenues should have been recognized in the past periods related to solar projects cancelled by customers and customer service projected completed, as well as a one-time credit in the United Segment of $650,000 as described in the preceding paragraph. China operations did not generate any revenue and did not incur any cost of revenue for the year ended December 31, 2023. We expect that if we are able to generate contracts for major solar farm projects in China, the China segment could generate higher revenue and a lower gross margin than the United States segment in the future, resulting in the China segment continuing to have a negative impact on our consolidated gross margin. To the extent that we incur higher than anticipated costs that we are not able to recover from our customer, the consolidated gross margin will be impacted. As of December 31, 2023 and through the date of this annual report, we did not have any agreements with respect to any solar farm projects in China, either with SPIC or any other customer, we had not generated any revenues from our China segment since 2022, and we cannot assure you that we will be able to generate profitable business in China.
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Operating expenses
Sales and marketing expenses for the year ended December 31, 2023 increased for our United States segment to $1.2 million, an increase of $78,000, or 7%, from $1.1 million in 2022. Sales and marketing expenses in the United States were 2.1% of revenue for the year ended December 31, 2023 compared to 2.4% for the year ended December 31, 2022. Our sales and marketing expenses in the United States may fluctuate from time to time based on the types of marketing and promotion initiatives we deploy. Due to the nature of our EPC business in our China segment, the EPC contracts for solar farm projects are generally obtained through customer relationship with just a few corporate customers, with substantially all revenues for our China segment since the second half of 2019 being generated by agreements with SPIC, Accordingly, our China segment did not incur sales and marketing expenses for the year ended December 31, 2023 and 2022.
General and administrative expenses for the United States segment for the year ended December 31, 2023 decreased to $8.8 million, a decrease of $4.1 million, or 32%, from $12.8 million for the comparable period of 2022. The decrease is a result of the prior period’s write-off of previously capitalized offering costs and notes receivable of $3.4 million related to the termination of our merger agreement with Alberton in April 2022, a decrease in the facility rental costs resulting from an increase in income from subleases at our Riverside headquarters. General and administrative expenses were 29% of revenue for the year ended December 31, 2022, compared to 16% for the year ended December 31, 2023. General and administrative expenses included compensation and benefits, depreciation and amortization (excluding auto depreciation), provision for losses, rental and leasing expense, and other corporate overhead expenses. We expect an overall increase in compensation expenses in 2024 as a result of the expected vesting of stock and options that became vested upon a public stock offering event, and the cost of compliance and other regulatory costs associated with being a public reporting company. All of our corporate overhead, other than overhead directly related to the China segment, is allocated to the United States segment.
General and administrative expenses relating to the China segment decreased by $0.8 million, or 53%, from $1.5 million in the prior year to $718,000 in the year ended December 31, 2023, primarily due to a $1.1 million recovery of previously reserved receivable on from a legal settlement relating to one of our projects for SPIC. General and administrative expenses relate to the corporate and overhead expenses specifically connected with the China segment and include personnel costs, facilities rental and leasing and other general overhead expenses and certain pre-development project costs that are expensed prior to the execution of the EPC agreements. All of the corporate headquarter overhead is allocated to the United States segment.
Income (loss) from operations
Our income from operations was $484,000 for the year ended December 31, 2023 compared to a loss from operations of $8.0 million in the year ended December 31, 2022, a decrease in loss of $8.5 million, or 106%, from the comparable period of 2022. Our income from operations for the United States segment was $1.2 million, compared to a loss from operations of $6.4 million in the year ended December 31, 2022, or a decrease in loss of $7.7 million or 119%, from the year ended December 31, 2022. Our loss from operations for our China segment was $718,000, compared to a loss) from operations from our China segment in the year ended December 31, 2022 of $1.5 million, primarily because our China segment received $1.2 million payment under a legal settlement relating to one of the SPIC projects which had been previously reserved in full. The operating results of our China segment fluctuate based on the timing of awards for EPC projects, the construction contracts in progress and completed as well as the underlying timing of the related performance obligations which relate to our recognition of revenue.
