U. S. Securities and Exchange Commission
Washington, D. C. 20549
FORM 10-Q
x QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |
For the quarterly period ended September 30, 2013 |
o TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |
For the transition period from _____ to _____ |
Commission File No. 0-54744
WONHE HIGH-TECH INTERNATIONAL, INC.
(Name of Registrant in its Charter)
Nevada | 26-0775642 | |
(State of Other Jurisdiction of incorporation or organization) | (I.R.S.) Employer I.D. No.) | |
Room 1001, 10th Floor, Resource Hi-Tech Building South Tower No. 1 Songpingshan Road, North Central Avenue North High-Tech Zone Nanshan District, Shenzhen, Guangdong Province, P.R. China 518057 | ||
(Address of Principal Executive Offices) |
Issuer's Telephone Number: 852-2815-0191
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Sections 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files.) Yes x No o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act) Yes o No x
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check One)
Large accelerated filer o | Accelerated filer o | Non-accelerated filer o | Smaller reporting company x |
APPLICABLE ONLY TO CORPORATE ISSUERS: Indicate the number of shares outstanding of each of the Registrant's classes of common stock, as of the latest practicable date:
November 15, 2013
Common Voting Stock: 38,380,130
WONHE HIGH-TECH INTERNATIONAL, INC.
QUARTERLY REPORT ON FORM 10-Q
FOR THE FISCAL QUARTER ENDED SEPTEMBER 30, 2013
TABLE OF CONTENTS
Page No | ||
Part I | Financial Information | |
Item 1. | Financial Statements (unaudited): | |
Consolidated Balance Sheets (Unaudited) – September 30, 2013 and December 31, 2012 | 1 | |
Consolidated Statements of Income and Other Comprehensive Income (Unaudited) - for the Three and Nine Months Ended Sept. 30, 2013 and 2012 | 3 | |
Consolidated Statement of Changes in Stockholders Equity (Unaudited) for the Nine Months Ended September 30, 2013 and 2012 | 5 | |
Consolidated Statements of Cash Flows (Unaudited) – for the Nine Months Ended September 30, 2013 and 2012 | 6 | |
Notes to Consolidated Financial Statements (Unaudited) | 8 | |
Item 2. | Management’s Discussion and Analysis of Financial Condition and | 31 |
Item 3 | Quantitative and Qualitative Disclosures about Market Risk Results of Operations | 41 |
Item 4. | Controls and Procedures | 41 |
Part II | Other Information | |
Item 1. | Legal Proceedings | 42 |
Items 1A. | Risk Factors | 42 |
Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds | 42 |
Item 3. | Defaults upon Senior Securities | 42 |
Item 4. | Mine Safety Disclosures | 42 |
Item 5. | Other Information | 42 |
Item 6. | Exhibits | 43 |
Signatures | 44 |
WONHE HIGH-TECH INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN U.S.$)
ASSETS | September 30, 2013 | December 31, 2012 | ||||||
(Unaudited) | ||||||||
Current assets: | ||||||||
Cash | $ | 34,103,698 | $ | 5,215,738 | ||||
Accounts receivable | 594,046 | 4,033,576 | ||||||
Inventory | 189,711 | 265,665 | ||||||
Advances to suppliers | 178,947 | 5,282,712 | ||||||
Prepaid expenses | 140,415 | 72,811 | ||||||
Total current assets | 35,206,817 | 14,870,502 | ||||||
Fixed assets | 486,816 | 473,942 | ||||||
Less: accumulated depreciation | (186,733 | ) | (123,251 | ) | ||||
Fixed assets, net | 300,083 | 350,691 | ||||||
Other assets: | ||||||||
Intangible assets | 19,512 | 25,328 | ||||||
Other assets – principally security deposits | 48,967 | 53,908 | ||||||
Prepaid income taxes | 2,619,017 | - | ||||||
Total other assets | 2,687,496 | 79,236 | ||||||
TOTAL ASSETS | $ | 38,194,396 | $ | 15,300,429 |
See accompanying notes to the consolidated financial statements.
1
WONHE HIGH-TECH INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN U.S.$)
LIABILITIES AND STOCKHOLDERS’ EQUITY | September 30, 2013 | December 31, 2012 | ||||||
(Unaudited) | ||||||||
Current liabilities: | ||||||||
Accounts payable | $ | 14,627 | $ | 14,241 | ||||
Payroll payable | 29,547 | 36,101 | ||||||
Taxes payable | 46,680 | 793,723 | ||||||
Loans from stockholder | 77,738 | 36,377 | ||||||
Accrued expenses and other payables | 164,414 | 127,172 | ||||||
Total current liabilities | 333,006 | 1,007,614 | ||||||
Commitments and Contingencies | ||||||||
Stockholders’ equity: | ||||||||
Preferred stock: $0.001 par value; 10,000,000 shares authorized; none issued and outstanding | - | - | ||||||
Common stock: $0.001 par value; 90,000,000 shares authorized; 38,380,130 and 23,900,130 shares issued and outstanding at September 30, 2013 and December 31, 2012, respectively | 38,380 | 23,900 | ||||||
Additional paid-in capital | 17,011,131 | 7,113,611 | ||||||
Statutory reserve fund | 1,892,563 | 600,844 | ||||||
Retained earnings | 16,657,629 | 5,469,214 | ||||||
Other comprehensive income | 867,869 | 373,062 | ||||||
Stockholders’ equity before noncontrolling interests | 36,467,572 | 13,580,631 | ||||||
Noncontrolling interests | 1,393,818 | 712,184 | ||||||
Total stockholders’ equity | 37,861,390 | 14,292,815 | ||||||
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY | $ | 38,194,396 | $ | 15,300,429 |
See accompanying notes to the consolidated financial statements.
2
WONHE HIGH-TECH INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME AND OTHER COMPREHENSIVE INCOME (UNAUDITED)
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2013 AND 2012 (IN U.S.$)
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||
2013 | 2012 | 2013 | 2012 | |||||||||||||
Sales | $ | 4,896,263 | $ | 6,739,797 | $ | 24,659,281 | $ | 15,701,801 | ||||||||
Cost of sales | (2,506,107 | ) | (3,449,590 | ) | (12,621,288 | ) | (8,032,479 | ) | ||||||||
Gross profit | 2,390,156 | 3,290,207 | 12,037,993 | 7,669,322 | ||||||||||||
Operating expenses: | ||||||||||||||||
R & D expenses | 32,243 | 62,170 | 128,577 | 214,334 | ||||||||||||
Selling and marketing | 109,681 | 116,481 | 299,706 | 283,101 | ||||||||||||
General and administrative | 160,432 | 273,174 | 542,800 | 1,457,685 | ||||||||||||
Total operating expenses | 302,356 | 451,825 | 971,083 | 1,955,120 | ||||||||||||
Income from operations | 2,087,800 | 2,838,382 | 11,066,910 | 5,714,202 | ||||||||||||
Interest income | - | - | - | 112,874 | ||||||||||||
Income before provision for income taxes | 2,087,800 | 2,838,382 | 11,066,910 | 5,827,076 | ||||||||||||
(Benefit from) provision for income taxes | (2,946 | ) | 709,578 | (2,067,773 | ) | 1,456,769 |
See accompanying notes to the consolidated financial statements.
3
WONHE HIGH-TECH INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME AND OTHER COMPREHENSIVE INCOME (UNAUDITED)
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2013 AND 2012 (IN U.S.$)
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||
2013 | 2012 | 2013 | 2012 | |||||||||||||
Net income | 2,090,746 | 2,128,804 | 13,134,683 | 4,370,307 | ||||||||||||
Noncontrolling interests | (103,813 | ) | (105,252 | ) | (654,549 | ) | (217,330 | ) | ||||||||
Net income attributable to common stockholders | $ | 1,986,933 | $ | 2,023,552 | $ | 12,480,134 | $ | 4,152,977 | ||||||||
Earnings per common share, basic and diluted | $ | 0.05 | $ | 0.08 | $ | 0.39 | $ | 0.20 | ||||||||
Weighted average shares outstanding, basic and diluted | 38,380,000 | 23,900,130 | 31,962,125 | 20,800,072 |
Comprehensive income: | ||||||||||||||||
Net income before noncontrolling interests | $ | 2,090,746 | $ | 2,128,804 | $ | 13,134,683 | $ | 4,370,307 | ||||||||
Foreign currency translation adjustment | 203,315 | (17,656 | ) | 521,892 | 32,916 | |||||||||||
Comprehensive income | 2,294,061 | 2,111,148 | 13,656,575 | 4,403,223 | ||||||||||||
Comprehensive income attributable to noncontrolling interests | 110,891 | 104,377 | 681,634 | 218,969 | ||||||||||||
Comprehensive income attributable to common stockholders | $ | 2,183,170 | $ | 2,006,771 | $ | 12,974,941 | $ | 4,184,254 |
See accompanying notes to the consolidated financial statements.
4
WONHE HIGH-TECH INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2013 (UNAUDITED) (IN U.S.$)
Common Stock | Additional Paid-in Capital | Retained Earnings | Statutory Reserve Fund | Noncontrolling Interests | Other Comprehensive Income | Total | ||||||||||||||||||||||
Balance, December 31, 2012 | $ | 23,900 | $ | 7,113,611 | $ | 5,469,214 | $ | 600,844 | $ | 712,184 | $ | 373,062 | $ | 14,292,815 | ||||||||||||||
Issuance of common stock | 14,480 | 9,897,520 | - | - | - | - | 9,912,000 | |||||||||||||||||||||
Net income | - | - | 12,480,134 | - | 654,549 | - | 13,134,683 | |||||||||||||||||||||
Appropriation of statutory reserves | - | - | (1,291,719 | ) | 1,291,719 | - | - | - | ||||||||||||||||||||
Other comprehensive income | - | - | - | - | 27,085 | 494,807 | 521,892 | |||||||||||||||||||||
Balance, September 30, 2013 | $ | 38,380 | $ | 17,011,131 | $ | 16,657,629 | $ | 1,892,563 | $ | 1,393,818 | $ | 867,869 | $ | 37,861,390 |
See accompanying notes to the consolidated financial statements.
