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 in August 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 (“BVI”) 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. Through our wholly-owned subsidiaries, BVI Wetouch, HK Wetouch, Sichuan Vtouch and Sichuan Wetouch, we are engaged in the research, development, manufacturing, sales and servicing of medium to large sized projected capacitive touchscreens, which constitutes our source of revenues. We are specialized in large-format touchscreens, which are developed and designed for a wide variety of markets and used in by 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 financial condition and results of operations of our subsidiaries Hong Kong Wetouch, Sichuan Wetouch and Sichuan Vtouch for the years ended December 30, 2022 and 2021, respectively. 49 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 significantly. The spread of COVID-19 has caused significant disruption to society as a whole, including the workplace. The resulting impact on the global supply chain has disrupted most aspects of national and international commerce, with government-mandated social distancing measures imposing stay-at-home and work-from-home orders in almost every country. The effects of social distancing have shut down significant parts of the local, regional, national, and international economies, for limited or extended periods of time, with the exception of government designated essential services. Commencing in the spring of 2021, China began to experience an increase of COVID-19 cases, and to some extent, local and national governments began to take more restrictive measures to stem the spread of the virus, particularly from October to December 2021. The Company has several shutdowns during the year ended December 31, 2022. 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. The Company has taken proactive measures to promote products to new customers and entering more regions during the year ended December 31, 2022. 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. Results of Operations Highlights for the year ended December 31, 2022 include: ● Revenues were $37.9 million, a decrease of 7.1% from $40.8 million for the year ended December 31, 2021 ● Gross profit was $14.0 million, an decrease of 23.9% from $18.4 million for the year ended December 31, 2021 ● Gross profit margin was 37.0%, as compared to 45.3% for the year ended December 31, 2021 ● Net income was $8.7 million, a decrease of 50.0% from $17.4 million for the year ended December 31, 2021 ● Total volume shipped was 1,916,976 units, a decrease of 0.3% from 1,922,353 units for the year ended December 31, 2021 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 2022 2021 % Revenues $ 37.9 $ 40.8 (7.1 )% Cost of revenues (23.9 ) (22.4 ) 6.7 % Gross profit 14.0 18.4 (23.9 )% Total operating expenses (2.6 ) (5.8 ) (55.2 )% Operating income 11.4 12.6 (9.5 )% Gain on asset disposal 0.0 7.6 0.0 % Loss on conversion of notes payable (0.1 ) - N/A Gain (loss) on changes of fair values of Common Stock Purchase Warrant 0.9 0.8 12.5 % Income before income taxes 12.1 21.8 (44.5 )% Income tax benefit (expense) (3.4 ) (4.4 ) (22.7 )% Net income $ 8.7 $ 17.4 (50.0 )% 50 For the Years Ended December 31, 2022 and 2021 Revenues Revenues were $37.9 million in the year ended December 31, 2022, a decrease of $2.9 million, or 7.1%, compared with $40.8 million in the same period of last year. This was mainly due to the decrease of 0.3% in sales volume, and a decrease of 2.7% in the average selling price of our products in RMB, and 4.4% negative impact from exchange rate due to depreciation of RMB against US dollars, as compared with those of the same period of last year. For the Years Ended December 31, 2022 2021 Change Change Amount % Amount % Amount % (in US Dollar except percentage) Revenue from sales to customers in PRC $ 26,440,376 69.7 % $ 27,213,684 66.7 % $ (773,307 ) (2.8 )% Revenue from sales to customers overseas 11,482,736 30.3 % 13,571,790 33.3 % (2,089,054 ) (15.4 )% Total Revenues $ 37,923,112 100 % $ 40,785,474 100 % $ (2,862,361 ) (7.1 )% 51 For the Years Ended December 31, 2022 2021 Change Change Unit % Unit % Unit % (in UNIT, except percentage) Units sold to customers in PRC 1,295,097 67.6 % 1,244,438 64.7 % 50,659 4.1 % Units sold to customers overseas 621,879 32.4 % 677,915 35.3 % (56,036 ) (8.3 )% Total Units Sold 1,916,976 100 % 1,922,353 100 % (5,377 ) (0.3 )% (i) Domestic market For the year ended December 31, 2022, revenue from domestic