Equity in income (loss) from unconsolidated entities
Equity in income from unconsolidated entities relates to our China segment and comprises the 30% equity in income from three unconsolidated project companies for which we had previously transferred a 70% interest to SPIC. We record our 30% noncontrolling interest under the equity method of accounting. The equity in income reported for the year ended December 31, 2023 was $864,000 compared to $494,000 in the year ended December 31, 2022, an increase of $370,000 or 75%. The increase is attributed to the higher power production this year resulting from the improvement over the prior year’s inferior sunshine quality affecting the Guizhou region in China, as well as additional costs incurred to comply with SPIC internal safety production requirements and increased interest expense due to the change in SPIC’s accounting from cash to accrual in 2022.
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Gain on debt extinguishment
Gain on debt extinguishment for the year ended December 31, 2023 was $27,000 and relates primarily to an exchange of two 3% EB5 note payable to a 4% convertible note payable. Gain on debt extinguishment for the year ended December 31, 2022 was $1.9 million and is primarily related to the forgiveness of three PPP loans to three U.S. subsidiaries and the related accrued interest.
Interest expense, net
Interest expense, net, for the year ended December 31, 2023 was $1.5 million, a decrease of $257,000, or 15%, from the 2022. Our interest expense in the year ended December 31, 2023 primarily includes interest at 3% on two loans from related parties in the United States with a total principal balance of $17.0 million at December 31, 2023, interest at 4% on convertible notes issued to former limited partners of CEF in transactions in which the former limited partners of CEF accepted a 4% convertible note issued by SolarMax and the subsidiary that borrowed the funds from CEF with an aggregate principal balance of $7.6 million at December 31, 2023, and interest at 8% on promissory notes issued to SMX Property (a related party) in October 2022 with a principal balance of $1.4 million at December 31, 2023. The convertible notes issued to the former limited partners of CEF were issued as payment of the former limited partner’s capital account in CEF and replace debt of an equal amount that had been due to CEF. The notes are secured by the same collateral as the notes to CEF.
Other income (expenses), net
During the year ended December 31, 2023, other income was $500,000, consisting primarily of $308,000 cash distributions declared from zero basis equity investments in Alliance entities in the United States segment, $264,000 of gain on insurance settlement related the fire claim at the Riverside headquarters for the United States segment, $266,000 of expense related to the foreign currency transaction for our United States segment intercompany receivable denominated in the Chinese currency, $114,000 of additional payment on one of the SPIC projects representing interest on the amount previously owed on the project in the China segment, and $54,000 of income related to a vendor invoice on the project due to the poor product quality in the China segment.
During the year ended December 31, 2022, other expenses, net was $615,000, consisting primarily of $262,000 cash distributions from zero basis equity investments in Alliance entities in the United States, offset by $938,000 of expense related to the foreign currency transaction loss for our United States segment intercompany receivable denominated in the Chinese currency.
Income tax benefit (provision)
For the year ended December 31, 2023 and 2022, our United States segment reported an income tax benefit (expense) of $(6,000) for both periods attributable to state minimum tax liabilities. For the China segment, an income tax benefit (expense) of $70,194 and $(35,431) was reported for the year ended December 31, 2023 and 2022, respectively, arising from profitable operations subject to China income tax.
Net income (loss)
As a result of the foregoing, we had consolidated net income of $434,786 for the year ended December 31, 2023, compared with a consolidated net (loss) of $(6.9) million for the year ended December 31, 2022. The basic and diluted net income per share was $0.01 and $(0.17) for the year ended December 31, 2023 and 2022, respectively.
Currency translation adjustment
Although our functional currency is the U.S. dollar, the functional currency of our China subsidiaries is the RMB. The financial statements of our subsidiaries are translated to U.S. dollars using period end exchange rates for assets and liabilities, and average exchange rates for the period for revenues, costs, and expenses. Net gains and losses resulting from foreign exchange transactions are included in the consolidated statements of operations and reflect changes in the exchange rates between U.S. dollars and RMB.
As a result of foreign currency translations, which are non-cash adjustments, we reported net foreign currency translation losses of approximately $0.1 million for the year ended December 31, 2023 and approximately $1.2 million for the year ended December 31, 2022.