5
WONHE HIGH-TECH INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2013 AND 2012 (IN U.S.$)
Nine Months Ended September 30, | ||||||||
2013 | 2012 | |||||||
Cash flows from operating activities: | ||||||||
Net income | $ | 13,134,683 | $ | 4,370,307 | ||||
Adjustment to reconcile net income to net cash provided by (used in) operating activities: | ||||||||
Depreciation and amortization | 65,860 | 57,989 | ||||||
Deferred income taxes | - | 294,302 | ||||||
Change in operating assets and liabilities: | ||||||||
Decrease (increase) in accounts receivable | 3,444,471 | (2,631,142 | ) | |||||
Decrease in interest receivable | - | 307,697 | ||||||
Decrease (increase) in inventory | 75,954 | (132,912 | ) | |||||
Decrease (increase) in advances to suppliers | 5,103,765 | (2,022,960 | ) | |||||
(Increase) in prepaid expenses | (67,604 | ) | (190,612 | ) | ||||
(Increase) in prepaid income taxes | (2,619,017 | ) | - | |||||
Increase in accounts payable | 386 | 391 | ||||||
(Decrease) in payroll payable | (6,554 | ) | (16,371 | ) | ||||
(Decrease) increase in taxes payable | (747,043 | ) | 583,449 | |||||
Increase in accrued expenses and other payables | 37,242 | 2,937 | ||||||
(Decrease) in advances from customers | - | (81,559 | ) | |||||
Net cash provided by (used in) operating activities | 18,422,143 | 541,516 | ||||||
Cash flows from investing activities: | ||||||||
Purchase of fixed assets | - | (7,779 | ) | |||||
Loans to related parties | - | (79,000 | ) | |||||
Cash received upon reverse merger | - | 40,901 | ||||||
Repayment from related party | - | 5,288,197 | ||||||
Net cash provided by investing activities | - | 5,242,319 | ||||||
Cash flows from financing activities: | ||||||||
Stockholder loans | 40,000 | - | ||||||
Proceeds from sale of common stock | 9,912,000 | - | ||||||
Net cash provided by financing activities | 9,952,000 | - | ||||||
Effect of exchange rate changes on cash | 513,817 | (891 | ) |
See accompanying notes to the consolidated financial statements.
6
WONHE HIGH-TECH INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2013 AND 2012 (IN U.S.$)
Nine Months Ended September 30, | ||||||||
2013 | 2012 | |||||||
Net increase in cash | 28,887,960 | 5,782,944 | ||||||
Cash, beginning | 5,215,738 | 76,084 | ||||||
Cash, ending | $ | 34,103,698 | $ | 5,859,028 |
Supplemental disclosure of cash flow information: | ||||||||
Cash paid for income taxes | $ | 1,165,885 | $ | 662,212 | ||||
Cash paid for interest | $ | - | $ | - |
See accompanying notes to the consolidated financial statements.
7
WONHE HIGH-TECH INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2013 AND 2012
1. ORGANIZATION
Wonhe High-Tech International, Inc. (the “Company” or “Wonhe High-Tech”) was incorporated in the State of Nevada on August 13, 2007 under the name “Baby Fox International, Inc.” as a specialty retailer, developer, and designer of fashionable, value-priced women’s apparel and accessories. The Company changed its name from Baby Fox International, Inc. to Wonhe High-Tech International, Inc. on April 20, 2012.
On June 27, 2012, the Company entered into and closed an exchange agreement with World Win International Holding Ltd. or “World Win,” all of the stockholders of World Win, and Super-stable Group Holdings Limited, or “Super-stable”, the majority stockholder of the Company (the “Exchange Agreement”), pursuant to which the stockholders of World Win transferred all of the issued and outstanding stock of World Win to the Company, and Super-stable transferred to such stockholders all of its 19,128,130 shares of the Company’s common stock (the “Share Exchange”). The funds used by Super-stable to purchase its 19,128,130 shares of the Company’s common stock were loaned to it by Shenzhen Wonhe Technology Co., Ltd., or “Shenzhen Wonhe”, the Company’s indirect, consolidated affiliate.
As a result of the acquisition, the Company’s consolidated subsidiaries include World Win, the Company’s wholly-owned subsidiary, which is incorporated under the laws of the British Virgin Island (“BVI”), Kuayu International Holdings Group Limited (Hong Kong), or “Kuayu”, a wholly-owned subsidiary of World Win which is incorporated under the laws of Hong Kong, Shengshihe Management Consulting (Shenzhen) Co., Ltd., or “Shengshihe Consulting”, a wholly-owned subsidiary of Kuayu which is incorporated under the laws of the People’s Republic of China (“PRC”). The Company also consolidates the financial condition and results of operations of Shenzhen Wonhe Technology Co., Ltd., or “Shenzhen Wonhe”, a limited liability company incorporated under the laws of the PRC which is effectively and substantially controlled by Shengshihe Consulting through a series of captive agreements. Shenzhen Wonhe is considered a variable interest entity (“VIE”) of Shengshihe Consulting.
Shenzhen Wonhe Technology Co., Ltd. is a Chinese entity established on November 16, 2010 with registered capital of $7,495,000. It specializes in the research and development, outsourced-manufacturing and trade of hi-tech products based on x86 (instruction set architecture based on Intel 8086 CPU and ARM 32-bit reduced instruction set architecture). Current products still under research and development include a Smart Media Box (SMB), Home Smart Server (HSS), Mini PC (MPC), All in One PC (AIO-PC), Business PAD (B-PAD), and Portable PAD (P-PAD). The product we currently offer to market is the Home Media Center (HMC). The Company is located in Shenzhen, Guangdong Province, China.
8
WONHE HIGH-TECH INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2013 AND 2012
1. ORGANIZATION (continued)
On May 30, 2012, Shenzhen Wonhe entered into (i) an Exclusive Technical Service and Business Consulting Agreement; (ii) a Proxy Agreement, (iii) Share Pledge Agreement, (iv) Call Option Agreement with Shengshihe Consulting. The foregoing agreements are collectively referred to as the “Management and Control Agreements.”
Exclusive Technical Service and Business Consulting Agreement: Pursuant to the Exclusive Technical Service and Business Consulting Agreement, Shengshihe Consulting provides technical support, consulting, training, marketing and business consulting services to Shenzhen Wonhe as related to its business activities. In consideration for such services, Shenzhen Wonhe has agreed to pay as an annual service fee to Shengshihe Consulting an amount equal to 95% of Shenzhen Wonhe’s annual net income with an additional payment of approximately $8,005 (RMB 50,000) each month. The agreement has an unlimited term and can only be terminated upon written agreement of both parties.
Proxy Agreement: Pursuant to the Proxy Agreement, the stockholders of Shenzhen Wonhe agreed to irrevocably entrust Shengshihe Consulting to designate a qualified person acceptable under PRC law and foreign investment policies, to vote all of the equity interests in Shenzhen Wonhe held by each of the stockholders of Shenzhen Wonhe. The Agreement has an unlimited term and only can be terminated upon the written agreement of both parties.
Share Pledge Agreement: Pursuant to the Share Pledge Agreement, each of the stockholders of Shenzhen Wonhe pledged his shares to Shengshihe Consulting to secure the obligations of Shenzhen Wonhe under the Exclusive Technical Service and Business Consulting Agreement. In addition, the stockholders of Shenzhen Wonhe agreed not to transfer, sell, pledge, dispose of or create any encumbrance on their interests in Shenzhen Wonhe that would affect Shengshihe Consulting’s interests. This Agreement remains effective until the obligations under the Exclusive Technical Service and Business Consulting Agreement, Call Option Agreement and Proxy Agreement have been fulfilled or terminated.
Call Option Agreement: Pursuant to the Call Option Agreement, Shengshihe Consulting has an exclusive option to purchase, or to designate a purchaser for, to the extent permitted by PRC law and foreign investment policies, part or all of the equity interests in Shenzhen Wonhe held by each of the stockholders of Shenzhen Wonhe. To the extent permitted by PRC laws, the purchase price for the entire equity interest is approximately $0.16 (RMB1.00) or the minimum amount required by the PRC law or government practice. This Agreement remains effective until all the call options under the Agreement have been transferred to Shengshihe Consulting or its designated entities or natural persons.
9
WONHE HIGH-TECH INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2013 AND 2012
1. ORGANIZATION (continued)
After the Share Exchange, the Company’s current organization structure is as follows:
![](https://capedge.com/proxy/10-Q/0001213900-13-006635/img001.jpg)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Accounting and Presentation
The accompanying consolidated financial statements have been prepared on the accrual basis of accounting. The unaudited consolidated financial statements as of September 30, 2013 and for the three and nine months ended September 30, 2013 and 2012 include Wonhe High-Tech, World Win, Kuayu, Shengshihe Consulting and its VIE, Shenzhen Wonhe. All significant intercompany accounts and transaction have been eliminated in consolidation when applicable.
10
WONHE HIGH-TECH INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2013 AND 2012
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Basis of Accounting and Presentation (continued)
The unaudited interim consolidated financial statements of the Company as of September 30, 2013 and for the three and nine months ended September 30, 2013 and 2012, have been prepared in accordance with accounting principles generally accepted in the United States of America and the rules and regulations of the SEC which apply to interim financial statements.
Accordingly, they do not include all of the information and footnotes normally required by accounting principles generally accepted in the United States of America for annual financial statements. The interim consolidated financial information should be read in conjunction with the consolidated financial statements and the notes thereto, included in the Company’s Form 10-K for the fiscal year ended December 31, 2012, previously filed with the SEC. In the opinion of management, the interim information contains all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of the results for the periods presented. The results of operations for the three and nine months ended September 30, 2013 are not necessarily indicative of the results to be expected for future quarters or for the year ending December 31, 2013.
Variable Interest Entity
Pursuant to Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 810, “Consolidation” (“ASC 810”), the Company is required to include in its consolidated financial statements the financial statements of its variable interest entities (“VIEs”). ASC 810 requires a VIE to be consolidated by a company if that company is subject to a majority of the risk of loss for the VIE or is entitled to receive a majority of the VIE’s residual returns. VIEs are those entities in which a company, through contractual arrangements, bears the risk of, and enjoys the rewards normally associated with ownership of the entity, and therefore the company is the primary beneficiary of the entity.
Under ASC 810, an enterprise has a controlling financial interest in a VIE, and must consolidate that VIE, if the enterprise has both of the following characteristics: (a) the power to direct the activities of the VIE that most significantly affected the VIE’s economic performance; and (b) the obligation to absorb losses, or the right to receive benefits, that could potentially be significant to the VIE. The enterprise’s determination of whether it has this power is not affected by the existence of kick-out rights or participating rights, unless a single enterprise, including its related parties and de facto agents, have the unilateral ability to exercise those rights. Shenzhen Wonhe’s actual stockholders do not hold any kick-out rights that affect the consolidation determination.
11
WONHE HIGH-TECH INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2013 AND 2012
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Variable Interest Entity (continued)
Through the VIE agreements as disclosed in Note 1, the Company is deemed the primary beneficiary of Shenzhen Wonhe and accordingly, their results have been included in the accompanying consolidated financial statements. Shenzhen Wonhe has no assets that are collateral for or restricted solely to settle their obligations. The creditors of Shenzhen Wonhe do not have recourse to the Company’s general credit.
