Wetouch Technology Inc. 10-K

ITEM 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations Our Management’s Discussion and Analysis contains forward-looking statements relating to future events or our future financial performance. In some cases, you can identify forward-looking statements by terminology such as “may”, “should”, “intends”, “expects”, “plans”, “anticipates”, “believes”, “estimates”, “predicts”, “potential”, or “continue” or the negative of these terms or other comparable terminology. These statements are only predictions and involve known and unknown risks, uncertainties and other factors which may cause our or our industry’s actual results, levels of activity or performance to be materially different from any future results, levels of activity or performance expressed or implied by these forward-looking statements. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity or performance. You should not place undue reliance on these statements, which speak only as of the date of this Annual Report. These cautionary statements should be considered with any written or oral forward-looking statements that we may issue in the future. You should read this Annual Report on Form 10-K with the understanding that our actual future results may be materially different from what we expect. All forward-looking statements speak only as of the date on which they are made. We undertake no obligation to update such statements to reflect events that occur or circumstances that exist after the date on which they are made, except as required by applicable law. Management’s discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements which have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). The following discussion and analysis of financial condition and results of operations of the Company is based upon, and should be read in conjunction with, the audited consolidated financial statements and related notes elsewhere in this Annual Report on Form 10-K. Overview We were originally incorporated under the laws of the state of Nevada on August 31, 1992. On October 9, 2020, we entered into a share exchange agreement (the “Share Exchange Agreement”) with Wetouch Holding Group Limited, a British Virgin Islands company incorporated on August 14, 2020 under the laws of the British Virgin Islands (“BVI Wetouch”), and all the shareholders of BVI Wetouch (each a “Shareholder” and collectively the “Shareholders”), to acquire all the issued and outstanding capital stock of BVI Wetouch in exchange for the issuance to the Shareholders an aggregate of 28 million shares of our common stock (the “Reverse Merger”). The Reverse Merger closed on October 9, 2020. Immediately after the closing of the Reverse Merger, we had a total of 31,396,394 issued and outstanding shares of common stock. As a result of the Reverse Merger, BVI Wetouch is now our wholly-owned subsidiary. 45 Through our wholly-owned subsidiaries, we are engaged in the research, development, manufacturing, sales and servicing of medium to large sized projected capacitive touchscreens, which constitute our source of revenue. We specialize in large-format touchscreens, which are developed and designed for a wide variety of markets and used in the financial terminals, automotive, POS, gaming, lottery, medical, HMI, and other specialized industries. Our product portfolio comprises medium to large sized projected capacitive touchscreens ranging from 7.0 inch to 42 inch screens. In terms of the structures of touch panels, we offer (i) Glass-Glass (“GG”), primarily used in GPS/car entertainment panels in mid-size and luxury cars, industrial HMI, financial and banking terminals, POS and lottery machines; (ii) Glass-Film-Film (“GFF”), mostly used in high-end GPS and entertainment panels, industrial HMI, financial and banking terminals, lottery and gaming industry; (iii) Plastic-Glass (“PG”), typically adopted by touchscreens in GPS/entertainment panels motor vehicle GPS, smart home, robots and charging stations; and (iv) Glass-Film (“GF”), mostly used in industrial HMI. The following discussion and analysis pertain to the financial condition and results of operations of our subsidiaries Hong Kong Wetouch, Sichuan Wetouch, and Sichuan Vtouch for the years ended December 30, 2021 and 2020, respectively. Effects of COVID-19 The COVID-19 pandemic and resulting global disruptions have affected our businesses, as well as those of our customers and suppliers. To serve our customers while also providing for the safety of our employees and service providers, we have modified numerous aspects of our logistics, transportation, supply chain, purchasing, and after-sale processes. Beginning in Q1 2020, we made numerous process updates across our operations worldwide, and adapted our fulfillment network, to implement employee and customer safety measures, such as enhanced cleaning and physical distancing, personal protective gear, disinfectant spraying, and temperature checks. We will continue to prioritize employee and customer safety and comply with evolving state and local standards as well as to implement standards or processes that we determine to be in the best interests of our employees, customers, and communities. Due to the COVID-19 pandemic, our subsidiary Sichuan Wetouch was temporarily shut down from early February 2020 to early March 2020 in accordance with the requirement of the local governments. Our business was negatively impacted and generated lower revenue and net income in 2020. The Company has taken proactive measures to promote products to new customers and entering more regions during the twelve-month period ended December 31, 2021. The extent of the impact of COVID-19 on the Company’s results of operations and financial condition will depend on the virus’ future developments, including the duration and spread of the outbreak and the impact on the Company’s customers, which are still uncertain and cannot be reasonably estimated at this point of time. 46 Results of Operations Highlights for the year ended December 31, 2021 include: ● Revenues were $40.8 million, an increase of 30.0% from $31.3 million for the year ended December 31, 2020 ● Gross profit was $18.4 million, an increase of 17.9% from $15.6 million for