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Liquidity and Capital Resources
The following tables show consolidated cash flow information for the years ended December 31, 2023 and 2022 (dollars in thousands):
Years Ended
December 31,
$ Increase
(Decrease)
2023
2022
Consolidated cash flow data:
Net cash provided by (used in) operating activities
$ 3,815
$ (1,972 )
$ 5,615
Net cash provided by (used in) investing activities
(6 )
(281 )
275
Net cash provided by (used in) financing activities
(5,046 )
(7,500 )
2,454
Net increase (decrease) in cash and cash equivalents and restricted cash
(1,275 )
(9,233 )
7,958
Net increase (decrease) in cash and cash equivalents and restricted cash excluding foreign exchange effect
(1,237 )
(9,752 )
8,515
Operating Activities
Net cash provided by operating activities for the year ended December 31, 2023 was $3.8 million, compared to net cash used by operating activities for the year ended December 31, 2022 of $2.0 million, a decrease in cash used of $5.8 million, resulting from a decrease in cash of $1.6 million from the overall change in operating assets and liabilities, a increase in cash used of $91,000 from non-cash expense and a decrease in net loss of $7.3 million. During the year ended December 31, 2023, our operating assets and liabilities provided $1.5 million in cash, compared to cash provided of $3.2 million for the year ended December 31, 2022, resulting in an decrease in cash provided of $1.6 million in operating assets and liabilities. The decrease in cash used by our operating assets and liabilities during the year ended December 31, 2023 is primarily due to a $4.8 million decrease in cash from unbilled receivables, $1.3 million decrease in cash from contract liabilities, $1.7 million decrease in cash from customer loans receivable, $281,000 decrease in cash from operating lease liabilities, and $2.3 million decrease in cash from accrued expenses and other liabilities, with an offset from a $4.0 million increase in cash from receivables and current assets, receivables from SPIC and project companies, and other receivables and current assets and other assets, $2.1 million increase in cash from inventories, $3.7 million increase in cash from accounts payable, and $0.9 million increase in cash from contract assets. We expect the fluctuations of working capital over time to vary based on the construction status and the related contractual billings of the EPC projects which could vary from project to project. Non-cash charges for the year ended December 31, 2023, which was a non-cash income of $1.84 million, compared to a non-cash income of $1.75 million, in 2022, an increase in non-cash income of $91,000, comprised of $343,000 increase from depreciation and amortization expense, $138,000 increase from loss provisions for bad debts, loan losses, inventories and warranties, $8,000 increase from deferred income taxes, $1.9 million increase from gain on debt extinguishment, $1.1 million increase from gain on early termination lease at the Riverside headquarters with SMX Property, LLC (a related party) in October 2022, $80,000 increase from gain on disposal of property and equipment, offset by a $370,000 decrease in equity in income of investments, and a $3.4 million decrease from the write-off of capitalized merger costs and loans made by us to Alberton and its sponsor in connection with the proposed merger which was terminated in April 2022.
Non-cash adjustments changes:
●
$370,000 decrease resulting from a net increase in equity in income from our equity investments.
●
$343,000 increase in depreciation and amortization expense which includes loan and debt discounts amortization.
●
$3.4 million decrease from the write-off of capitalized merger costs and loans made by us to Alberton and its sponsor in connection with the proposed merger which was terminated in April 2022.
●
$1.9 million net increase from the reduction in gain on debt extinguishment with respect to the PPP loans that were forgiven in 2022 and other loans.
●
$80,000 increase from the reduction in gain on disposal of property and equipment.
●
$138,000 increase in expenses associated with loss provisions for bad debts, loan losses, inventories, warranty, customer care and production guaranty.
●
$8,000 increase in deferred income taxes.
●
$1.1 million increase resulting from the gain associated with the early termination of our headquarters lease in Riverside, California.
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Changes in operating assets and liabilities:
●
$4.0 million increase in net cash inflow from receivables and current assets, receivables from SPIC and project companies, and other receivables and current assets and other assets.
●
$4.8 million decrease in cash from unbilled receivables.
●
$2.1 million increase in net cash inflow from inventories.
●
$1.7 million decrease in net cash inflow from customer loans receivable.