All of the assets recorded on the balance sheets of the Company, other than cash, are owned by Shenzhen Wonhe. In addition, all of the unrecognized revenue-producing assets of the Company, such as intellectual property and the assembled workforce, are owned by Shenzhen Wonhe. Likewise, all of the recognized assets of Shenzhen Wonhe are recorded on the Company’s balance sheets, and all of the unrecognized assets of Shenzhen Wonhe are utilized for the benefit of the Company. The following are financial statement amounts and balances of Shenzhen Wonhe that have been included in the accompanying consolidated financial statements.
ASSETS | September 30, 2013 | December 31, 2012 | ||||||
(Unaudited, In U.S. $) | (In U.S. $) | |||||||
Current assets: | ||||||||
Cash | $ | 33,986,597 | $ | 5,159,917 | ||||
Accounts receivable | 594,046 | 4,033,576 | ||||||
Inventory | 189,711 | 265,665 | ||||||
Advances to suppliers | 178,947 | 5,282,712 | ||||||
Prepaid expenses | 140,415 | 72,811 | ||||||
Total current assets | 35,089,716 | 14,814,681 | ||||||
Fixed assets | 486,816 | 473,942 | ||||||
Less: accumulated depreciation | (186,733 | ) | (123,251 | ) | ||||
Fixed assets, net | 300,083 | 350,691 | ||||||
Other assets: | ||||||||
Intangible assets | 19,512 | 25,328 | ||||||
Other assets – principally security deposits | 48,967 | 53,908 | ||||||
Prepaid income taxes | 2,619,017 | - | ||||||
Total other assets | 2,687,496 | 79,236 | ||||||
TOTAL ASSETS | $ | 38,077,295 | $ | 15,244,608 |
12
WONHE HIGH-TECH INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2013 AND 2012
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Variable Interest Entity (continued)
LIABILITIES | ||||||||
Current liabilities: | ||||||||
Accounts payable | $ | 14,627 | $ | 14,241 | ||||
Payable to WFOE(1) | 19,284,685 | 6,848,259 | ||||||
Payroll payable | 28,051 | 34,645 | ||||||
Taxes Payable | 20,346 | 783,212 | ||||||
Payable for sale of common stocks(2) | 9,888,682 | - | ||||||
Loans from stockholder | 41,026 | - | ||||||
Accrued expenses and other payables | 208,231 | 168,838 | ||||||
Total current liabilities | 29,485,648 | 7,849,195 | ||||||
TOTAL LIABILITIES | $ | 29,485,648 | $ | 7,849,195 |
(1) | Payable to WFOE represents amounts due to Shengshihe Consulting under the Exclusive Technical Service and Business Consulting Agreement for consulting services provided to Shenzhen Wonhe in exchange for 95% of Shenzhen Wonhe’s net income. Monthly payments for the three and nine months ended September 30, 2013 of RMB 50,000 (approximately US$8,035) were paid in full as of September 30, 2013. |
(2) | Payable for sale of common stock represents the proceeds received by Shenzhen Wonhe for the 14,480,000 common shares issued by Wonhe High-Tech International, Inc. on May 2, 2013 at $0.68 each (approximately total US$9,800,000). |
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||
2013 | 2012 | 2013 | 2012 | |||||||||||||
(Unaudited) | (Unaudited) | (Unaudited) | (Unaudited) | |||||||||||||
(In U.S. $) | (In U.S. $) | (In U.S. $) | (In U.S. $) | |||||||||||||
Sales | $ | 4,896,263 | $ | 6,741,196 | $ | 24,659,281 | $ | 15,701,801 | ||||||||
Net income(3) | 2,076,258 | 2,105,117 | 13,090,975 | 4,346,607 |
(3) | Under the Exclusive Technical Service and Business Consulting Agreement, 95% of the net income is to be remitted to the WFOE. |
13
WONHE HIGH-TECH INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2013 AND 2012
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Variable Interest Entity (continued)
Nine Months Ended September 30, | ||||||||
2013 | 2012 | |||||||
(Unaudited) | (Unaudited) | |||||||
(In U.S. $) | (In U.S. $) | |||||||
Net cash provided by (used in) operating activities | $ | 28,250,160 | $ | 582,229 | ||||
Net cash provided by investing activities | - | 5,201,423 | ||||||
Net cash provided by financing activities | 40,000 | - | ||||||
Effect of exchange rate changes on cash | 536,520 | (732 | ) | |||||
Net increase in cash | $ | 28,826,680 | $ | 5,782,920 |
The Company believes that Shengshihe Consulting’s contractual agreements with Shenzhen Wonhe are in compliance with PRC law and are legally enforceable. The stockholders of Shenzhen Wonhe are also the senior management of the Company and therefore the Company believes that they have no current interest in seeking to act contrary to the contractual arrangements. However, Shenzhen Wonhe and its stockholders may fail to take certain actions required for the Company’s business or to follow the Company’s instructions despite their contractual obligations to do so. Furthermore, if Shenzhen Wonhe or its stockholders do not act in the best interests of the Company under the contractual arrangements and any dispute relating to these contractual arrangements remains unresolved, the Company will have to enforce its rights under these contractual arrangements through the operations of PRC law and courts and therefore will be subject to uncertainties in the PRC legal system. All of these contractual arrangements are governed by PRC law and provide for the resolution of disputes through arbitration in the PRC. Accordingly, these contracts would be interpreted in accordance with PRC law and any disputes would be resolved in accordance with PRC legal procedures. As a result, uncertainties in the PRC legal system could limit the Company’s ability to enforce these contractual arrangements, which may make it difficult to exert effective control over Shenzhen Wonhe, and its ability to conduct business may be adversely affected.
14
WONHE HIGH-TECH INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2013 AND 2012
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Use of Estimates
The preparation of financial statements in accordance with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect certain reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates.
Foreign Currency Translation
Almost all of the Company’s assets are located in the PRC. The functional currency for the majority of the operations is the Renminbi (“RMB”). For Kuayu, the functional currency for the majority of its operations is the Hong Kong Dollar (“HKD”). The Company uses the US Dollar for financial reporting purposes. The unaudited consolidated financial statements of the Company have been translated into US dollars in accordance with FASB ASC 830, “Foreign Currency Matters.”
All asset and liability accounts have been translated using the exchange rate in effect at the balance sheet date. Equity accounts have been translated at their historical exchange rates when the capital transactions occurred. Statements of operations and other comprehensive income amounts have been translated using the average exchange rate for the periods presented. Adjustments resulting from the translation of the Company’s consolidated financial statements are recorded as other comprehensive income.
The exchange rates used to translate amounts in RMB and HKD into US dollars for the purposes of preparing the consolidated financial statements are as follows:
September 30, 2013 | December 31, 2012 | September 30, 2012 | ||||||||||||||||||||||
RMB | HKD | RMB | HKD | RMB | HKD | |||||||||||||||||||
Balance sheet items, except for stockholders’equity, as of periods end | 0.1626 | 0.1290 | 0.1583 | 0.1290 | N/A | N/A | ||||||||||||||||||
Amounts included in the statements of income and cash flows for the periods | 0.1607 | 0.1289 | N/A | N/A | 0.1580 | 0.1289 |
15
WONHE HIGH-TECH INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2013 AND 2012
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Foreign Currency Translation (continued)
Foreign currency translation adjustments of $203,315 and ($17,656) for the three months ended September 30, 2013 and 2012, respectively, and $521,892 and $32,916 for the nine months then ended, respectively, have been reported as other comprehensive income (loss). Other comprehensive income of the Company consists entirely of foreign currency translation adjustments. Pursuant to ASC 740-30-25-17, “Exceptions to Comprehensive Recognition of Deferred Income Taxes”, the Company does not recognize deferred U.S. taxes related to the undistributed earnings of its foreign subsidiaries and, accordingly, recognizes no income tax expense or benefit from foreign currency translation adjustments.
Although government regulations now allow convertibility of the RMB for current account transactions, significant restrictions still remain. Hence, such translations should not be construed as representations that the RMB could be converted into US dollars at that rate or any other rate.
The value of the RMB against the US dollar and other currencies may fluctuate and is affected by, among other things, changes in the PRC’s political and economic conditions. Any significant revaluation of the RMB may materially affect the Company’s financial condition in terms of US dollar reporting.
Revenue and Cost Recognition
The Company receives revenue from sales of electronic products. The Company’s revenue recognition policies are in compliance with SEC Staff Accounting Bulletin (“SAB”) 104 (codified in FASB ASC Topic 605). Sales revenue is recognized when the products are delivered and when customer acceptance occurs, the price is fixed or determinable, no other significant obligations of the Company exist and collectability is reasonably assured. Finished goods are delivered from outsourced manufacturers to the Company. Revenue is recognized when the title to the products has been passed to customers, which is the date the products are picked up by the customers at the Company’s location or delivered to the designated locations by Company employees and accepted by the customers and the previously discussed requirements are met. The customers’ acceptance occurs upon inspection at the time of pickup or delivery by signing an acceptance form. The Company does not provide the customers with the right of return. A 36-month warranty is offered to customers for exchange or repair of defective products, the cost of which is substantially covered by the outsourced manufacturers’ warranty policies as specified in the contract between the Company and outsourced manufacturers. As a result, the Company does not recognize a warranty liability. Payments received before all of the relevant criteria for revenue recognition are met are recorded as advances from customers.
16
WONHE HIGH-TECH INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2013 AND 2012
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Revenue and Cost Recognition (continued)
The Company follows the guidance set forth by FASB ASC 605-45-45 to assess whether the Company acts as the principal or agent in the transaction. The determination involves judgment and is based on an evaluation of whether the Company has the substantial risks and rewards of ownership under the terms of arrangement. Based on the assessment, the Company determined it acts as principal in the transaction and reports revenues on the gross basis.
FASB ASC 605-45-45 sets forth eight criteria that support reporting recognition of gross revenue (i.e. principal sales) and three that support reporting net revenue (i.e. agent sales). As applied to the relationship between the Company and its manufacturers, seven of the criteria that support reporting gross revenue are satisfied as follows:
· | Shenzhen Wonhe is the primary obligor in each sale, as it is responsible for fulfillment of customer orders, including the acceptability of the products purchased by the customer. |
· | Shenzhen Wonhe has general inventory risk, as it takes title to a product before that product is ordered by or delivered to a customer. |
· | Shenzhen Wonhe establishes its own pricing for its products. |
· | Shenzhen Wonhe has discretion in supplier selection. |
· | Shenzhen Wonhe designed HMC660 and is responsible for all specifications. |
· | Shenzhen Wonhe has physical loss inventory risk until the product is delivered to the customer. |
· | Shenzhen Wonhe has full credit risk for amounts billed to its customers |
The only criterion supporting recognition of gross revenue that is not satisfied by the relationship between the Company and its manufacturers is: entity changes the product or performs part of the service. Moreover, none of the three criteria supporting recognition of net revenue is present in the Company’s sales transactions. For this reason, the Company records gross revenue with respect to sales of Shenzhen Wonhe.