the year ended December 31, 2020 ● Net income was $17.4 million, an increase of 95.5% from $8.9 million for the year ended December 31, 2020 ● Total volume shipped was 1,922,353 units, an increase of 16.1% from 1,656,050 units for the year ended December 31, 2020 Results of Operations The following table sets forth, for the periods indicated, statements of income data: (in US Dollar millions, except percentage) For the Years Ended December 31, Change 2021 2020 % Revenues $ 40.8 $ 31.3 30.0 % Cost of revenues (22.4 ) (15.7 ) 42.7 % Gross profit 18.4 15.6 17.9 % Total operating expenses (5.8 ) (3.7 ) 56.8 % Operating income 12.6 11.9 5.9 % Total other income (expenses) 9.2 (1.4 ) 757.1 % Income before income taxes 21.8 10.4 107.6 % Income tax benefit (expense) (4.4 ) (1.5 ) 193.3 % Net income $ 17.4 $ 8.9 95.5 % For the Years Ended December 31, 2021 and 2020 Revenues Revenues were $40.8 million in the year ended December 31, 2021, an increase of $9.4 million, or 30.0%, compared with $31.3 million in the year ended December 31, 2020. This increase was due to the increase of 16.1% in sales volume, an increase of 12.1% in the average selling price of our products, and 6.6% positive impact from exchange rate due to appreciation of RMB against US dollars, as compared with those of the same period of last year. 47 For the Years Ended December 31, 2021 2020 Change Change Amount % Amount % Amount % (in US Dollar except percentage) Revenue from sales to customers in PRC $ 27,213,684 66.7 % $ 21,430,226 68.4 % $ 5,783,458 27.0 % Revenue from sales to customers overseas 13,571,790 33.3 % 9,915,725 31.6 % 3,656,065 36.9 % Total Revenues $ 40,785,474 100 % $ 31,345,951 100 % $ 9,439.523 30.0 % For the Years Ended December 31, 2021 2020 Change Change Unit % Unit % Unit % (in UNIT, except percentage) Units sold to customers in PRC 1,244,438 64.7 % 1,111,516 67.1 % 132,922 12.0 % Units sold to customers overseas 677,915 35.3 % 544,534 32.9 % 133,381 24.5 % Total Units Sold 1,922,353 100 % 1,656,050 100 % 266,303 16.1 % (i) Domestic market For the year ended December 31, 2021, revenue from our domestic market increased by $5.8 million or 27.0%, as a combined result of (i) an increase of 12.0% in sales volume, (ii) an increase of 6.0% in the average selling price of our products, and (iii) 6.6% positive impact from exchange rate due to appreciation of RMB against US dollars, as compared with those of last year. As for the RMB selling price, the increase of 6.0% was mainly due to the increased sales of new models of higher-end products with higher selling prices, such as touch screens used in gaming machines and medical touchscreens in our domestic market during the year ended December 31, 2021. The weakening in macroeconomic conditions since the outbreak of COVID-19 pandemic in January 2020 weakened the touch screen business environment. For the year ended December 31, 2020, the Company’s business was negatively impacted. Due to our proactive efforts to market new models such as POS touchscreens and market to new customers and into new regions, we had sales increases of 30.4% in Southwest China, 24.6% in East China, 22.4% in North china, and partially offset by decreases of 15.3% in South China, for the year ended December 31, 2021 as compared to the year ended December 31, 2020. (ii) Overseas market For the year ended December 31, 2021, revenue from our overseas market was $13.6 million as compared to $9.9 million for the year ended December 31, 2020, an increase of $3.7 million or 36.9%, mainly due to an increase of 24.5% in sales volume and an increase of 9.9% in the average selling price of our products. 48 The following table summarizes the breakdown of revenues by categories in US dollars : Revenues For the Years Ended December 31, 2021 2020 Change Change Amount % Amount % Amount % (in US Dollars, except percentage) Product categories by end applications Automotive Touchscreens $ 11,597,467 28.4 % $ 10,247,157 32.7 % $ 1,350,310 13.2 % Industrial Control Computer Touchscreens 7,988,346 19.6 % 6,304,721 20.1 % 1,683,625 26.7 % POS Touchscreens 6,291,534 15.4 % 4,136,640 13.2 % 2,154,894 52.1 % Gaming Touchscreens 5,831,529 14.3 % 4,654,133 14.9 % 1,177,396 25.3 % Medical Touchscreens 5,205,304 12.8 % 3,055,324 9.7 % 2,149,980 70.4 % Multi-Functional Printer Touchscreens 3,748,868 9.2 % 2,922,380 9.3 % 826,488 28.3 % Others* 122,426 0.3 % 25,596 0.1 % 96,830 378.3 % Total Revenues $ 40,785,474 100.0 % $ 31,345,951 100.0 % $ 9,439,523 30.1 % *Others include applications in financial terminals, ticket vending machines, and self-service kiosks. The Company continued to shift production mix from traditional lower-end products such as touchscreens used in the automotive and industrial control computer industries to high-end products such as touchscreens used in self-service kiosks, medical touchscreens, ticket vending machine and financial terminals, primarily due to (i) greater growth potential of computer screen models in China, and (ii) the stronger demand and better quality demand from consumers’ recognition of higher-end touch screens made with better raw materials. Gross Profit and Gross Profit Margin Years Ended December 31, Change (in millions, except percentage) 2021 2020 Amount % Gross Profit $ 18.4 $ 15.6 $ 2.8 17.9 % Gross Profit Margin 45.3 % 49.8 % (4.2 )% Gross profit was $18.4 million during the year ended December 31, 2021, as compared to $15.6 million in the year ended December 31, 2020, representing an increase of $2.8 million, or 17.9%, primarily due to the increase in sales of $9.5 million, partially offset by the increase of cost of materials by 33.5% and overhead by 62.3% for the year ended December 31, 2021. As a result, our gross margin was 45.3% during the year ended December 31, 2021 as compared to 49.8% for the year ended December 31, 2020. General and Administrative Expenses Years Ended December 31, Change (in millions, except percentage) 2021 2020 Amount % General and Administrative Expenses $ 1.9 $ 2.3 $ (0.4 ) (17.4 )% as a percentage of revenues 4.7 % 7.3 % (2.6 )% General and administrative (G&A) expenses were $1.9 million for the year ended December 31, 2021, as compared to $2.3 million for the year ended December 31, 2020, representing a decrease of $0.4 million, or 17.4%, primarily due to $0.8 million in professional fees and $0.2 million in miscellaneous fees, partially offset by (i) the increase of $0.3 million loss of VAT input credits due to Sichuan Wetouch ceasing operation and relocation to comply with local PRC government guidelines on local environmental issues and the national overall plan (see Note 5 of our Consolidated Financial Statements) and (ii) the increase of $0.1 million in accelerated amortization expense due to Sichuan Wetouch ceasing operation and relocation to comply with local PRC government guidelines on local environmental issues and the national overall plan (see Note 5 of our Consolidated Financial Statements ). 