●
$3.7 million increase in cash inflows from accounts payable.
●
$2.7 million decrease in cash from accrued expenses and other liabilities.
●
$1.3 million decrease in net cash outflow from contract liabilities related to projects for which the performance obligations have not been satisfied under the revenue recognition standard which became effective January 1, 2019.
●
$0.9 million increase in net cash inflow from contract assets related to projects for which the performance obligations have not been satisfied under the revenue recognition standard which became effective January 1, 2019.
●
$281,000 decrease in net cash from operating lease liabilities.
Investing Activities
Net cash used in investing activities for the year ended December 31, 2023 was $6,550, consisting of $27,999 for the purchase of property and equipment, partially offset by cash received of $21,449 related to the disposal of property and equipment. Net cash provided by investing activities for the year ended December 31, 2022 was $280,524, consisting of $288,856 advanced to Alberton and its sponsor and $83,466 for the purchase of property and equipment, partially offset by cash received of $91,798 related to the disposal of property and equipment.
Financing Activities
Net cash used in financing activities for the year ended December 31, 2023 was $5.0 million, consisting of $4.8 million principal payments on convertible notes in the United States segment, $48,939 payments on other borrowings and equipment leases in the United States segment, $6.6 million of additional legal settlement proceeds received on behalf of Uonone in the China segment, and $6.8 million payment to Uonone and related expenses on Uonone’s behalf related to the legal settlement received on its behalf in the China segment.
Net cash used in financing activities for the year ended December 31, 2022 was $7.5 million, consisting of $7.1 million principal payments on convertible notes in the United States segment, $93,636 payments on other borrowings and equipment leases in the United States segment and $356,329 payment to Uonone related to legal settlement received by SolarMax on Uonone’s behalf in the China segment.
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Cash and Cash Equivalents and Restricted Cash
The following table sets forth, our cash and cash equivalents and restricted cash held by our United States and China segments at December 31, 2023 and 2022 (dollars in thousands):
December 31,
2023
2022
US Segment
Insured cash
$ 819
$ 1,458
Uninsured cash
813
1,163
1,632
2,621
China Segment
Insured cash
295
391
Uninsured cash
967
1,157
1,262
1,548
Total cash and cash equivalents & restricted cash
2,894
4,169
Cash and cash equivalents
2,539
3,822
Restricted cash
$ 355
$ 347
We currently do not plan to repatriate any cash or earnings from any of our non-United States operations because we intend to utilize such funds to expand our China operations. Therefore, we do not accrue any China exit taxes related to the repatriation.
Under applicable PRC law and regulations, our PRC subsidiaries are required to set aside at least 10% of their respective accumulated after-tax profits, if any, each year, to fund certain reserve funds, until the aggregate amount of such fund reaches 50% of its registered capital before they may pay dividends. We do not believe that this restriction will impair our operations since we do not anticipate that we will use the cash generated from our PRC operations in those operations and we do not plan to repatriate such funds to the United States.
Borrowings
Prior to October 13, 2022, we leased our headquarters from SMX Property, LLC, a California limited liability company (“SMXP”), which is a related party. The owners and principal management group of SMXP consist of David Hsu, our chief executive officer and a director, Simon Yuan, a director, and Ching Liu, our former executive vice president and a current 5% stockholder. In October 2022, SMXP sold its interest in the building at 3080 12th Street, Riverside, California, which serves as our headquarters, to an unrelated party known as 3080 12 Street, LLC. (“3080 Landlord”). In October 2022, we entered into a lease agreement with 3080 Landlord to lease the property until December 31, 2026. Under the lease with 3080 Landlord, we lease the entire building, whereas under the prior lease we leased the portion of the building we occupy. We have the right to sublease space in the property with the consent of the landlord, such consent not to be unreasonably withheld, and we currently sublease the portion of the building that we are not using. Rent for the first lease year is at the annual rate of $1.6 million and increases 3% per year. Since the lease is a net lease, we pay all of the operating expenses of the building.