The Company has not offered customers the right of return because the product has performance capabilities that are not rivaled by competitive products. However, the Company is responsible for replacement or repair of a defective product and such costs will be the responsibility of the outsourced manufacturers.
17
WONHE HIGH-TECH INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2013 AND 2012
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Fair Value of Financial Instruments
FASB ASC 820, “Fair Value Measurement,” defines fair value as the price that would be received upon sale of an asset or paid upon transfer of a liability in an orderly transaction between market participants at the measurement date and in the principal or most advantageous market for that asset or liability. The fair value should be calculated based on assumptions that market participants would use in pricing the asset or liability, not on assumptions specific to the entity.
Research and Development Costs
The Company develops software to be marketed as part of its products, and that is not for internal use. The software is essential to the functionality of the Company’s tangible products. Therefore, the Company accounts for research and development costs incurred in development of its software in accordance with FASB ASC 985-20.
Research and development costs are charged to operations when incurred. Development costs of computer software to be sold, leased, or otherwise marketed are subject to capitalization beginning when a product’s technological feasibility has been established and ending when a product is available for general release to customers. In most instances, the Company’s products are released soon after technological feasibility has been established. Therefore, costs incurred subsequent to achievement of technological feasibility are usually not significant, and generally most software development costs have been expensed as incurred. Research and development costs were $32,243 and $62,170, respectively, and $128,577 and $214,334, respectively, for the three and nine months ended September 30, 2013 and 2012.
Advertising Costs
Advertising costs are charged to operations when incurred. Advertising costs were $97,028 and $94,740, and $259,137 and $158,583, respectively, for the three and nine months ended September 30, 2013 and 2012.
18
WONHE HIGH-TECH INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2013 AND 2012
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Cash and Cash Equivalents
The Company considers all demand and time deposits and all highly liquid investments with an original maturity of three months or less to be cash equivalents.
Accounts Receivable
Accounts receivable is stated at cost, net of an allowance for doubtful accounts. Receivables outstanding longer than the payment terms are considered past due. The Company maintains an allowance for doubtful accounts for estimated losses resulting from the failure of customers to make required payments. The Company reviews the accounts receivable on a periodic basis and makes allowances where there is doubt as to the collectability of the outstanding balance. In evaluating the collectability of an individual receivable balance, the Company considers many factors, including the age of the balance, the customer’s payment history, its current credit-worthiness and current economic trends. The Company considers all accounts receivable at September 30, 2013 and December 31, 2012 to be fully collectible and, therefore, did not provide for an allowance for doubtful accounts. For the periods presented, the Company did not write off any accounts receivable as bad debts.
Inventory
Inventory, comprised principally of computer components, is valued at the lower of cost or market value. The value of inventories is determined using the first-in, first-out method.
The Company estimates an inventory allowance, if necessary, for estimated unmarketable inventories. Inventory amounts are reported net of such allowances, if any. There were no allowances for inventory as of September 30, 2013 and December 31, 2012.
Advances to Suppliers
Advances to suppliers consist of payments made to suppliers for future deliveries.
Prepaid Expenses
Prepaid expenses primarily consist of prepaid consulting fees for listing on the American stock exchange and an advance to an advertising company.
19
WONHE HIGH-TECH INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2013 AND 2012
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Fixed Assets and Depreciation
Fixed assets are recorded at cost, less accumulated depreciation. Cost includes the price paid to acquire the asset, and any expenditure that substantially increases the asset’s value or extends the useful life of an existing asset. Leasehold improvements are amortized over the lesser of the term of the related lease or the estimated useful lives of the improvements. Depreciation is computed using the straight-line method over the estimated useful lives of the assets. Major repairs and betterments that significantly extend original useful lives or improve productivity are capitalized and depreciated over the periods benefited. Maintenance and repairs are generally expensed as incurred. The estimated useful lives for fixed asset categories are as follows:
Office equipment | 5 years |
Motor vehicles | 5 years |
Leasehold improvements | Shorter of the length of lease or life of the improvements |
Impairment of Long-lived Assets
The Company applies FASB ASC 360, “Property, Plant and Equipment,” which addresses the financial accounting and reporting for the recognition and measurement of impairment losses for long-lived assets. In accordance with ASC 360, long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. The Company may recognize the impairment of long-lived assets in the event the net book value of such assets exceeds the future undiscounted cash flows attributable to those assets. No impairment of long-lived assets was recognized for the periods presented.
Statutory Reserve Fund
Pursuant to corporate law of the PRC, the Company’s VIE is required to transfer 10% of its net income, as determined under PRC accounting rules and regulations, to a statutory reserve fund until such reserve balance reaches 50% of the VIE’s registered capital. The statutory reserve fund is non-distributable other than during liquidation and can be used to fund prior years’ losses, if any, and may be utilized for business expansion or used to increase registered capital, provided that the remaining reserve balance after such issue is not less than 25% of the registered capital. As of September 30, 2013, $1,892,563 was transferred from retained earnings to the statutory reserve fund.
20
WONHE HIGH-TECH INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2013 AND 2012
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Income Taxes
The Company accounts for income taxes in accordance with FASB ASC 740, “Income Taxes” (“ASC 740”), which requires the recognition of deferred income taxes for differences between the basis of assets and liabilities for financial statement and income tax purposes. Deferred tax assets and liabilities represent the future tax consequences for those differences, which will either be taxable or deductible when the assets and liabilities are recovered or settled. Deferred taxes are also recognized for operating losses that are available to offset future taxable income. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized.
ASC 740 addresses the determination of whether tax benefits claimed or expected to be claimed on a tax return should be recorded in the financial statements. Under ASC 740, the Company may recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such a position would be measured based on the largest benefit that has a greater than 50% likelihood of being realized upon ultimate settlement. ASC 740 also provides guidance on de-recognition of income tax assets and liabilities, classification of current and deferred income tax assets and liabilities, and accounting for interest and penalties associated with uncertain tax positions. As of September 30, 2013 and December 31, 2012, the Company does not have any uncertain tax positions.
The income tax laws of various jurisdictions in which the Company and its subsidiaries operate are summarized as follows:
United States
The Company is subject to United States tax at graduated rates from 15% to 35%. No provision for income tax in the United States has been made as the Company had no U.S. taxable income for the three and nine months ended September 30, 2013 and 2012.
21
WONHE HIGH-TECH INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2013 AND 2012
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Income Taxes (continued)
PRC
Shenzhen Wonhe and Shengshihe Consulting are subject to an Enterprise Income Tax at 25% and file their own tax returns. Consolidated tax returns are not permitted in China. On July 23, 2012, the National Tax Bureau, Shenzhen Nanshan Branch declared that Shenzhen Wonhe is qualified for the preferential tax treatment afforded by the PRC to enterprises engaged in the development of software or integrated circuits. As a result, starting from its first profitable year, Shenzhen Wonhe is entitled to a two-year exemption from the Enterprise Income Tax followed by a three year 50% reduction in its Enterprise Income Tax rate. The tax regulations require that the enterprise pay income tax until its eligibility for the exemption is determined - i.e. until the local tax bureau determines that the enterprise has recorded its first profitable year. The Company had already made payments of approximately $2,600,000 (RMB 16,107,000) on account of 2012 while the local tax bureau reviewed the Company’s financial results and determined that we had realized a profit in 2012. Since the Company has now been declared exempt from tax with respect to 2012, the payments will be applied to the future income tax due. The payments have been reflected as prepaid income taxes on our balance sheet as of September 30, 2013 and as a benefit from income taxes in the consolidated statements of income and other comprehensive income for nine months ended September 30, 2013.
BVI
World Win is incorporated in the BVI and is governed by the income tax laws of the BVI. According to current BVI income tax law, the applicable income tax rate for the Company is 0%.
Hong Kong
Kuayu International is incorporated in Hong Kong. Pursuant to the income tax laws of Hong Kong, the Company is not subject to tax on non Hong Kong source income.
Noncontrolling Interests
The Company evaluated and determined that under the VIE agreements as disclosed in Note 1, it is deemed to be the primary beneficiary of Shenzhen Wonhe. The noncontrolling interest, representing 5% of the net assets in Shenzhen Wonhe not attributable directly or indirectly to the Company, is measured at its carrying value in the equity section of the consolidated balance sheets.
Reclassifications
Certain amounts in the prior periods financial statements have been reclassified for comparative purposes to conform to the presentation in the current periods financial statements. These reclassifications had no effect on previously reported earnings.
22
WONHE HIGH-TECH INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2013 AND 2012
3. RECENTLY ISSUED ACCOUNTING STANDARDS
On March 5, 2013, the FASB issued ASU 2013-05 to provide guidance for whether to release cumulative translation adjustments (“CTA”) upon certain derecognition events. The update was issued to resolve the diversity in practice about whether Subtopic ASC 810-10, “Consolidation-Overall,” or ASC 830-30, “Foreign Currency Matters-Translation of Financial Statements,” applies to such transactions. ASU 2013-05 is effective prospectively for all entities with derecognition events after the effective date. For public entities, the guidance is effective for fiscal years, and interim periods within those years, beginning after December 31, 2013. ASC 830-30 applies when an entity ceases to have a controlling financial interest in a subsidiary or group of assets that is a business within a foreign entity. Consequently, the CTA is released into net income only if the transaction results in complete or substantially complete liquidation of the foreign entity in which the subsidiary or group of assets resided. Otherwise, no portion of the CTA is released. The adoption of this pronouncement is not expected to have a significant impact on the Company’s consolidated financial condition or results of operations.
In February 2013, the FASB issued ASU 2013-02, “Comprehensive Income (Topic 220): Reporting of Amounts Reclassified out of Accumulated Other Comprehensive Income.” ASU 2013-02 requires an entity to report the effect of significant reclassifications out of accumulated other comprehensive income on the respective line items in net income if the amount being reclassified is required to be reclassified in its entirety to net income. For other amounts that are not required to be reclassified in their entirety to net income in the same reporting period, an entity is required to cross-reference other disclosures that provide additional detail about those amounts. The amendments do not change the current requirements for reporting net income or other comprehensive income in financial statements. For public entities, the amendments are effective prospectively for reporting periods beginning after December 15, 2012. The adoption of this pronouncement did not have a material effect on the Company’s consolidated financial statements.