49 Research and Development Expenses Years Ended December 31, Change (in millions, except percentage) 2021 2020 Amount % Research and Development Expenses $ 0.1 $ 0.1 $ 0.0 0.0 % as a percentage of revenues 0.2 % 0.3 % (0.1 )% Research and development (R&D) expenses were $89,477 in the year ended December 31, 2021 compared to $77,997 in the year ended December 31, 2020, representing an increase of $11,480, or 0.0%. The increase was primarily due to the increase of salary and welfare expenses of R&D personnel. Share-based Compensation Years Ended December 31, Change (in millions, except percentage) 2021 2020 Amount % Share-based compensation $ 3.1 $ 1.1 $ 2.0 181.8 % as a percentage of revenues 7.6 % 3.5 % 4.1 % Share-based compensation were $3.1 million for the year ended December 31, 2021 compared to $1.1 million for the year ended December 31, 2020, representing an increase of $2.0 million or 181.8%. On January 1, 2021, the Board of Directors of the Company authorized the issuance of an aggregate of 310,830 shares and 631,080 warrants to a consultant for advisory services that had been rendered. The Company recognized relevant share-based compensation expense of $1,041,281 for the vested shares and $2,107,825 for the warrants. On December 22, 2020, the Board of Directors of the Company authorized the issuance of an aggregate of 103,610 shares and 210,360 warrants to The Crone Law Group P.C. or its designees for legal services that had been rendered. The Company recorded relevant share-based compensation expense of $351,238 for the vested shares and $713,120 for the warrants, respectively. Operating Income Total operating income was $12.6 million for the year ended December 31, 2021, compared to $11.9 million for the year ended December 31, 2020, representing an increase of $0.7 million or 5.9%. This increase is primarily due to the higher gross profit, partially offset by higher operating expenses described above. Gain on changes in fair value of Common Stock Purchase Warrants Years Ended December 31, Change (in millions, except percentage) 2021 2020 Amount % Gain on changes in fair value of Common Stock Purchase Warrants $ 0.8 $ 0.0 $ 0.8 0.0 % as a percentage of revenues 2.0 % 0.0 % 2.0 % Gain on changes in fair value of common stock purchase warrants was $0.8 million for the year ended December 31, 2021 as compared to nil in 2020 (See Note 11(b)). 50 Gain on Asset Disposal Years Ended December 31, Change (in millions, except percentage) 2021 2020 Amount % Gain on asset disposal $ 7.6 $ 0.0 $ 7.6 0.0 % as a percentage of revenues 20.5 % 0.0 % 20.5 % Gain on asset disposal was $7.6 million for the year ended December 31, 2021 compared to nil for the year ended December 31, 2020. Pursuant to local PRC government guidelines on local environmental issues and the national overall plan, Sichuan Wetouch was under government directed relocation order to relocate no later than December 31, 2021 and received compensation accordingly. On March 18, 2021, pursuant to the agreement with the local government and an appraisal report issued by a mutual agreed appraiser, Sichuan Wetouch received a compensation of RMB115.2 million ($18.0 million) (“Compensation Funds”) for the withdrawal of the right to use of state-owned land and the demolition of all buildings, facilities, equipment and all other appurtenances on the land. During the year ended December 31, 2021, the Company recorded a gain of $7,648,423 for the asset disposal. Income Taxes Years Ended December 31, Change (in millions, except percentage) 2021 2020 Amount % Income before Income Taxes $ 21.8 $ 10.5 $ 11.3 107.6 % Income Tax Benefit (Expense) (4.4 ) (1.5 ) (2.9 ) 193.3 % Effective income tax rate 20.2 % 14.8 % 5.4 % The effective income tax rates for the years ended December 31, 2021 and 2020 were 20.2% and 14.8%, respectively. The effective income tax rate increased from 14.8% for the year ended December 31, 2020 to 20.2% for the year ended December 31, 2021, primarily due to i) the increased income before income taxes for the year ended December 31, 2021 as compared to the prior year; ii) the operations of Sichuan Wetouch, which enjoyed preferential income tax rates, was taken over by Sichuan Vtouch during the first quarter of 2021 (see Note 1). The effective income tax rate for the year ended December 31, 2021 differs from the PRC statutory income tax rate of 25% primarily due to Sichuan Wetouch’s preferential income tax rate. Our PRC subsidiaries had $46.2 million of cash and cash equivalents at December 31, 2021, which amount is planned to be indefinitely reinvested within the PRC. The distributions from our PRC subsidiary are subject to U.S. federal income tax at 21%, less any applicable foreign tax credits. Due to our policy of indefinitely reinvesting our earnings in our PRC business, we have not provided for deferred income tax liabilities related to PRC withholding income tax on undistributed earnings of our PRC subsidiaries. Net Income As a result of the above factors, we had a net income of $17.4 million for the year ended December 31, 2021 compared to net income of $8.9 million for the year ended December 31, 2020. LIQUIDITY AND CAPITAL RESOURCES Historically, our primary uses of cash have been to finance working capital needs. We expect that we will be able to meet our needs to fund operations, capital expenditures and other commitments in the next 12 months primarily with our cash and cash equivalents, operating cash flows and bank borrowings. We may, however, require additional cash resources due to changes