Contemporaneously with the execution of our lease with 3080 Landlord and the termination of our former lease with SMXP, we issued two two-year 8% notes to SMXP. Both notes provide for quarterly payments of interest during the term with the principal being due at maturity. One note, in the principal amount of $414,581, was issued to pay past due rent under our former lease with SMXP for the period June 1, 2022 to October 12, 2022. The second note, for $944,077 was issued in respect of a loan from SMXP to finance our security deposit ($809,209) and one month’s rent under our lease with 3080 Landlord.
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EB-5 Loans
On January 3, 2012, CEF entered into a loan agreement with SREP, one of our United States subsidiaries, pursuant to which CEF advanced $45.0 million. On August 26, 2014, CEF II entered into a loan agreement with LED, another United States subsidiary, for up to $13.0 million. CEF II advanced $10.5 million pursuant to the agreement. The proceeds of the loans were used by our subsidiaries for their operations. The loans from CEF and CEF II accrue interest at 3% per annum, payable quarterly in arrears. The loans are secured by a security interest in the accounts and inventory of the borrowing subsidiary. CEF and CEF II are limited partnerships, the general partner of which is Inland Empire Renewable Energy Regional Center, a related party. The limited partners of both CEF and CEF II are investors who made a capital contribution to CEF or CEF II pursuant to the United States EB-5 immigration program and are not related parties. The EB-5 immigrant investor visa is a federal program that grants green cards and a path to citizenship to foreign investors who invest at least $500,000 toward job-creating projects. Under this program, which is administered by the United States Customs and Immigration Service, entrepreneurs (and their spouses and unmarried children under 21) are eligible to apply for a green card (permanent residence) if they make the necessary investment in a commercial enterprise in the United States and plan to create or preserve 10 permanent full-time jobs for qualified United States workers. We are a commercial enterprise that creates permanent full-time jobs in the United States.
The loans from CEF and CEF II become due, as to the investment of each limited partner, four years from the date of the loan and may be extended as may be necessary to meet applicable USCIS immigrant investor visa requirements, which will be the date that the limited partner is eligible for a green card. Under the limited partnership agreements for CEF and CEF II, the limited partners have the right to demand repayment of their capital account when the petition is approved, which demand may trigger a maturity of the loan from CEF or CEF II in the amount of the limited partner’s investment. The initial four-year term of notes in the principal amount of $55.5 million, which were issued to CEF and CEF II, and had expired prior to December 31, 2023 and are on extension until the limited partners meet applicable immigrant investor visa requirements. We cannot determine the period of the extensions. As of March 31, 2024, limited partners whose capital contributions funded loans of $41.5 million had received their green card approval and their extensions expired and one limited partner whose capital contribution funded $500,000 had withdrawn from CEF II and the limited partner’s capital contribution was returned. The petitions of limited partners of CEF whose capital contribution funded loans of $3.5 million are pending.
As the loans matured and the limited partners requested return of their capital contribution, we offered the limited partners, in lieu of the payment by the limited partnership, a convertible note with a term of five years, with 20% of the principal amount being due on each of the first, second, third, fourth and fifth anniversaries of the date of issuance. The notes are secured by the same assets that secured the notes issued to CEF. As of March 31, 2024, we had issued convertible notes in the principal amount of $36.5 million to former limited partners of CEF, of which principal payments of $19.75 million had been made on the anniversary of the respective dates of issuance, and convertible notes in the principal amount of $2.5 million had been purchased by us for $1.77 million, leaving convertible notes in the principal amount of $14.25 million outstanding. As of March 31, 2024, notes to CEF and CEF II in the aggregate principal amount of $15.0 million were outstanding.
Six of the limited partners commenced an action against CEF, us and others, including Mr. Hsu and Mr. Yuan, seeking cash payment of their capital contribution to CEF totaling $3.0 million and other relief, including a declaration that the $45.0 million note to CEF is due and payable. All six of these limited partners settled their actions. One of these limited partners accepted a convertible note.
During the years ended December 31, 2023 and 2022, we made payments on account of the EB-5 notes exchanged for convertible notes in the amount of $3.8 million and $6.05 million, respectively, either as payments of installments of principal due under the convertible notes or to pay the principal amount of the notes at a discount. Such payments were made from our cash flow from operations. We plan to use our cash flow to make any payments necessary to pay the convertible notes as they become due to the extent that the note holders do not exercise their conversion rights under the notes. However, to the extent that we do not have the funds to pay these notes we may use the proceeds of our initial public offering to meet our liquidity needs, including to make such payments.