23
WONHE HIGH-TECH INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2013 AND 2012
4. FIXED ASSETS
Fixed assets at September 30, 2013 and December 31, 2012 are summarized as follows:
September 30, 2013 | December 31, 2012 | |||||||
Office equipment | $ | 157,848 | $ | 153,674 | ||||
Motor vehicles | 219,554 | 213,748 | ||||||
Leasehold improvements | 109,414 | 106,520 | ||||||
486,816 | 473,942 | |||||||
Less: Accumulated depreciation | (186,733 | ) | (123,251 | ) | ||||
Fixed assets, net | $ | 300,083 | $ | 350,691 |
Depreciation expense charged to operations for the three months ended September 30, 2013 and 2012 was $20,212 and $19,453, respectively. Depreciation expense charged to operations for the nine months ended September 30, 2013 and 2012 was $59,432 and $57,989, respectively.
5. INTANGIBLE ASSETS
Intangible assets at September 30, 2013 and December 31, 2012 are summarized as follows:
September 30, 2013 | December 31, 2012 | |||||||
Software | $ | 26,016 | $ | 25,328 | ||||
Less: Accumulated amortization | (6,504 | ) | - | |||||
Intangible assets, net | $ | 19,512 | $ | 25,328 |
Software was purchased in December, 2012, and is being amortized over three years, beginning January 2013. Amortization expense charged to operations for the three months ended September 30, 2013 and 2012 was $2,159 and $0, respectively. Amortization expense charged to operations for the nine months ended September 30, 2013 and 2012 was $6,428 and $0, respectively.
24
WONHE HIGH-TECH INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2013 AND 2012
6. LEASE OBLIGATIONS
The Company leased its offices in Shenzhen from an unrelated third party at a monthly rental of $15,732 under an operating lease, which was to expire on February 28, 2019. The Company terminated the lease on September 30, 2013 without paying any penalty. On September 30, 2013, the Company entered into another lease with an unrelated third party at a monthly rental of $9,538 per month. The new lease expires on August 31, 2014. The Company also leases one apartment at a monthly rental of $1,628, which expires in the second quarter of 2014. The Company had a lease for office space in Beijing at a monthly rent of $716 that expired in September 2012 and was not renewed.
The minimum future rentals under these leases as of September 30, 2013 are as follows:
Year Ending | |||||
December 31, | Amount | ||||
2013 | $ | 28,614 | |||
2014 | 76,303 | ||||
$ | 104,917 |
Rent expense for the three months ended September 30, 2013 and 2012 was $47,530 and $46,260, respectively. Rent expense for the nine months ended September 30, 2013 and 2012 was $137,089 and $134,680, respectively.
7. RELATED PARTY TRANSACTIONS
On December 16, 2010, the Company entered into a twelve month loan agreement with a third party in the amount of $7,560,000, which matured on December 31, 2011 with interest at 12% per annum. Prepaid interest of $393,120 was received upon signing of the agreement. The loan was guaranteed by Guowang Xinke Venture Capital Investment (Jiangsu) Co., Ltd. (“Guowang Capital”), an entity related to the Company through certain stockholders. The agreement provided for the interest rate to increase to 15% on the amount not repaid by December 31, 2011. In May 2011, Guowang Capital assumed the loan.
At March 31, 2012, the loan was fully repaid. Interest charged by the Company for the three months ended March 31, 2013 and 2012, included in interest income was $0 and $112,067, respectively.
On April 25, 2011, the Company entered into a twelve month non-interest bearing loan agreement with Guowang Capital in the amount of $314,200, due April 27, 2012. The loan was fully paid at March 31, 2012.
25
WONHE HIGH-TECH INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2013 AND 2012
7. RELATED PARTY TRANSACTIONS (Continued)
On April 30, 2011, the Company entered into a twelve month non-interest bearing loan agreement with Zhongshan Puruisi Power Equipment Technology Co., Ltd. (“Puruisi Power”), an entity related to the Company through one of its stockholders, in the amount of $141,390, due May 2, 2012. On March 14, 2012, the Company lent additional $79,000 to Zhongshan Puruisi and the two loans were fully repaid on March 19, 2012.
Loans from stockholder are non-interest bearing and are due on demand.
8. FAIR VALUE MEASUREMENTS
FASB ASC 820 specifies a hierarchy of valuation techniques based upon whether the inputs to those valuation techniques reflect assumptions other market participants would use based upon market data obtained from independent sources (observable inputs). In accordance with ASC 820, the following summarizes the fair value hierarchy:
Level 1 Inputs – | Unadjusted quoted market prices for identical assets and liabilities in an active market that the Company has the ability to access. | |
Level 2 Inputs – | Inputs other than the quoted prices in active markets that are observable either directly or indirectly. | |
Level 3 Inputs – | Inputs based on prices or valuation techniques that are both unobservable and significant to the overall fair value measurements. |
ASC 820 requires the use of observable market data, when available, in making fair value measurements. When inputs used to measure fair value fall within different levels of the hierarchy, the level within which the fair value measurement is categorized is based on the lowest level input that is significant to the fair value measurements. Valuation techniques used need to maximize the use of observable inputs and minimize the use of unobservable inputs. As of September 30, 2013 and December 31, 2012, none of the Company’s assets and liabilities were required to be reported at fair value on a recurring basis. Carrying values of non-derivative financial instruments, including cash, receivables and various payables, approximate their fair values due to the short term nature of these financial instruments. There were no changes in methods or assumptions during the periods presented.
26
WONHE HIGH-TECH INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2013 AND 2012
9. INCOME TAXES
The Company is required to file income tax returns in both the United States and the PRC. Its operations in the United States have been insignificant and income taxes have not been accrued. In the PRC, the Company files tax returns for Shenzhen Wonhe and Shengshihe Consulting.
The provision for (benefit from) income taxes consisted of the following for the three and nine months ended September 30, 2013 and 2012:
Three Months ended September 30, | Nine Months ended September 30, | |||||||||||||||
2013 | 2012 | 2013 | 2012 | |||||||||||||
(Unaudited) | (Unaudited) | (Unaudited) | (Unaudited) | |||||||||||||
Current | $ | (2,946 | ) | $ | 709,578 | $ | (2,067,773 | ) | $ | 1,162,467 | ||||||
Deferred | - | - | - | 294,302 | ||||||||||||
$ | (2,946 | ) | $ | 709,578 | $ | (2,067,773 | ) | $ | 1,456,769 |
The following is a reconciliation of the statutory rate with the effective income tax rate for the three and nine months ended September 30, 2013. The effective tax rate was the same as the statutory tax rate for the three and nine months ended September 30, 2012.
Three Months Ended September 30, 2013 | Nine Months Ended September 30, 2013 | |||||||||||||||
Tax Provision | Rate of Tax | Tax Provision | Rate of Tax | |||||||||||||
Tax at statutory rate | $ | 521,950 | 25 | % | $ | 2,766,727 | 25 | % | ||||||||
VIE tax holiday | (524,896 | ) | (25 | %) | (4,834,500 | ) | (44 | %) | ||||||||
Tax at effective tax rate | $ | (2,946 | ) | (0.14 | %) | $ | (2,067,773 | ) | (23 | %) |
The Company’s PRC tax filings for the tax years ended December 31, 2012, 2011 and 2010 were examined by the tax authorities in April 2013, 2012 and 2011, respectively. The examinations were completed and resulted in no adjustments.
27
WONHE HIGH-TECH INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2013 AND 2012
9. INCOME TAXES (Continued)
The Company did not file its U.S. federal income tax returns, including, without limitation, information returns on Internal Revenue Service (“IRS”) Form 5471, “Information Return of U.S. Persons with Respect to Certain Foreign Corporations” for the fiscal year ended June 30, 2012 and for the six months period ended December 31, 2012, a short year income tax return required to be filed as a result of the change in the fiscal year. Failure to furnish any income tax returns and information returns with respect to any foreign business entity required, within the time prescribed by the IRS, subjects the Company to certain civil penalties. Management is of the opinion that penalties, if any, that may be assessed would not be material to the consolidated financial statements.
Because the Company did not generate any income in the United States or otherwise have any U.S. taxable income, the Company does not believe that it has any U.S. federal income tax liabilities with respect to any transactions that the Company or any of its subsidiaries may have engaged in through September 30, 2013. However, there can be no assurance that the IRS will agree with this position, and therefore the Company ultimately could be liable for U.S. federal income taxes, interest and penalties. The tax year ended October 31, 2012 and 2011 and two-month tax period ended December 31, 2012 remain open to examination by the IRS.
10. ISSUANCE OF COMMON STOCK
On May 2, 2013, the Company sold 14,480,000 shares of common stock to 32 unrelated individuals in a private offering. The purchase price for the shares was RMB 4.2 (approximately $0.68) per share, or a total of RMB 60,816,000 (approximately $9,800,000). The shares were sold to individuals who are accredited investors and were purchasing for their own accounts. The offering, therefore, was exempt from registration under the Securities Act of 1933 pursuant to Section 4(2) and Section 4(5) of the Securities Act. The offering was also sold in compliance with the exemption from registration provided by Regulation S, as all of the purchasers are residents of the PRC.
11. CONTINGENCIES
As disclosed in Note 9, the Company was delinquent in filing certain tax returns with the U.S. Internal Revenue Service. The Company is unable to determine the amount of penalties, if any, that may be assessed at this time. Management is of the opinion that penalties, if any, that may be assessed would not be material to the consolidated financial statements.
The Company did not file the information report for the year ended December 31, 2012 concerning its interest in foreign bank accounts on form TDF 90-22.1, “Report of Foreign Bank and Financial Accounts” (“FBAR”). Not complying with the FBAR reporting and recordkeeping requirements will subject the Company to civil penalties up to $10,000 for each of its foreign bank accounts. The Company has not determined the amount of any penalties that may be assessed at this time and believes that penalties, if any, that may be assessed would not be material to the consolidated financial statements.
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WONHE HIGH-TECH INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2013 AND 2012
12. CONCENTRATION OF CREDIT RISK
Concentration of Credit Risk
Substantially all of the Company’s bank accounts are in The People’s Republic of China and are not covered by protection similar to that provided by the FDIC on funds held in United States banks.
Vulnerability Due to Operations in PRC
The Company’s operations may be adversely affected by significant political, economic and social uncertainties in the PRC. Although the PRC government has been pursuing economic reform policies for more than twenty years, no assurance can be given that the PRC government will continue to pursue such policies or that such policies may not be significantly altered, especially in the event of a change in leadership, social or political disruption or unforeseen circumstances affecting the PRC’s political, economic and social conditions. There is also no guarantee that the PRC government’s pursuit of economic reforms will be consistent or effective in the future.