market decreased by $0.8 million or 2.8%, as a combined result of (i) a decrease of 2.6% in the average selling price of our products in RMB, and (ii) 4.4% negative impact from exchange rate due to depreciation of RMB against US dollars, and offset by (iii) an increase of 4.1% in sales volume, as compared with those of last year. As for the RMB selling price, the decrease of 2.6% was mainly due to the marketing initiatives to enhance sales of new models of higher-end products such as touch screens used in POS touchscreens, medical touchscreens and gaming touchscreens in marketing regions such as East China during the year ended December 31, 2022. The weakening in macroeconomic conditions since the outbreak of COVID-19 pandemic continued to exacerbate the touch screen business environment. Since April 2022, the Chinese government has imposed strict zero tolerance virus policies and the Company’s business has been negatively impacted and has continued to generate lower revenues during the year ended December 31, 2022. Although the Company has taken proactive efforts to market new models such as POS touchscreens and obtain new customers and penetrate into new regions with a sales increase of 0.8% in Eastern China, the Company had hard suffering of a decrease of 1.6% in Southwest China, and of 0.5% in Southern China due to the government lockdown in this region during the year ended December 31, 2022. (ii) Overseas market For the year ended December 31, 2022, revenue from overseas market was $11.5 million as compared to and $13.6 million of the same period of 2021, a decrease of $2.1 million or 15.4%, mainly due to a decrease of 8.3% in sales volume primarily due to 1) the slack overseas orders; 2) negative effects of COVID 19 impact, such as more strict customs inspection in China leading to delayed product shipment during the second half of 2022, and a decrease of 7.8% in average selling price of our products due to the decreased higher pricing medical touchscreens during the year ended December 31, 2022, compared with those of the same period of last year. 52 The following table summarizes the breakdown of revenues by categories in US dollars : Revenues For the Years Ended December 31, 2022 2021 Change Amount % Amount % Amount % (in US Dollars, except percentage) Product categories by end applications Automotive Touchscreens $ 9,293,357 24.5 % $ 11,597,467 28.4 % $ (2,304,110 ) (19.9 )% Industrial Control Computer Touchscreens 7,991,356 21.1 % 7,988,346 19.6 % 3,010 0.0 % POS Touchscreens 6,556,348 17.3 % 6,291,534 15.4 % 264,814 4.2 % Gaming Touchscreens 5,199,118 13.7 % 5,831,529 14.3 % (632,411 ) (10.8 )% Medical Touchscreens 5,050,067 13.3 % 5,205,304 12.8 % (155,237 ) (3.0 )% Multi-Functional Printer Touchscreens 3,822,054 10.1 % 3,748,868 9.2 % 73,186 2.0 % Others* 10,812 0.0 % 122,426 0.3 % (111,614 ) (19.9 )% Total Revenues $ 37,923,112 100.0 % $ 40,785,474 100.0 % $ (2,862,362 ) (7.1 )% *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 automotive to high-end products such as touchscreens used in POS touchscreens and multi-functional printer touchscreens, 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 touchscreens made with better raw materials. Gross Profit and Gross Profit Margin Years Ended December 31, Change (in millions, except percentage) 2022 2021 Amount % Gross Profit $ 14.0 $ 18.4 $ (4.4 ) (23.9 )% Gross Profit Margin 37.0 % 45.3 % (8.3 )% Gross profit was $14.0 million during the year ended December 31, 2022, as compared to $18.4 million in the same period of 2021, representing a decrease of $4.4 million, or 23.9%. Our gross margin was 37.0% during the year ended December 31, 2022, as compared to 45.3% for the year ended December 2021, primarily due to the decrease of sales by 7.1%, and the increase of 13.2% in cost of materials such as the chip cost, partially offset by the decrease of labor cost by 2.2%, depreciation and other overhead cost such as rent and electricity by 9.0% due to the reduced production volume for the year ended December 31, 2022. Selling Expenses Years Ended December 31, Change (in millions, except percentage) 2022 2021 Amount % Selling Expenses $ 1.3 $ 0.6 $ 0.7 116.7 % as a percentage of revenues 3.5 % 1.5 % 2.0 % Selling expenses were $1.3 million during the year ended December 31, 2022, as compared to $0.6 million for the year ended December 31, 2021, primarily due to the increase of marketing expenses of $0.7 million as the Company took promotional efforts to market new models such as POS touchscreens and obtain new customers and penetrate into new regions in order to reduce the negative impact of COVID 19. 