Other Debt Obligations
We have a loan for $2.0 million from an unrelated party bearing interest rate at 6% per annum which becomes due at June 30, 2024. This loan had been extended periodically since the original maturity date of April 30, 2021.
On February 1, 2021, we received loans pursuant to the PPP Second Draw totaling $1,855,813. The loans were issued to three of our United States subsidiaries and may be entirely or partially forgivable if the loan proceeds are used for eligible expenses which include employee payroll, mortgage interest, rents, utilities and other eligible costs allowed by the Small Business Administration, during the 24-week period beginning on the date of the first disbursement of the loans. For the non-forgivable portion, the loans would be due in five years at a fixed interest rate of one percent per annum with the first payment due 16 months from the date of the first disbursement of the loans. In February and April 2022, $1,852,291 of the loans from the PPP Second Draw were forgiven and in May 2022 the remaining $3,522 of the loans were repaid.
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On October 10, 2022, SMX Property LLC, a related party, made unsecured loans to us for $944,077 and $414,581 at an interest rate of 8%, with interest payable quarterly at the end of each quarter. The principal amount plus accrued interest of both notes is due on October 10, 2024. The proceeds of the loans were used to pay the security deposit and lease obligations for one month owed to the new owner of our headquarters building under the new lease agreement and for rent on our headquarters building from June 1, 2022 to October 12, 2022.
Contractual Obligations
Borrowings
Principal maturities for the financing arrangements as of December 31, 2023 are as follows (dollars in thousands):
For the year ending December 31,
Bank and Other Unsecured Loans
EB-5 Loans - Related Party
Notes Payable - Related Party
Convertible Notes
Total
2024
$ 2,000
$ 10,000
$ 1,359
$ 8,680
$ 22,039
2025
7,000
4,990
11,990
2026
1,890
1,890
2027
500
500
2028
190
190
Total
$ 2,000
$ 17,000
$ 1,359
$ 16,250
$ 36,609
Operating Leases
Future minimum lease commitments for office facilities and equipment for each of the next five years as of December 31, 2023, are as follows (dollars in thousands):
For the year ending December 31,
Related Parties
Others
Total
2024
$ 133
$ 1,684
$ 1,817
2025
133
1,726
1,859
2026
133
1,768
1,901
2027
133
-
133
2028
133
-
133
Thereafter
554
-
554
Total
$ 1,219
$ 5,178
$ 6,397
Employment Agreements
On October 7, 2016, we entered into employment agreements with our chief executive officer, David Hsu, for a five-year term commencing January 1, 2017 and continuing on a year-to-year basis unless terminated by us or Mr. Hsu on not less than 90 days’ notice prior to the expiration of the initial term or any one-year extension. The agreements provide for an annual salary with an increase of not less than 3% and an annual bonus in restricted stock and cash equal to a specified percentage of consolidated revenues for each year. Mr. Hsu’s annual salary for 2023 was $716,431, and his salary for 2024 is at the annual rate of $737,924. We also owe Mr. Hsu $675,000 as the cash payment in connection with his exchange of 1,348,213 restricted shares of common stock for options to purchase 1,428,432 shares of common stock at $5.01 per share and a cash payment of $675,000, which was initially payable by December 15, 2019 and has been extended and is now due commencing on February 27, 2025 in twelve equal monthly installments. In addition, at March 31, 2024, we owed Mr. Hsu $1,833,378, representing deferred salary from 2019, 2020, 2021, 2022, 2023, and 2024 and cash bonuses deferred from 2017 and 2018. Mr. Hsu waived his bonus for 2019, 2020, 2021, 2022, and 2023 as part of the suspension of incentive programs for key employees, and he agreed that the $1,833,378 deferred salary and bonus be paid in twelve equal monthly installments with the first payment becoming due on February 27, 2025.