in business conditions or other future developments. If these sources are insufficient to satisfy our cash requirements, we may seek to sell additional equity or debt securities or obtain a credit facility. The sale of additional equity or equity-linked securities could result in additional dilution to stockholders. The incurrence of indebtedness would result in increased debt service obligations and could result in operating and financial covenants that would restrict operations. Financing may not be available in amounts or on terms acceptable to us, or at all. 51 The following table sets forth a summary of our cash flows for the periods indicated. Years Ended December 31, (in US Dollar millions) 2021 2020 Net cash provided by operating activities $ 14.0 $ 13.0 Net cash provided by investing activities 6.2 - Net cash provided by (used in) financing activities 1.9 (4.7 ) Effect of foreign currency exchange rate changes on cash and cash equivalents 0.1 1.4 Net increase (decrease) in cash and cash equivalents 22.2 9.7 Cash and cash equivalents at the beginning of period 24.0 14.3 Cash and cash equivalents at the end of period $ 46.2 $ 24.0 Operating Activities Net cash provided by operating activities was $14.0 million for the year ended December 31, 2021, as compared to $13.0 million provided by operating activities for the year ended December 31, 2020, primarily due to (i) the increase of $8.4 million in net income for the year ended December 31, 2021 as compared to the year ended December 31, 2020, (ii) the increase of $2.1 million of share-based compensation, (iii) the decrease of $1.6 million in accrued expenses and other current liabilities; (iv) the increase of $0.8 million in gain on changes in fair value of common stock purchase warrants, partially offset by (v) the decrease of $7.6 million gain on asset disposal for the year ended December 31, 2021, (vi) the decrease of $2.3 million in prepaid expenses including $1.0 million in prepaid marketing expenses; (vii) the decrease of $0.5 million income tax payable due to income tax clearance for Sichuan Wetouch during the year ended December 31, 2021; and (viii) the increase of 0.5 million of deferred income due to Sichuan Wetouch’s write-off of the government grant in the ceasing of operations process for the year ended December 31, 2021 as compared to the year ended December 31, 2020. Investing Activities Net cash provided by investing activities was $6.2 million for the year ended December 31, 2021, primarily due to i) $17.8 million in proceeds from asset disposal for Sichuan Wetouch, partially offset by ii) $11.7 million in purchase of property, plant, and equipment for the year ended December 31, 2021. There were no investing activities for the year ended December 31, 2020. Financing Activities Net cash provided by financing activities was $1.8 million for the year ended December 31, 2021 as a result of proceeds of $2.0 million from the issuance of seven (7) convertible promissory notes, partially offset by the payment of issue cost of $0.2 million related to the notes financing (see Note 11). Net cash used in financing activities was $4.7 million for the year ended December 31, 2020, primarily consisting of (i) the repayment of advances from related parties of $4.3 million, and (ii) repayments of bank borrowings of $0.4 million for the year ended December 31, 2020. At December 31, 2021, our cash and cash equivalents were $46.2 million, as compared to $24.0 million at December 31, 2020. Days Sales Outstanding (“DSO”) decreased from 161 days for the year ended December 31, 2020 to 88 days for the year ended December 31, 2021, as a result of Sichuan Wetouch settling all accounts receivable collection from customers. 52 The following table provides an analysis of the aging of accounts receivable as of December 31, 2021 and December 31, 2020: December 31, 2021 December 31 2020 -Current $ 1,403,187 $ 3,531,963 -1-3 months past due 2,827,048 8,136,340 -4-6 months past due 3,742,732 123,581 7-12 months past due 18,070 160,844 -greater than 1 year past due - 49,726 Total accounts receivable $ 7,991,037 $ 12,002,454 The majority of the Company’s revenues and expenses were denominated primarily in Renminbi (“RMB”), the currency of the People’s Republic of China. There is no assurance that exchange rates between the RMB and the U.S. Dollar will remain stable. Inflation has not had a material impact on the Company’s business. Our industry’s typical payment term is 180 days. Accounts receivable are written off against the allowances only after exhaustive collection efforts. Although the Company did not extend payment terms to its customers during the year ended December 31, 2020, collection activities were stalled during February and March 2020, during which most businesses were not in operation, except essential services. Based on past performance and current expectations, we believe our cash and cash equivalents provided by operating activities and financing activities will satisfy our working capital needs, capital expenditures and other liquidity requirements associated with our operations for at least the next 12 months. COMMITMENTS AND CONTINGENCIES Off-Balance Sheet Arrangements The Company and Mr. Guangde Cai had provided guarantees for seven different loans for parties related to the Company and Mr. Cai. As of October 9, 2020, the Company and Mr. Guangde Cai have been unconditionally and fully released from all such guarantees. See “ Certain Relationships and Related Transactions, and Director Independence ”. Critical Accounting Policies An accounting policy is considered critical if it requires an accounting estimate to be made based on assumptions about matters that are highly uncertain at the time such estimate is made, and if different accounting estimates that reasonably could have been used, or changes in the accounting estimates that are reasonably likely to occur periodically, could materially impact the consolidated financial statements. We prepare our financial statements in conformity with U.S. GAAP, which requires us to make judgments, estimates and assumptions. We continually evaluate these estimates and assumptions based on the most recently available information, our own historical experiences