53 General and Administrative Expenses Years Ended December 31, Change (in millions, except percentage) 2022 2021 Amount % General and Administrative Expenses $ 1.3 $ 1.9 $ (0.6 ) (31.6 )% as a percentage of revenues 3.4 % 4.7 % (1.3 )% General and administrative (G&A) expenses was $1.3 million for the year ended December 31, 2022, as compared to $1.9 million for the year ended December 31, 2022, representing a decrease of 31.6%, or $0.6 million. The decrease was primarily due to i) $0.4 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, ii) $0.1 million 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 during the year ended December 31, 2021 (See Note 5), iii) the decrease of $0.4 million miscellaneous fees, and partially offset by iv) an increase of $0.3 million professional fees during the year ended December 31, 2022. Research and Development Expenses Years Ended December 31, Change (in US dollars, except percentage) 2022 2021 Amount % Research and Development Expenses $ 85,251 $ 89,477 $ (4,226 ) (4.7 )% as a percentage of revenues 0.0 % 0.0 % 0.0 % Research and development (R&D) expenses were $85,251 in the year ended December 31, 2022 compared to $89,477 in the same period in 2021, representing a decrease of $4,226, or 0.0, mainly due to the decrease of salary and welfare expenses of R&D personnel. Share-based Compensation Years Ended December 31, Change (in millions, except percentage) 2022 2021 Amount % Share-based compensation $ 0.0 $ 3.1 $ (3.1 ) (0.0 )% as a percentage of revenues 0.0 % 7.6 % (7.6 )% Share-based compensation were nil and $3.1 million for the years ended December 31, 2022 and 2021, respectively. 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 during the year ended December 31, 2021. Operating Income Total operating income was $11.4 million for the year ended December 31, 2022 compared to $12.6 million for the year ended December 31, 2021, representing a decrease of $1.2 million or 9.5% due to lower gross profit and higher selling expenses, partially offset by the lower G&A expenses and share-based compensation expenses. 54 Gain on Asset Disposal Years Ended December 31, Change (in millions, except percentage) 2022 2021 Amount % Gain on asset disposal $ 0.0 $ 7.6 $ (7.6 ) (0.0 )% as a percentage of revenues 0.0 % 20.5 % (20.5 )% Gain on asset disposal was nil for the year ended December 31, 2022 compared to $7.6 million for the year ended December 31, 2021. Pursuant to local PRC government guidelines on local environmental issues and the national overall plan, Sichuan Wetouch was under the 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 ($17.9 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 $7,625,279 for the asset disposal. Loss on conversion of notes payable Years Ended December 31, Change (in millions, except percentage) 2022 2021 Amount % Loss on conversion of notes payable $ 0.1 $ 0.0 $ 0.1 N/A as a percentage of revenues 0.3 % 0.0 % 0.3 % Loss on conversion of notes payable were $0.1 million for the year ended December 31, 2022, as lenders of convertible promissory note payable converted certain principal, accrued and unpaid interest and default charges totaling $1,038,426 into 1,384,564 shares of common stock of the Company, including two notes fully converted. As a result, the Company recorded a loss on the conversion of notes payable of $0.1 million accordingly (see Note (9 (a)). Gain on changes in fair value of Common Stock Purchase Warrants Years Ended December 31, Change (in millions, except percentage) 2022 2021 Amount % Gain on changes in fair value of Common Stock Purchase Warrants $ 0.9 $ 0.8 $ 0.1 12.5 % as a percentage of revenues 2.4 % 2.0 % 0.4 % Gain on changes in fair value of common stock purchase warrants was $0.9 million and $0.8 million for the years ended December 31, 2022 and 2021, respectively (See Note 9 (b)). Income Taxes Years Ended December 31, Change (in millions, except percentage) 2022 2021 Amount % Income before Income Taxes $ 12.1 $ 21.8 $ (9.7 ) (44.5 )% Income Tax Benefit (Expense) (3.4 ) (4.4 ) 1.0 (22.7 )% Effective income tax rate 27.7 % 20.2 % (7.5 )% 55 The effective income tax rates for the years ended December 31, 2022 and 2021 were 27.1% and 20.2%, respectively. The effective income tax rate increased during the year ended December 31, 2022 primarily due to Sichuan Wetouch’s preferential income tax rate for the same period of 2021. Our PRC subsidiaries had $51.2 million of cash and cash equivalents at December 31, 2022, which are planned to be indefinitely reinvested in PRC. The distributions from our PRC subsidiary are subject to the 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 $8.7 million the year ended December 31, 2022 compared to net income of $17.4 million for the year ended December 31, 2021. 