13. CONTRIBUTIONS TO MULTI-EMPLOYER WELFARE PROGRAMS
Shenzhen Wonhe is required to make contributions to multi-employer welfare programs by government regulation sometimes identified as the Mainland China Contribution Plan. Specifically, the following regulations require that we pay a percentage of employee salaries into the specified plans:
Regulation | Plan | % of Salary | ||||
Shenzhen Special Economic Zone Social Retirement Insurance Regulations | Pension | 13% | ||||
Shenzhen Work-Related Injury Insurance Regulations | Workers Comp. | 0.4% | ||||
Guangdong Unemployment Insurance Regulations | Unemployment | 2% | ||||
Housing Provident Fund Management Regulations | Housing | 5% | ||||
Shenzhen Social Medical Insurance Measures | Medical | 6.5% or 0.6%* | ||||
Guangdong Employees Maternity Insurance | Maternity | 0.5% or 0.2%* |
* Depending on their position in the company, employees receive either hospitalization medical and maternity insurance or comprehensive medical and maternity insurance, which is a lower premium.
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WONHE HIGH-TECH INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2013 AND 2012
13. CONTRIBUTIONS TO MULTI-EMPLOYER WELFARE PROGRAMS (continued)
Total contribution to employee welfare for the three and nine months ended September 30, 2013 and 2012 were as follow:
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||
2013 | 2012 | 2013 | 2012 | |||||||||||||
Total Contributions | $ | 5,455 | 5,582 | $ | 21,481 | $ | 117,751 |
14. MAJOR CUSTOMERS
Four customers accounted for 56% and two customers accounted for 22% of total sales during the three months and nine months ended September 30, 2013, respectively. Two customers accounted for 25% and one customer accounted for 11% of sales for the three months and nine months ended September 30, 2012, respectively.
As of September 30, 2013, seven customers accounted for 100% of accounts receivable. At December 31, 2012, four customers accounted for 52% of accounts receivable.
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ITEM 2. | MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONS AND RESULTS OF OPERATIONS |
Overview
We conduct our operations through our consolidated affiliate Shenzhen Wonhe Technology Co., Ltd. (hereinafter referred to as “Shenzhen Wonhe”). Shenzhen Wonhe, founded in November 2010, is a high tech enterprise which specializes in research and development and the marketing of high-end business and personal IT products that provide third party application services. All of our revenue to date has been derived from sales of our Home Media Center 660 (“HMC660”). Our HMC660 is a data storage, management and control center for household equipment, and a central processing center which uses remote wireless technology to allow a user to control various devices while at home or remotely when away from home. HMC660 provides a software platform that has the functional characteristics of both a family security device and a direct TV receiver, with the ability to access TV and video on demand, as well as to function as a game console and storage facility for family and business information. We sell the HMC660 primarily to electronic products distributors.
Our major product under development is a computer set-top-box (“PC-STB”), which combines the system architecture of a multimedia computer with that of a digital set-top box, and features wireless remote control, fully integrating a family’s multimedia application requirements into a single device. In addition, we have seven other hardware products that are in various stages of research and development, including a domestic mini-terminal server, a minicomputer, an All-In-One PC, an ARM panel personal computer and an Android smartphone, We are also developing a Wonhe applications platform and a metropolis business information operating website.
Corporate Structure
Wonhe High-Tech International, Inc. is a Nevada corporation that was, until June 30, 2011, a specialty retailer, developer, and designer of fashionable, value-priced women’s apparel and accessories. On June 30, 2011, Wonhe High-Tech International disposed of its prior business operations and became a shell company. Then on June 27, 2012 Wonhe High-Tech International acquired ownership of World Win International Holding Ltd. (BVI), a holding company organized in the British Virgin Islands (“World Win”). World Win, in turn, is the owner of Kuayu International Holding Group, Ltd. (Hong Kong), an entity organized in Hong Kong that, in April 2012, acquired ownership of Shengshihe Management Consulting (Shenzhen) Co., Ltd. (“Shengshihe Consulting”). The only business of Shengshihe Consulting is to provide management services to Shenzhen Wonhe pursuant to the VIE Agreements described below.
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Accounting for Variable Interest Entity
On May 30, 2012, Shengshihe Consulting and Shenzhen Wonhe and its shareholders Youliang Wang, Qing Tong, Jingwu Li and Nanfang Tong (together referred to as “Shenzhen Wonhe Shareholders”) entered into a series of agreements known as variable interest agreements (the “VIE Agreements”) pursuant to which Shenzhen Wonhe became Shengshihe Consulting’s contractually controlled affiliate. The use of VIE agreements is a common structure used to acquire PRC corporations, particularly in certain industries in which foreign investment is restricted or forbidden by the PRC government. The VIE Agreements included:
(1) | Exclusive Technical Service and Business Consulting Agreement between Shengshihe Consulting and Shenzhen Wonhe pursuant to which Shengshihe Consulting is granted the exclusive right and undertakes the obligation to provide technical support and management consulting services to Shenzhen Wonhe, such services being designed to encompass all aspects of the business of Shenzhen Wonhe. In exchange for the services to be provided by Shengshihe Consulting, Shenzhen Wonhe is required to pay to Shengshihe Consulting (i) 95% of the total annual net profit of Shenzhen Wonhe and (ii) RMB50,000 per month ($8,035). The fee for services payable to Shengshihe Consulting, therefore, represents all but a small percentage of the net income generated by Shenzhen Wonhe. The Exclusive Technical Service and Business Consulting Agreement can be terminated only by mutual agreement of the two parties. |
(2) | Call Option Agreement among the Shenzhen Wonhe Shareholders and Shengshihe Consulting under which the Shenzhen Wonhe Shareholders have granted to Shengshihe Consulting the irrevocable right and option to acquire all of the equity interests in Shenzhen Wonhe to the extent permitted by PRC law. If PRC law limits the percentage of Shenzhen Wonhe that Shengshihe Consulting may purchase at any time, then Shengshihe Consulting may repeatedly exercise its option in such increments as may be allowed by PRC law. The exercise price of the option is RMB1.00 ($0.16) or any lower price permitted by PRC law. The Shenzhen Wonhe Shareholders agreed to refrain from taking certain actions which might harm the value of Shenzhen Wonhe or Shengshihe Consulting’s option. In addition, the Call Option Agreement gives to Shengshihe Consulting the right of prior approval of any significant action by Shenzhen Wonhe, including appointment of management, sale of assets or equity, distribution of profits, or entry into any material agreement. The Call Option Agreement will not terminate until the option is exercised. |
(3) | Proxy Agreement by the Shenzhen Wonhe Shareholders pursuant to which they each authorize Shengshihe Consulting to designate someone to exercise all of his shareholder rights with respect to Shenzhen Wonhe. The Proxy Agreement states that Shengshihe Consulting will be entitled to all information regarding Shenzhen Wonhe’s operations, business, clients, accounting and employees in order to perform its function under the Proxy Agreement. The Proxy Agreement has no termination date nor any termination clause, and is binding on each Shenzhen Wonhe Shareholder as long as he owns equity in Shenzhen Wonhe. |
(4) | Share Pledge Agreement among the Shenzhen Wonhe Shareholders, Shenzhen Wonhe, and Shengshihe Consulting under which the Shenzhen Wonhe Shareholders have pledged all of their equity in Shenzhen Wonhe to Shengshihe Consulting to guarantee Shenzhen Wonhe’s and Shenzhen Wonhe Shareholders’ performance of their obligations under the Exclusive Technical Service and Business Consulting Agreement, the Call Option Agreement and the Proxy Agreement. In the event of a default under any of those agreements, Shengshihe Consulting will be entitled to auction the equity interests of the Shenzhen Wonhe Shareholders and shall receive a priority payment from the auction proceeds to the extent of its unpaid receivable. The Share Pledge Agreement will not terminate until all obligations under the three other agreements have been satisfied. |
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The accounting effect of the VIE Agreements between Shengshihe Consulting and Shenzhen Wonhe is to cause the balance sheets and financial results of Shenzhen Wonhe to be consolidated with those of Shengshihe Consulting, with respect to which Shenzhen Wonhe is now a variable interest entity. Since the entities that are parties to the VIE Agreements were under common control at the time when the VIE Agreements were executed, the financial statements included in this report reflect the consolidation of the results of operations and cash flows of Shenzhen Wonhe.
The Company believes that Shengshihe Consulting’s contractual agreements with Shenzhen Wonhe are in compliance with PRC law and are legally enforceable. The Shenzhen Wonhe Shareholders are also the senior management of the Company and therefore the Company believes that they have no current interest in seeking to act contrary to the contractual arrangements. However, Shenzhen Wonhe and its stockholders may fail to take certain actions required for the Company’s business or to follow the Company’s instructions despite their contractual obligations to do so. Furthermore, if Shenzhen Wonhe or its stockholders do not act in the best interests of the Company under the contractual arrangements and any dispute relating to these contractual arrangements remains unresolved, the Company will have to enforce its rights under these contractual arrangements through the operations of PRC law and courts and therefore will be subject to uncertainties in the PRC legal system.
All of these contractual arrangements are governed by PRC law and provide for the resolution of disputes through arbitration in the PRC. Accordingly, these contracts would be interpreted in accordance with PRC law and any disputes would be resolved in accordance with PRC legal procedures. As a result, uncertainties in the PRC legal system could limit the Company’s ability to enforce these contractual arrangements, which may make it difficult to exert effective control over Shenzhen Wonhe, and its ability to conduct the Company’s business may be adversely affected. The VIE Agreements with our Chinese affiliate and its shareholders, which relate to critical aspects of our operations, may not be as effective in providing operational control as direct ownership.
Results of Operations
The following table sets forth in U.S. dollars key components of our results of operations during the three and nine months ended September 30, 2013 and 2012, and the percentage change between comparable numbers recorded in 2013 and 2012.
Three Months Ended September 30 | Percentage | |||||||||||
2013 | 2012 | Increase/(Decrease) | ||||||||||
Sales | $ | 4,896,263 | $ | 6,739,797 | (27 | ) % | ||||||
Gross Profit | 2,390,156 | 3,290,207 | (27 | ) % | ||||||||
Operating Income | 2,087,800 | 2,838,382 | (26 | ) % | ||||||||
Net income attributable to common stockholders | $ | 1,986,933 | $ | 2,023,552 | (2 | ) % |
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Nine Months Ended September 30 | Percentage | |||||||||||
2013 | 2012 | Increase/(Decrease) | ||||||||||
Sales | $ | 24,659,281 | $ | 15,701,801 | 57 | % | ||||||
Gross Profit | 12,037,993 | 7,669,322 | 57 | % | ||||||||
Operating Income | 11,066,910 | 5,714,202 | 94 | % | ||||||||
Other Income | -- | 112,874 | (100 | %) | ||||||||
Net income attributable to common stockholders | $ | 12,480,134 | $ | 4,152,977 | 201 | % |
Sales. At the end of 2011, our major product, HMC660, passed the stability test administered by Shenzhen Yitong Testing Technology Co., Ltd., an independent entity authorized by the government to perform such tests. The stability test, which was developed by the regulatory board of the electronics industry, is a test to examine product hardware operation, heat dissipation and chip stability to ensure the product is qualified to operate properly under normal conditions. The stability test was the final requirement before our product could be launched to the market. We started sales of our HMC 660 products in December 2011 and the first quarter of 2012 was our first profitable quarter.