and various other assumptions that we believe to be reasonable under the circumstances. Since the use of estimates is an integral component of the financial reporting process, actual results could differ from our expectations as a result of changes in our estimates. Some of our accounting policies require a higher degree of judgment than others in their application and require us to make significant accounting estimates. The following descriptions of critical accounting policies, judgments and estimates should be read in conjunction with our consolidated financial statements and accompanying notes and other disclosures included in this annual report. When reviewing our financial statements, you should consider (i) our selection of critical accounting policies, (ii) the judgments and other uncertainties affecting the application of such policies, and (iii) the sensitivity of reported results to changes in conditions and assumptions. 53 Revenue recognition The Company adopted Accounting Standards Codification (“ASC”) 606 using the modified retrospective approach. The adoption of this standard did not have a material impact on the Company’s consolidated financial statements. Therefore, no adjustments to opening retained earnings were necessary. ASC 606, Revenue from Contracts with customers, establishes principles for reporting information about the nature, amount, timing and uncertainty of revenue and cash flows arising from the entity’s contracts to provide goods or services to customers. The core principle requires an entity to recognize revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration that it expects to be entitled to receive in exchange for those goods or services recognized as performance obligations are satisfied. ASC 606 requires the use of a five-step model to recognize revenue from customer contracts. The five-step model requires that the Company (i) identify the contract with the customer, (ii) identify the performance obligations in the contract, (iii) determine the transaction price, including variable consideration to the extent that it is probable that a significant future reversal will not occur, (iv) allocate the transaction price to the respective performance obligations in the contract, and (v) recognize revenue when (or as) the Company satisfies the performance obligation. The application of the five-step model to the revenue streams compared to the prior guidance did not result in significant changes in the way the Company records its revenue. The Company has assessed the impact of the guidance by reviewing its existing customer contracts and current accounting policies and practices to identify differences that would result from applying the new requirements, including the evaluation of its performance obligations, transaction price, customer payments, transfer of control and principal versus agent considerations. Based on the assessment, the Company concluded that there was no change to the timing and pattern of revenue recognition for its current revenue streams. In accordance to ASC 606, the Company recognizes revenue when it transfers its goods and services to customers in an amount that reflects the consideration to which the Company expects to be entitled in such exchange. The Company accounts for the revenue generated from sales of its products primarily to its customers in PRC and overseas, as the Company is acting as a principal in these transactions, is subject to inventory risk, has latitude in establishing prices, and is responsible for fulfilling the promise to provide customers the specified goods, which the Company has control of the goods and has the ability to direct the use of goods to obtain substantially all the benefits. All of the Company’s contracts have one single performance obligation as the promise is to transfer the individual goods to customers, and there is no separately identifiable other promises in the contracts. The Company’s revenue streams are recognized at a point in time when title and risk of loss passes and the customer accepts the goods, which generally occurs at delivery. The Company’s products are sold with no right of return and the Company does not provide other credits or sales incentive to customers. The Company’s sales are net of value added tax (“VAT”) and business tax and surcharges collected on behalf of tax authorities in respect of product sales. Contract Assets and Liabilities Payment terms are established on the Company’s pre-established credit requirements based upon an evaluation of customers’ credit quality. Contract assets are recognized for in related accounts receivable. Contract liabilities are recognized for contracts where payment has been received in advance of delivery. The contract liability balance can vary significantly depending on the timing when an order is placed and when shipment or delivery occurs. As of December 31, 2021 and 2020, other than accounts receivable and advances from customers, the Company had no other material contract assets, contract liabilities or deferred contract costs recorded on its consolidated balance sheet. Costs of fulfilling customers’ purchase orders, such as shipping, handling and delivery, which occur prior to the transfer of control, are recognized in selling, general and administrative expense when incurred. The Company generally warrants that its products will substantially conform to the agreed-upon specifications for three years from the date of shipment. The Company’s liability is limited to either a credit equal to the purchase price or replacement of the defective part. Returns, after sales services and technical support under warranty have historically been immaterial. As such, the Company does not record a specific warranty reserve or consider activities related to such warranty, if any, to be a separate performance obligation. 