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Cash Requirements
We require substantial funds for our business, and we believe that the net proceeds from our initial public offering, together with cash generated by our operations should enable us to meet our cash requirements for at least the twelve months from the date of this annual report. However, we cannot assure you that we will not require additional funds to meet our commitments or that funds will be available on reasonable terms, if at all. We have significant debt obligations which mature or may mature during the next year. We have extended our loan obligation to an unrelated third party for $2.0 million to June 30, 2024 and, with respect to the loans made under the EB-5 program, as described above, we are seeking to refinance the loans through the issuance of secured subordinated convertible notes to the limited partners of the lenders. We also have obligations to Mr. Hsu described above, approximately $2.5 million of which will be paid in twelve equal monthly installments with the first payment becoming due on February 27, 2025. We cannot assure you that we will be able to negotiate extensions to our loans or refinancing of our EB-5 debt. The willingness of the limited partners of CEF and CEF II to accept convertible notes rather than a cash payment of their investment in the limited partnership may be affected by their perception of our performance and the performance of our common stock as well as their perception that they could get a more favorable result with litigation. If our current liabilities exceed the available cash, including the proceeds of our initial public offering, we will need to obtain alternative financing. We cannot assure you that such financing will be available on acceptable, if any terms, which would impair our ability to develop our business. Our financial statements for the year ended December 31, 2023 have a going concern paragraph.
Critical Accounting Estimates and Policies
The accounting policies described below are considered critical to obtaining an understanding of our consolidated financial statements because their application requires the use of significant estimates and judgments by management in preparing the consolidated financial statements. Management estimates and judgments are inherently uncertain and may differ significantly from actual results achieved. Management considers an accounting estimate to be critical if the estimate requires significant assumptions and changes in the estimate or, the use of alternative estimates, could have a material impact on our results of operations or financial position. For more information on our accounting policies, see "Notes to Consolidated Financial Statements—Note 2. Basis of Presentation and Summary of Significant Accounting Policies."
Impairment assessment of goodwill
Nature of Estimates Required
At least annually, we are required to assess the carrying value of our long-lived assets and related intangibles for impairment whenever events or changes in circumstances indicate that the carrying value of the long-lived asset, or group of assets, may not be recoverable. Recoverability of long-lived assets is measured by comparing the carrying amount of the long-lived assets to the respective estimated future undiscounted cash flows. The estimated future undiscounted cash flows are calculated utilizing the lowest level of identifiable cash flows that are largely independent of the cash flows of other assets and liabilities. If our analysis indicates that the carrying value of the long-lived assets is not recoverable on an undiscounted cash flow basis, it recognizes an impairment charge for the amount by which the carrying value exceeds the fair value of the long-lived asset.
Key Assumptions and Approach Used
Goodwill is tested for impairment at least annually based on certain qualitative factors to determine if it is more likely than not that the fair value of a reporting unit is less than its carrying amount. When assessing goodwill for impairment, we consider the enterprise value and if necessary, the discounted cash flow model, which involves assumptions and estimates, including our future financial performance, weighted-average cost of capital and interpretation of currently enacted tax laws. Circumstances that could indicate impairment and require us to perform a quantitative impairment test include a significant decline in the financial results, a significant decline in the enterprise value relative to our net book value, an unanticipated change in competition or the market share and a significant change in the strategic plans.
Our China segment did not complete any new projects in 2021, 2022 or 2023; however, we believe it is more likely than not the fair value of our China segment is greater than its carrying value because we believe that we will generate business in 2024 from SPIC and/or other PRC customers with which we are engaged in negotiations.
Because of the COVID restrictions, we were not able to complete negotiation for new projects with SPIC and with one other potential customer. In China, in order for us to generate business, we need to have face-to-face meetings with the representatives of SPIC or any other potential customers rather than remote meetings such as Zoom. These negotiations were initially deferred from late 2021 until 2022 and further deferred to 2023 as a result of COVID restrictions. We are now engaged in negotiations with respect to new projects for our China segment. In addition, our negotiations were impacted by a temporary spike in panel prices in China, which began to moderate in 2022. Despite the interruption of COVID in China, we believe that the macroeconomic conditions for the solar market in China continues to be strong. China remains the number one market in the world for photovoltaic systems, which includes the solar farms that our China segment designs and builds for third parties. As COVID restrictions eased in late 2022, discussions, negotiations, design work and permitting on potential projects resumed in the first quarter of 2023, although, as of the date of this annual report, we have not entered into any agreements.