During 2011 we had twelve full-time employees involved in developing a market for HMC660. They introduced the product to electronics distribution companies throughout China and established cooperative sales relationships with several of them. When we initiated sales at the end of 2011, we engaged an advertising company at a monthly cost of $31,820 to generate publicity about the HMC660. This program caused demand for the product to rise quickly, which contributed to the rapid growth of sales. For the three and nine months ended September 30, 2012, sales of $6,739,797 and $15,701,801 represented 14,456 and 33,671 units of HMC 660 sold respectively with a unit price of approximately $489.
Sales of the HMC660 continued to grow through the first six months of 2013. In the third quarter, however, we announced that we were developing the second generation of HMC660. As a result, demand for our first generation product fell significantly. So sales for the nine months ended September 30, 2013 increased by $8,957,480 compared with sales during the nine months ended September 30, 2012, reaching $24,659,281 (51,991 units). But sales for the quarter ended September 30, 2013 fell by $1,843,534 compared the sales for the same period in 2012, a decrease rate of 12%, yielding only $4,896,263 (10,167 units).
We expect that 4th quarter sales will also be weak, as the market awaits the second generation HMC660. For 2014 and beyond, however, we expect sales growth to rebound, as the second generation HMC660 will be enhanced by improvements we have made in response to customer feedback during 2012 and 2013. And while we have no fixed date for introduction of any other new product, we expect that sales of new products, when they are ready, will be facilitated by our success with the HMC660 and our utilization of a now-established marketing network.
Gross Profit. All the products sold during the three and nine months ended September 30, 2013 were manufactured by our two main contractors at a cost per unit of $241 and were sold by us at a consistent price in Renminbi that equates to approximately $489. Since we have no significant direct costs of goods sold other than our payment to our manufacturers, this arrangement resulted in a gross profit margin of 49% on sales in the three and nine months ended September 30, 2013. During the three and nine months ended September 30, 2012, the manufacture and sale of 14,456 and 33,671 units yielded the same gross margin of 49%.
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Our agreement with one of the outsourced manufacturers terminated in August 2013, and we did not renew due to the reduction in market demand for our core product. Our agreement with our other manufacturer will continue in effect through December 2013. We believe that if we commit to the same or greater quantity of units for 2014 as we ordered in 2013, that we will be afforded the same pricing by our manufacturer. But that decision has not been made yet. Nevertheless, we expect that our gross profit on the HMC660 will remain stable at least through the 4th quarter of 2013, and will not change materially in 2014. In the long term, however, our Company’s overall gross profit will be affected by competition and by our introduction to market of new products.
Income from Operations. Our operating expenses for the three and nine months ended September 30, 2013 decreased to $302,356 from $451,825 and $971,083 from $1,955,120, respectively, compared with the three and nine months ended September 30, 2012. The primary reason for the improvement was a significant reduction in our general and administrative expenses. The components of our operating expenses were:
· | Research and development expenses. Research and development expenses are primarily comprised of salaries for R&D employees and materials used in research and development. In the three and nine months ended September 30, 2013, our research and development expenses decreased to $32,243 from $62,170 and to $128,577 from $214,334, respectively, compared with the three and nine months ended September 30, 2012. The primary reason for the decrease is that we paid more attention to developing and improving the function of HMC 660 during the three months ended September 30, 2012. We expect research and development expenses will grow into the near future, as we work to bring our pipeline of products closer to their market launch. |
· | Selling and Marketing Expenses. Selling and marketing expenses were primarily comprised of salaries, insurance, traveling expenses and marketing promotion. Even though our HMC660 sales decreased in the recent quarter, we still expect the second generation HMC660 will gain market share and that our new products will piggy-back on that momentum, so we keep investing in market promotions in order to achieve further growth. Selling and marketing expenses decreased by 6% to $109,681 and increased by 6% to $299,706, respectively, for the three and nine months ended September 30, 2013 from $116,481 and $283,101 for the three and nine months ended September 30, 2012, respectively. |
· | General and Administrative Expenses. Our general and administrative (“G&A”) expenses were primarily comprised of administrative employees’ salaries, insurance, rent and other expenses incurred for G&A functions. G&A expenses decreased to $160,432 and $542,800, respectively, for the three and nine months ended September 30, 2013 from $273,174 and $1,457,685, respectively, for the three and nine months ended September 30, 2012, representing a 41% and 63% decrease, respectively. The decrease was primarily because during 2012 we incurred additional expenses for our common stock to be traded in the United States, such as expenses for attorneys, auditors and financial advisors. |
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General and administrative expenses are affected by changes in employees’ remuneration. Shenzhen Wonhe is required to make contributions to multi-employer welfare programs by government regulation sometimes identified as the Mainland China Contribution Plan. Specifically, the following regulations require that we pay a percentage of employee salaries into the specified plans:
Regulation | Plan | % of Salary | ||||
Shenzhen Special Economic Zone Social Retirement Insurance Regulations | Pension | 13 | % | |||
Shenzhen Work-Related Injury Insurance Regulations | Workers Comp. | 0.4 | % | |||
Guangdong Unemployment Insurance Regulations | Unemployment | 2 | % | |||
Housing Provident Fund Management Regulations | Housing | 5 | % | |||
Shenzhen Social Medical Insurance Measures | Medical | 6.5% or 0.6%* | ||||
Guangdong Employees Maternity Insurance | Maternity | 0.5% or 0.2%* |
* Depending on their position in the company, employees receive either hospitalization medical and maternity insurance or comprehensive medical and maternity insurance, which is a lower premium.
Because our contributions are proportionate to salaries paid, as expansion of our business causes an increase in our staff, our contributions to these welfare funds will likewise increase. In addition, labor rates in China have increased significantly in recent years and can be expected to continue to increase. Any such increases will in turn cause an increase in the amount we pay to employee welfare plans.
After deducting these operating expenses, for the three and nine months ended September 30, 2013 we realized operating income of $2,087,800 and $11,066,910, respectively, a decrease of $750,582 or 26% and an increase of $5,352,708 or 94%, respectively, from the operating income of $2,838,382 and $5,714,202 that we reported in the three and nine months ended September 30, 2012, respectively.
Other Income. In 2010, while we were still developing our flagship product, the cash we deposited into Shenzhen Wonhe was idling. To achieve a favorable return on equity, we loaned the greater portion of our cash reserves to an unrelated third party and received a loan guarantee from Guowang Capital, which was controlled by some of our related parties. The loan yielded 12% per annum interest, which increased to 15% in 2012. The loan was repaid in full by Guowang Capital in March 2012. Primarily because of that loan, we recorded interest income of $0 and $112,874 as other income for the three and nine months ended September 30, 2012. For the three and nine months ended September 30, 2013, we didn’t have such income.
Provision for Income Taxes. The corporate income tax rate in China is 25%, and that was our effective tax rate in 2012 when we recorded a provision for taxes of $2,355,125 on pre-tax income of $7,240,206. Beginning in 2013, however, our operating entity has received a preferential tax treatment from the PRC State Administration of Taxation. Shenzhen Wonhe will be entitled to a two-year exemption from the Enterprise Income Tax followed by a three year 50% reduction in its Enterprise Income Tax rate. On May 10, 2013, we were informed by the local tax bureau that the income tax paid as of the date of notification of RMB 16,107,114 ($2,578,749) could be offset against our future income tax after the tax exemption period. As a result, a tax benefit of $2,946 and $2,067,773 were recorded for the three and nine months ended September 30, 2013.
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Net Income. We reported net income of $2,090,746 and $13,134,683, respectively, and $2,128,804 and $4,370,307, respectively, for the three and nine months ended September 30, 2013 and 2012. The VIE agreements assign to Shengshihe Consulting only 95% of the net profit generated from Shenzhen Wonhe. For that reason, we deducted a “non-controlling interest” of $103,813 and $654,549 before recognizing net income attributable to the common stockolders on our Consolidated Statements of Income and Comprehensive Income for the three and nine months ended September 30, 2013. After that deduction , our net income attributable to the common stockholders’ for the three and nine months ended September 30, 2013 and 2012 was $1,986,933 ($.05 per share) and $12,480,134 ($.39 per share), and $2,023,552 ($.08 per share) and $4,152,977 ($.20 per share), respectively.
Foreign Currency Translation Adjustment. Our reporting currency is the U.S. dollar. Our local currency, Renminbi (RMB), is our functional currency. Results of operations and cash flows are translated at average exchange rates during the period, and assets and liabilities are translated at the unified exchange rate as quoted by the People’s Bank of China at the end of the period. Translation adjustments resulting from this process are included in accumulated other comprehensive income in the statement of stockholders’ equity. Transaction gains and losses that arise from exchange rate fluctuations on transactions denominated in a currency other than the functional currency are included in the results of operations as incurred. For the three and nine months ended September 30, 2013 and 2012, foreign currency translation adjustments of $203,315 and $521,892, and $(17,656) and $32,916, respectively, have been reported as other comprehensive income in the consolidated statements of operations and other comprehensive income.
Liquidity and Capital Resources
To date, we have financed our operations primarily through cash flows from operations, equity contributions by our shareholders, and a private placement. As a result, at September 30, 2013 we had no debt, and ourworking capitaltotaled $34,873,811, an increase of $21,010,923 since December 12, 2012, which includes $9,912,000 in proceeds from the private placement of common stock. cash and cash equivalents of $34,103,698, primarily consisting of cash on hand and demand deposits. All of that amount is held in the PRC: $117,101 by our subsidiary and $33,986,597 by Shenzhen Wonhe, our VIE. Our ability to repatriate those amounts to the United States will be limited by limited by the factors discussed below in “Restrictions on Transfer of Funds.”
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The remainder of our working capital primarily consisted of $594,046 in accounts receivable and $178,947 in advances to suppliers. We consider both of these assets to be liquid: at September 30, 2013 only a nominal portion of our accounts receivable were aged more than thirty days, and all were fully collected in the following month; and the amount prepaid to our outsourced manufacturers was much lower than our cost of goods for the nine months ended September 30, 2013.
Because we outsource almost all of our manufacturing operations, our cash flows can be dedicated to working capital. Accordingly, despite the rapid growth of our business, we stayed current with our vendors - only $14,627 in accounts payable at September 30, 2013 - and utilized the cash generated by sales to fund the purchases needed for future sales.