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. As of December 31, 2022, we had current assets of $62.2 million, consisting of $51.3 million in cash, $9.1 million in accounts receivable, $0.4 million in inventories, and $1.5 million in prepaid expenses other current assets. Our current liabilities as of December 31, 2022, were $4.0 million, which is comprised of $1.4 million in accounts payable, $0.9 million in accrued expenses and other current liabilities, $0.4 million loan from a third party, and $1.3 million convertible promissory notes payable. The following table sets forth a summary of our cash flows for the periods indicated. Years Ended December 31, (in US Dollar millions) 2022 2021 Net cash provided by operating activities $ 8.6 $ 14.0 Net cash provided by investing activities - 6.2 Net cash provided by (used) in financing activities (0.7 ) 1.9 Effect of foreign currency exchange rate changes on cash and cash equivalents (2.8 ) 0.1 Net increase (decrease) in cash and cash equivalents 5.1 22.2 Cash and cash equivalents at the beginning of period 46.2 24.0 Cash and cash equivalents at the end of period $ 51.3 $ 46.2 56 Operating Activities Net cash provided by operating activities was $8.6 million for the year ended December 31, 2022, as compared to $14.0 million provided by operating activities for for the year ended December 31, 2021, primarily due to (i) the decrease of $8.7 million net income for the year ended December 31, 2022 as compared to the same period of 2021, (ii) the decrease of $3.1 million of share-based compensation during the year ended December 31, 2022 , (iii) ) the increase of $6.5 million account receivable due to slower collection from the impact of the COVID-19 pandemic and Sichuan Wetouch settling customer receivables during the year ended December 31, 2021; partially offset by (iv) the increase of $0.8 million of account payable due to the longer payment period (v) $7.6 million gain on asset disposal for the year ended December 31, 2021, (vi) the decrease of $3.1 million prepaid expenses including amortization of $1.0 million prepaid marketing expenses during the year ended December 31, 2022; (vii) 0.5 million of deferred income due to Sichuan Wetouch write-off government grant in the operating ceasing process for the year ended December 31, 2021. Investing Activities There was nil investing activities for the year ended December 31, 2022. There were $17.8 million in proceeds from asset disposal for Sichuan Wetouch, and $0.2 million in purchase of property, plant and equipment for year ended December 31, 2021. See Note 5 in the interim financial information. Financing Activities Net cash used in the financing activities was $0.7 million for the year ended December 31, 2022, including $1.4 million of repayment of convertible promissory note payable (see Note 9 (a)), partially offset by 0.4 million loan from a third party. Net cash provided by the financing activities was $1.8 million for the year ended December 31, 2021 as a result of proceeds of $2.0 million from issuance of seven convertible promissory notes, partially offset by the payment of issue cost of $0.2 million related to notes financing (see Note 11). As of December 31, 2022, our cash and cash equivalents were $51.3 million, as compared to $46.2 million at December 31, 2021. Days Sales Outstanding (“DSO”) has decreased at 81 days for the year ended December 31, 2022 compared to 88 days for the year ended December 31, 2021. The following table provides an analysis of the aging of accounts receivable as of December 31, 2022 and December 31, 2021: December 31, 2022 December 31 2021 -Current $ 1,252,152 $ 1,403,187 -1-3 months past due 4,998,596 2,827,048 -4-6 months past due 2,806,973 3,742,732 7-12 months past due 20 18,070 -greater than 1 year past due - - Total accounts receivable $ 9,057,741 $ 7,991,037 57 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 typical payment term is 180 days. Accounts receivables are written off against the allowances only after exhaustive collection efforts. 