Effect if Different Assumptions Used
Under different assumptions, there could be a likelihood that the fair value of our China segment is less than its carrying value and would require an impairment.
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Allowance for credit and loan losses
Nature of Estimates Required
In adopting ASU 2016-13, we are required to estimate credit and loan losses based on a forward-looking methodology and, if needed, record a reserve for each of the following assets: accounts receivable, customer loans receivable and certain contract assets.
Key Assumptions and Approach Used
In determining the expected loss, we make assumptions based on historical collection experience, current and forecasted economic and business conditions, and a review of the status of each customer’s financial asset account. Specifically, we estimate loss reserve based on the aging of the financial asset balances and the financial condition of customers and provide for specific allowance amounts for those customers that have a higher probability of default. With respect to our China segment, we review China’s current and future economic conditions along with its political landscape, and how these factors may affect our receivable from SPIC, a state-owned entity. We regularly monitor collection status of these financial assets through account reconciliation, payment tracking, customer’s financial condition and macroeconomics conditions.
Effect if Different Assumptions Used
We believe that assumptions not based on the use of historical collection experience, current and forecasted economic, political (China segment) and business conditions, and a review of the status of each customer’s financial asset account would be contra to the requirements of ASU 2016-13 and a departure from GAAP.
Income Taxes
Nature of Estimates Required
As part of the process of preparing our consolidated financial statements, we are required to estimate income taxes for each jurisdiction in which we operate. This process involves estimating actual current period tax expense together with assessing temporary differences resulting from differing treatment of items, such as depreciation, for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included within our balance sheets, including net operating loss and tax credit carryforwards. Certain estimates and assumptions are required to determine whether deferred tax assets can and will be utilized in future periods.
We take certain tax positions we believe are in accordance with the applicable tax laws. However, these tax positions are subject to interpretation by the Internal Revenue Service, state tax authorities and the courts. We determine uncertain tax positions in accordance with the authoritative guidance.
Key Assumptions and Approach Used
In determining whether it is more likely than not that all or some portion of net operating loss and tax credit carryforwards can be utilized, we analyze the trend of GAAP earnings and then estimates the impact of future taxable income, reversing temporary differences and available prudent and feasible tax planning strategies based on currently enacted tax laws.
Accounting for tax obligations requires management judgment. We use judgment in determining whether the evidence indicates it is more likely than not, based solely on the technical merits, that a tax position will be sustained, and to determine the amount of tax benefits to be recognized. Judgment is also used in determining the likelihood a tax position will be settled and possible settlement outcomes. In assessing uncertain tax positions we consider, among others, the following factors: the facts and circumstances of the position, regulations, rulings, and case law, opinions or views of legal counsel and other advisers, and the experience gained from similar tax positions. We evaluate uncertain tax positions at the end of each reporting period and make adjustments when warranted based on changes in fact or law.
Effect if Different Assumptions Used
Should a change in facts or circumstances, including a change in enacted tax legislation, lead to a change in judgment about the ultimate realizability of a deferred tax asset, we would record or adjust the related valuation allowance in the period that the change in facts and circumstances occurs, along with a corresponding increase or decrease in the provision for income taxes.
Actual income taxes may differ from the estimated amounts which could have a significant impact on the liabilities, revenue and expenses recorded in the financial statements. Significant judgment is required to determine the tax treatment of particular tax positions that involve interpretations of complex tax laws. Such liabilities are based on judgment and a final determination could take many years from the time the liability is recorded. Furthermore, settlement of tax positions included in open tax years may be resolved by compromises of tax positions based on current factors and business considerations that may result in material adjustments to income taxes previously estimated. For a discussion of current and deferred taxes, net operating losses and tax credit carryforwards, accounting for uncertainty in income taxes, unrecognized tax benefits, and tax disputes, see "Notes to Consolidated Financial Statements—Note 18. Income Taxes."
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Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Not applicable
Item 8. Financial Statements and Supplementary Data
The financial statements start on Page F-1
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosures
Not applicable