The following table summarizes our cash flows for the periods indicated:
Nine Months Ended September 30, 2013 | Nine Months Ended September 30, 2012 | |||||||
Net cash provided by operating activities | $ | 18,422,143 | $ | 541,516 | ||||
Net cash provided by investing activities | - | 5,242,319 | ||||||
Net cash provided by financing activities | 9,952,000 | - | ||||||
Effects of Exchange Rate Changes on Cash | 513,817 | (891) | ||||||
Net Change in Cash and Cash Equivalents | 28,887,960 | 5,782,944 | ||||||
Cash and Cash Equivalents at Beginning of the Period | 5,215,738 | 76,084 | ||||||
Cash and Cash Equivalent at End of the Period | $ | 34,103,698 | $ | 5,859,028 |
Operating activities
Our operations provided $18,422,143 in cash during the nine months ended September 30, 2013. This exceeded our net profit of $13,134,683, because during this period we utilized credits we had accumulated by prepaying our manufacturers and decreased the balance of our advances to suppliers by $5,103,765. Our agreements with our manufacturers require us to prepay for the delivery of units of the HMC660. In order to assure that units are available for sale when needed, we had $5,282,712 prepaid to our suppliers as of December 31, 2012. Because of the reduction in the level of sales of the HMC660, at September 30, 2013 we had only $178,947 prepaid to suppliers.
During the same period, our prepaid income tax increased by $2,619,017 due to the tax exemption benefit. Also we decreased accounts receivable by $3,444,471 as our sales decreased in the third quarter and we collected outstanding accounts. All of this contributed to our positive cash flow. In contrast, during the nine months ended September 30, 2012, our operations generated a net profit of $4,370,307 but provided only $541,516 in cash, because we increased our advances to suppliers balance by $2,022,960 and our accounts receivable increased by $2,631,142.
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Investing activities
We have relatively low need for capital investment because we outsource all of our manufacturing operations. There were no investing transactions during the nine months ended September 30, 2013. Unless we expand our business activities in the future, investing activities will involve insignificant amounts of cash.
As noted previously, in 2011, when we had large cash reserves without an immediate purpose, we were able to obtain a high return on cash by loaning the funds to a related party. This loan was repaid in 2012, and so recorded $5,242,319 in net cash provided by investing activities for the nine months ended September 30, 2012.
Financing activities
The net cash provided by financing activities of $9,952,000 for the nine months ended September 30, 2013 represented a loan of $40,000 from related parties to allow us to pay professional fees in the U.S and $9,912,000 from a private placement in which we sold 14,480,000 common shares at $0.68 per share on May 2, 2013.
We believe that our cash on hand and cash flow from operations will meet our cash needs for the next 12 months.
Restrictions on Transfers of Funds
The VIE Agreements among Shengshihe Consulting and the Shenzhen Wonhe Shareholders provide that Shengshihe Consulting is entitled to 95% of total net profits (and will bear all losses) arising from Shenzhen Wonhe’s operations. The VIE Agreements also entitle Shengshihe Consulting to manage the operations and control the cash flows of Shenzhen Wonhe. Although Shengshihe Consulting is entitled to Shenzhen Wonhe’s profits, any distributions of such profits from Shengshihe Consulting to our U.S. parent company must comply with applicable Chinese laws affecting payments from Chinese companies to non-Chinese companies.
The sales revenue and expenses of Shenzhen Wonhe are denominated in RMB. The Chinese government strictly regulates conversion of RMB into foreign currencies. Currently, Shenzhen Wonhe and Shengshihe Consulting may purchase foreign currencies for settlement of current account transactions, including payments of dividends to us, without the approval of the State Administration of Foreign Exchange (“SAFE”), by complying with certain procedural requirements. Pursuant to applicable Chinese laws and regulations, foreign invested enterprises incorporated in China, such as Shengshihe Consulting, are required to apply for “Foreign Exchange Registration Certificates.” Currently, conversion within the scope of the “current account” (e.g. remittance of foreign currencies for payment of dividends, trade and service-related foreign exchange transactions, etc.) can be effected without requiring the approval of SAFE, but must be effected through authorized Chinese banks in accordance with regulatory procedures. However, conversion of currency in the “capital account” (e.g. for capital items such as direct investments, loans, securities, etc.) still requires the approval of SAFE. Compliance with those procedural requirements can result in delays in obtaining foreign exchange, which could interfere with offshore activities by the Company, such as acquisitions, offshore investments, or the payment of dividends to the Company’s shareholders. Because of the effort involved in obtaining foreign currencies in exchange for RMB, the Company intends to pay most of the operating expenses of its U.S. parent from dollars loaned to the Company by related parties.
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Under PRC regulations, the Company’s operating subsidiary, Shenzhen Wonhe, may pay dividends only out of its accumulated profits, if any, determined in accordance with the accounting standards and regulations prevailing in the PRC (“PRC GAAP”). The following table shows the difference between the accumulated profits reported by Shengshihe Consulting (the “WFOE”) and by Shenzhen Wonhe in accordance with U.S. GAAP and their accumulated profits determined in accordance with PRC GAAP.
Items | PRC GAAP | US GAAP | ||||||
Accumulated profit) as of January 1, 2013 – Shenzhen Wonhe | $ | 6,356,365 | $ | 6,356,365 | ||||
Net income for the nine months ended September 30, 2013 – Shenzhen Wonhe | 13,090,975 | 13,090,975 | ||||||
Accumulated profit as of September 30, 2013 – Shenzhen Wonhe | 19,447,340 | 19,447,340 | ||||||
Appropriation of statutory reserves - Shenzhen Wonhe* | 1,944,734 | |||||||
Accumulated profit available for dividend as of September 30, 2013 – Shenzhen Wonhe | 17,502,606 | 19,447,340 | ||||||
Accumulated profit as of September 30, 2013 – WFOE | 75,220 | 75,220 | ||||||
Noncontrolling interest - Shenzhen Wonhe** | (875,130 | ) | (972,367 | ) | ||||
Accumulated profit as of September 30, 2013 - consolidated | $ | 16,702,696 | $ | 18,550,193 |
* Appropriation of statutory reserves is calculated as 10% of Shenzhen Wonhe’s accumulated profit. |
** Noncontrolling interest is calculated as 5% of Shenzhen Wonhe’s accumulated profit available for dividend. |
In addition, Shenzhen Wonhe is required to set aside at least 10% of its accumulated profits each year, if any, to fund the statutory general reserve until the balance of the reserve reaches 50% of its registered capital. The amount in excess of 10% of accumulated profits that may be contributed to the statutory general reserve is at Shenzhen Wonhe’s discretion. The statutory general reserve is not distributable in the form of cash dividends to the Company and can be used to make up cumulative prior year losses, if any, and may be converted into share capital by the issue of new shares to shareholders in proportion to their existing shareholdings, or by increasing the par value of the shares currently held by them, provided that the reserve balance after such issue is not less than 25% of the registered capital. As of September 30, 2013 and December 31, 2012, an aggregate amount of $1,892,563 and $600,844 respectively have been appropriated from retained earnings and set aside for the statutory reserve by Shenzhen Wonhe. As of September 30, 2013 and December 31, 2012, $1,914,567 and $3,156,406 will and would be appropriated from our future profits and set aside for the statutory reserve.
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Impact of Accounting Pronouncements
There were no recent accounting pronouncements that have or will have a material effect on the Company’s financial position or results of operations.
Off-Balance Sheet Arrangements
We do not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition or results of operations.
ITEM 3. | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK |
Not applicable.
ITEM 4. | CONTROLS AND PROCEDURES |
Disclosure Controls and Procedures
Evaluation of Disclosure Controls and Procedures. Our Chief Executive Officer and Chief Financial Officer carried out an evaluation of the effectiveness of the Company’s disclosure controls and procedures (as defined in Rule13a-15(e) promulgated by the Securities and Exchange Commission) as of September 30, 2013. The evaluation revealed that there are material weaknesses in our disclosure controls, specifically:
· | The relatively small number of employees who are responsible for accounting functions prevents us from segregating duties within our internal control system. |
· | Our internal financial staff lack expertise in identifying and addressing complex accounting issued under U.S. Generally Accepted Accounting Principles. |
· | Our Chief Financial Officer is not familiar with the accounting and reporting requirements of a U.S. public company. |
· | We have not developed sufficient documentation concerning our existing financial processes, risk assessment and internal controls. |
Based on their evaluation, our Chief Executive Officer and Chief Financial Officer concluded that the Company’s system of disclosure controls and procedures was not effective as of September 30, 2013.
It is our intention to increase staffing to mitigate the current lack of segregation of duties within the general administrative and financial functions. In an effort to remediate the material weaknesses, we plan to document our process and procedures governing our internal reporting, including (1) timely review of reports prior to issuance, (2) a re-evaluation of our staffing needs, and (3) analysis of unusual transactions as they are occurring to allow adequate time for multiple levels of review.
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In addition, we plan to designate individuals responsible for identifying reportable developments and to implement procedures designed to remediate the material weakness by focusing additional attention and resources on our internal accounting functions. However, the material weakness will not be considered remediated until the applicable remedial controls operate for a sufficient period of time and management has concluded, through testing, that these controls are operating effectively.
Changes in Internal Control over Financial Reporting
There have been no changes in our internal control over financial reporting during the period covered by this report that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
PART II - OTHER INFORMATION
Item 1. | Legal Proceedings |
None. | |
Item 1A | Risk Factors |
There have been no material changes from the risk factors included in the Annual Report on Form 10-K for the year ended December 31, 2012. | |
Item 2 | Unregistered Sale of Securities and Use of Proceeds |
(a) Unregistered sales of equity securities | |
The Company did not effect any unregistered sale of securities during the third quarter of fiscal 2013. | |
(c) Purchases of equity securities | |
The Company did not repurchase any of its equity securities that were registered under Section 12 of the Securities Exchange Act during the third quarter of fiscal 2013. | |
Item 3. | Defaults Upon Senior Securities. |
None. | |
Item 4. | Mine Safety Disclosures. |
Not Applicable. | |
Item 5. | Other Information. |
None. |
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Item 6. | Exhibits |
31.1 | Rule 13a-14(a) Certification - CEO |
31.2 | Rule 13a-14(a) Certification - CFO |
32 | Rule 13a-14(b) Certification |
101.INS | XBRL Instance |
101.SCH | XBRL Schema |
101.CAL | XBRL Calculation |
101.DEF | XBRL Definition |
101.LAB | XBRL Label |
101.PRE | XBRL Presentation |
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned thereunto duly authorized.
WONHE HIGH-TECH INTERNATIONAL, INC. | ||
Date: November 15, 2013 | By: | /s/ Nanfang Tong |
Nanfang Tong, Chief Executive Officer | ||
By: | /s/ Chahua Yuan | |
Chahua Yuan, Chief Financial Officer, Chief Accounting Officer |
* * * * *
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