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 Legal Proceedings From time to time, the Company is a party to various legal actions arising in the ordinary course of business. The Company accrues costs associated with these matters when they become probable and the amount can be reasonably estimated. Legal costs incurred in connection with loss contingencies are expensed as incurred. As of December 31, 2022, the Company had several legal claims or litigations. As of the date of this Annual Report, all actions have been settled and Sichuan Wetouch, Hong Kong Wetouch and Mr. Guangde Cai were unconditionally and fully discharged and released therefrom. For a discussion of the Company’s legal proceedings, see Note 13 to the Financial Statements in Item 8 . Capital expenditure commitment On December 20, 2021, the Company entered into a contract with Shenzhen Municipal Haoyutuo Decoration & Cleaning Engineering Company Limited to purchase a facility decoration contract of RMB20.0 million (equivalent to US$3.1 million). As of December 31, 2022, the Company has prepaid RMB15.0 million (equivalent to US$2.2 million) and recorded as construction in progress (see Note 5) and had a remaining balance of RMB5.0 million (equivalent to US$0.7 million) to be paid by the end of 2023. Off-Balance Sheet Arrangements There were no off-balance sheet arrangements as of December 31, 2022. 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 registration statement. 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. 58 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, 2022 and 2021, 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. 59 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, 2022 and 2021 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. $74,100 and nil inventory write-off was recorded for the years ended December 31, 2022 and 2021, 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 underlyings 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 the net proceeds or net settled investment, the management assessed that the Notes did not 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. 60 Common stock purchase warrants The Company also analyzed the Warrants 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 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, 2022 and 2021, the Company recorded $256,957 and $1,128,635 common stock purchase warrants liability, respectively, and $871,677 and $759,471 gain on change of fair value of common stock purchase liability warrants for the year ended December 31, 2022 and 2021, respectively. 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, 2022 and 2021. The Company does not believe there was any uncertain tax provision at December 31, 2022 and 2021. 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, 2022 and 2021. As of December 31, 2022, all of the Company’s tax returns of its PRC Subsidiaries remain open for statutory examination by PRC tax authorities. 61 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. 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. 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. 62 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. In October 2021, the FASB issued ASU No. 2021-08, which will require companies to apply the definition of a performance obligation under ASC Topic 606 to recognize and measure contract assets and contract liabilities (i.e., deferred revenue) relating to contracts with customers that are acquired in a business combination. Under current U.S. GAAP, an acquirer generally recognizes assets acquired and liabilities assumed in a business combination, including contract assets and contract liabilities arising from revenue contracts with customers, at fair value on the acquisition date. ASU No. 2021-08 will result in the acquirer recording acquired contract assets and liabilities on the same basis that would have been recorded by the acquiree before the acquisition under ASC Topic 606. ASU No. 2021-08 is effective for fiscal years beginning after December 15, 2022, with early adoption permitted. The Company is currently evaluating the impact of this ASU on its financial statements and the effects will be based upon the contract assets and liabilities acquired in the future. 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. 63 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. 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, 2022, the RMB traded at 6.8972 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 2022 and 2021 were increases of 2.0%, and 0.9%, 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. 64