54 Disaggregation of Revenues The Company disaggregates its revenue from contracts by geography, as the Company believes it best depicts how the nature, amount, timing and uncertainty of the revenue and cash flows are affected by economic factors. The Company’s disaggregation of revenues for the years ended December 31, 2021 and 2020 are disclosed in Note 14 to the financial statements. Use of estimates In preparing the consolidated financial statements in conformity with accounting principles generally accepted in the United States of America (“US GAAP”), management makes estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. These estimates are based on information as of the date of the consolidated financial statements. Significant estimates required to be made by management include, but are not limited to, the allowance for estimated uncollectible receivables, inventory valuations, useful lives of property, plant and equipment, intangible assets, the recoverability of long-lived assets, provision necessary for contingent liabilities, revenue recognition and realization of deferred tax assets. Actual results could differ from those estimates. Inventories Inventory consists of raw materials, work-in-process and finished goods and is stated at the lower of cost or net realizable value. Cost is determined using a weighted average. For work-in-process and manufactured inventories, cost consists of raw materials, direct labor and an allocated portion of the Company’s production overhead. The Company writes down excess and obsolete inventory to its estimated net realizable value based upon assumptions about future demand and market conditions. For finished goods and work-in-process, if the estimated net realizable value for an inventory item, which is the estimated selling price in the ordinary course of business, less reasonably predicable costs to completion and disposal, is lower than its cost, the specific inventory item is written down to its estimated net realizable value. Net realizable value for raw materials is based on replacement cost. Provisions for inventory write-downs are included in the cost of revenues in the consolidated statements of operations. Inventories are carried at this lower cost basis until sold or scrapped. Nil and US$66,944 inventory write-off was recorded for the years ended December 31, 2021 and 2020, respectively. Convertible Promissory Notes The Company accounts for its convertible promissory notes according to guidance of ASU 2020-06, “Debt—Debt with Conversion and Other Options (Subtopic 470-20) and Derivatives and Hedging— Contracts in Entity’s Own Equity (Subtopic 815-40): Accounting for Convertible Instruments and Contracts in an Entity’s Own Equity”, which simplifies the accounting for convertible instruments by eliminating the requirement to separate embedded conversion features from the host contract when the conversion features are not required to be accounted for as derivatives under Topic 815. We analyze the convertible notes for the existence of a beneficial conversion feature. The Company considered the three characteristics of a derivative instrument listed in ASC 815-10-15-83: (i) having one or more underlying and one or more notional amounts or payment provisions or both; (ii) requiring no initial net investment; and (iii) permitting net settlement. Since the Company’s notes have fixed interest rate, specified notional principal and settlement date, which no other events would affect specified settlement, and the Company received net proceeds after issuance costs and discount, which the Company recorded as net proceeds or net settled investment, the management assessed that the Notes do not meet the definition of a derivative instruments and an embedded feature would not be bifurcated. The discounts on the convertible notes, are amortized to interest expense, using the effective interest method, over the terms of the related convertible notes. Common stock purchase warrants The Company also analyzed the Warrants issued in the November and December 2021 financing in accordance with ASC 815, to determine whether the Warrants meet the definition of a derivative and, if so, whether the Warrants meet the scope exception of ASC 815-40, which is that contracts issued or held by the reporting entity that are both (1) indexed to its own stock and (2) classified in stockholders’ equity shall not be considered to be derivative instruments for purposes of ASC 815-40. The Company concluded that the Warrants issued in the November and December 2021 financing should be treated as a derivative liability because the Warrants are entitled to a price adjustment provision to allow the exercise price to be increased or reduced in the event the Company issues or sells any additional shares of common stock at a price per share more or less than the then-applicable exercise price or without consideration, which is typically referred to as a “Down-round protection” or “anti-dilution” provision. According to ASC 815-40, the “Down-round protection” provision is not considered to be an input to the fair value of a fixed-for-fixed option on equity shares which leads the Warrants to fail to be qualified as indexed to the Company’s own stock and then to fail to meet the scope exceptions of ASC 815. Therefore, the Company accounted for the Warrants as derivative liabilities under ASC 815. Pursuant to ASC 815, derivatives are measured at fair value and re-measured at fair value with changes in fair value recorded in earnings at each reporting period. The Company used a black-scholes-pricing model to estimate the fair values of common stock purchase warrants at the balance sheet dates. As of December 31, 2021, the Company recorded $1,128,635 common stock purchase warrants liability and $759,471 gain on change of fair value of common stock purchase liability warrants for the year ended December 31, 2021. 55 Income taxes The Company accounts for current income taxes in accordance with the laws of the relevant tax authorities. Deferred income taxes are recognized when temporary differences exist between the tax bases of assets and liabilities and their reported amounts in the consolidated financial statements. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period including the enactment date. Valuation allowances are established, when necessary, to reduce deferred tax assets to the amount expected to be realized. An uncertain tax position is recognized only if it is “more likely than not” that the tax position would be sustained in a tax examination. The amount recognized is the largest amount of tax benefit that is greater than 50% likely of being realized on examination. For tax positions not meeting the “more likely than not” test, no tax benefit is recorded. Penalties and interest incurred related to underpayment of income tax are classified as income tax expense in the period incurred. No significant penalties or interest relating to income taxes have been incurred during the years ended December 31, 2021 and 2020. The Company does not believe there was any uncertain tax provision at December 31, 2021 and 2020. The Company’s operating subsidiaries in China are subject to the income tax laws of the PRC. No significant income was generated outside the PRC for the fiscal years ended December 31, 2021 and 2020. As of December 31, 2021, all of the Company’s tax returns of its PRC subsidiaries remain open for statutory examination by PRC tax authorities. Property, plant and equipment, net Property, plant and equipment are stated at cost less accumulated depreciation and amortization. Depreciation and amortization of property and equipment is provided using the straight-line method over their expected useful lives, as follows: Useful life Buildings 20 years Machinery and equipment 10 years Office and electric equipment 3 years Expenditures for maintenance and repairs, which do not materially extend the useful lives of the assets, are charged to expense as incurred. Expenditures for major renewals and betterments which substantially extend the useful life of assets are capitalized. The cost and related accumulated depreciation of assets retired or sold are removed from the respective accounts, and any gain or loss is recognized in the consolidated statements of income and other comprehensive income in other income or expenses. Intangible assets, net The Company’s intangible assets primarily includes land use rights and patent right. A land use right in the PRC represents an exclusive right to occupy, use and develop a piece of land during the contractual term of the land use right. The cost of a land use right is usually paid in one lump sum at the date the right is granted. The prepayment usually covers the entire period of the land use right. The lump sum advance payment is capitalized and recorded as land use right and then charged to expense on a straight-line basis over the period of the right, which is normally 50 years. 56 Patents are recognized at cost of acquisition. They have a finite life and are carried at cost less any accumulated amortization and any impairment losses. Useful life Land use right 50 years Patents 10 years Impairment of long-lived Assets Long-lived assets, such as property, plant and equipment, land use rights, are reviewed for impairment when events or changes in circumstances indicate that the carrying value of such assets may not be recoverable. Recoverability of a long-lived asset or asset group to be held and used is measured by a comparison of the carrying amount of an asset or asset group to the estimated undiscounted future cash flows expected to be generated by the asset or asset group. If the carrying value of an asset or asset group exceeds its estimated undiscounted future cash flows, an impairment charge is recognized by the amount that the carrying value exceeds the estimated fair value of the asset or asset group. Fair value is determined through various valuation techniques including discounted cash flow models, quoted market values and third party independent appraisals, as considered necessary. Assets to be disposed are reported at the lower of carrying amount or fair value less costs to sell, and are no longer depreciated. No impairment of long-lived assets was recognized for any of the years presented. Share-Based Compensation The Company awards share options and other equity-based instruments to its employees, directors and third party service providers (collectively “share-based payments”). Compensation cost related to such awards is measured based on the fair value of the instrument on the grant date. The Company recognizes the compensation cost over the period the employee is required to provide service in exchange for the award, which generally is the vesting period. The amount of cost recognized is adjusted to reflect the expected forfeiture prior to vesting. When no future services are required to be performed by the employee in exchange for an award of equity instruments, and if such award does not contain a performance or market condition, the cost of the award is expensed on the grant date. The Company recognizes compensation cost for an award with only service conditions that has a graded vesting schedule on a straight-line basis over the requisite service period for the entire award, provided that the cumulative amount of compensation cost recognized at any date at least equals the portion of the grant-date value of such award that is vested at that date. Comprehensive income Comprehensive income (loss) consists of two components, net income and other comprehensive income (loss). The foreign currency translation gain or loss resulting from translation of the financial statements expressed in RMB to US$ is reported in other comprehensive income (loss) in the consolidated statements of income and comprehensive income. 57 Recently issued accounting guidance The Company considers the applicability and impact of all accounting standards updates (“ASUs”). Management periodically reviews new accounting standards that are issued. In August 2020, the FASB issued ASU No. 2020-06 (“ASU 2020-06”) “Debt—Debt with Conversion and Other Options (Subtopic 470-20) and Derivatives and Hedging—Contracts in Entity’s Own Equity (Subtopic 815-40): Accounting for Convertible Instruments and Contracts in an Entity’s Own Equity.” ASU 2020-06 will simplify the accounting for convertible instruments by reducing the number of accounting models for convertible debt instruments and convertible preferred stock. Limiting the accounting models results in fewer embedded conversion features being separately recognized from the host contract as compared with current U.S. GAAP. Convertible instruments that continue to be subject to separation models are (1) those with embedded conversion features that are not clearly and closely related to the host contract, that meet the definition of a derivative, and that do not qualify for a scope exception from derivative accounting, and (2) convertible debt instruments issued with substantial premiums for which the premiums are recorded as additional paid-in capital. ASU 2020-06 also amends the guidance for the derivatives scope exception for contracts in an entity’s own equity to reduce form-over-substance-based accounting conclusions. For public business entities, the amendments in ASU 2020-06 are effective for public entities which meet the definition of a smaller reporting company are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2023, including interim periods within those fiscal years. Early application of the guidance will be permitted for all entities for fiscal years beginning after December 15, 2020, including interim periods within those fiscal years . The Company adopted ASU 2020-06 effective January 1, 2021. In June 2016, the FASB issued ASU 2016-13, Financial Instruments – Credit Losses (Topic 326), which introduces new guidance for the accounting for credit losses on instruments within its scope. The new guidance introduces an approach based on expected losses to estimate credit losses on certain types of financial instruments. It also modifies the impairment model for available-for-sale (AFS) debt securities and provides for a simplified accounting model for purchased financial assets with credit deterioration since their origination. The pronouncement will be effective for public business entities that are SEC filers in fiscal years beginning after December 15, 2022, including interim periods within those fiscal years. Early application of the guidance will be permitted for all entities for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. The Company adopted ASU 2016-13 utilizing the modified retrospective transition method. The adoption of ASU 2016-13 did not have a material impact on the Company’s condensed consolidated financial statements. In December 2019, the FASB issued ASU 2019-12, “Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes”. The amendment simplifies the accounting for income taxes by eliminating some exceptions to the general approach in ASC 740, Income Taxes. It also clarifies certain aspects of the existing guidance to promote more consistent application, among other things. The guidance is effective for interim and annual reporting periods beginning within 2021 with early adoption permitted. From time to time, the FASB or other standards setting bodies issue new accounting pronouncements. Updates to the FASB ASCs are communicated through issuance of ASUs. Unless otherwise discussed, the Company believes that the recently issued guidance, whether adopted or to be adopted in the future, is not expected to have a material impact on its consolidated financial statements upon adoption. Quantitative and Qualitative Disclosures about Market Risks Interest Rate Risk Our exposure to interest rate risk primarily relates to the interest income generated by excess cash, which is mostly held in interest-bearing bank deposits. Interest-earning instruments carry a degree of interest rate risk. We have not been exposed to material risks due to changes in interest rates, and we have not used any derivative financial instruments to manage our interest risk exposure. 58 Foreign Currency Exchange Rates The some of our revenues are collected in and our expenses are paid in RMB. We face foreign currency rate translation risks when our results are translated to U.S. dollars. The RMB was relatively stable against the U.S. dollar at approximately 8.28 RMB to the US$1.00 until July 21, 2005 when the Chinese currency regime was altered resulting in a 2.1% revaluation versus the U.S. dollar. From July 21, 2005 to September 30, 2010, the RMB exchange rate was no longer linked to the U.S. dollar but rather to a basket of currencies with a 0.3% margin of fluctuation resulting in further appreciation of the RMB against the U.S. dollar. Since September 30, 2009, the exchange rate had remained stable at 6.8307 RMB to 1.00 U.S. dollar until September 30, 2010 when the People’s Bank of China allowed a further appreciation of the RMB by 0.43% to 6.798 RMB to 1.00 U.S. dollar. The People’s Bank of China allowed the RMB and U.S. dollar exchange rate to fluctuate within 1% on April 16, 2012 and 2% on March 17, 2014, respectively. On December 31, 2021, the RMB traded at 6.3726 RMB to 1.00 U.S. dollar. There remains international pressure on the Chinese government to adopt an even more flexible currency policy and the exchange rate of RMB is subject to changes in China’s government policies which are, to a large extent, dependent on the economic and political development both internationally and locally and the demand and supply of RMB in the domestic market. There can be no assurance that such exchange rate will continue to remain stable in the future amongst the volatility of currencies, globalization and the unstable economies in recent years. Since (i) our revenues and net income of our PRC operating entities are denominated in RMB, and (ii) the payment of dividends, if any, will be in U.S. dollars, any decrease in the value of RMB against U.S. dollars would adversely affect the value of the shares and dividends payable to shareholders, in U.S. dollars. Inflation To date, inflation in China has not materially affected our results of operations. According to the National Bureau of Statistics of China, the year-over-year percent changes in the consumer price index for December 2021 and 2020 were increases of 0.9%, and 2.5%, respectively. Although we have not been materially affected by inflation in the past, we may be affected if China experiences higher rates of inflation in the future. ITEM 7A. Quantitative and Qualitative Disclosure About Market Risk As a “smaller reporting company” as defined by Item 10 of Regulation S-K, we are not required to provide information required by this Item. ITEM 8. Financial Statements and Supplementary Data Please see the financial statements beginning on page F-1 following the signature pages in this Annual Report on Form 10-K and incorporated herein by reference. ITEM 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure Not Applicable.