U. S. Securities and Exchange Commission
Washington, D. C. 20549
FORM 10-Q
☒ QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2014
☐ 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 | ☐ | Accelerated filer | ☐ |
Non-accelerated filer | ☐ | Smaller reporting company | ☒ |
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 19, 2014
Common Voting Stock: 38,380,130
WONHE HIGH-TECH INTERNATIONAL, INC.
QUARTERLY REPORT ON FORM 10-Q
FOR THE FISCAL QUARTER ENDED SEPTEMBER 30, 2014
TABLE OF CONTENTS
Page No | ||
Part I | Financial Information | |
Item 1. | Financial Statements (unaudited): | |
Consolidated Balance Sheets (Unaudited) – September 30, 2014 and December 31, 2013 | 3 | |
Consolidated Statements of Income and Other Comprehensive Income (Unaudited) - for the Three and Nine Months Ended September 30, 2014 and 2013 | 5 | |
Consolidated Statement of Changes in Stockholders Equity (Unaudited) for the Nine Months Ended September 30, 2014 and 2013 | 7 | |
Consolidated Statements of Cash Flows (Unaudited) – for the Nine Months Ended September 30, 2014 and 2013 | 8 | |
Notes to Consolidated Financial Statements (Unaudited) | 9 | |
Item 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations | 32 |
Item 3 | Quantitative and Qualitative Disclosures about Market Risk | 42 |
Item 4. | Controls and Procedures | 42 |
Part II | Other Information | |
Item 1. | Legal Proceedings | 43 |
Items 1A. | Risk Factors | 43 |
Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds | 43 |
Item 3. | Defaults upon Senior Securities | 43 |
Item 4. | Mine Safety Disclosures | 43 |
Item 5. | Other Information | 43 |
Item 6. | Exhibits | 43 |
Signatures | 44 |
2 |
WONHE HIGH-TECH INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN U.S.$)
ASSETS | September 30, 2014 | December 31, 2013 | ||||||
(Unaudited) | ||||||||
Current assets: | ||||||||
Cash | $ | 34,566,031 | $ | 35,146,245 | ||||
Inventory | 704,417 | 165,407 | ||||||
Prepaid expenses | 19,628 | 65,616 | ||||||
Total current assets | 35,290,076 | 35,377,268 | ||||||
Fixed assets | 486,217 | 489,810 | ||||||
Less: accumulated depreciation | (268,758 | ) | (209,301 | ) | ||||
Fixed assets, net | 217,459 | 280,509 | ||||||
Other assets: | ||||||||
Intangible assets, net | 10,827 | 17,451 | ||||||
Other assets – principally security deposits | 27,206 | 27,343 | ||||||
Prepaid income taxes | 2,615,795 | 2,635,124 | ||||||
Total other assets | 2,653,828 | 2,679,918 | ||||||
TOTAL ASSETS | $ | 38,161,363 | $ | 38,337,695 |
See accompanying notes to theconsolidatedfinancial statements.
3 |
WONHE HIGH-TECH INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN U.S.$)
LIABILITIES AND STOCKHOLDERS’ EQUITY | September 30, 2014 | December 31, 2013 | ||||||
(Unaudited) | ||||||||
Current liabilities: | ||||||||
Accounts payable | $ | 566,770 | $ | 14,717 | ||||
Payroll payable | 20,968 | 21,628 | ||||||
Taxes payable | 50,654 | 33,719 | ||||||
Loan from stockholder | 147,317 | 143,222 | ||||||
Accrued expenses and other payables | 222,416 | 174,483 | ||||||
Total current liabilities | 1,008,125 | 387,769 | ||||||
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 shares issued and outstanding at September 30, 2014 and December 31, 2013 | 38,380 | 38,380 | ||||||
Additional paid-in capital | 17,011,131 | 17,011,131 | ||||||
Retained earnings | 16,130,657 | 16,634,433 | ||||||
Statutory reserve fund | 1,848,579 | 1,835,144 | ||||||
Other comprehensive income | 768,340 | 1,036,323 | ||||||
Stockholders’ equity before noncontrolling interests | 35,797,087 | 36,555,411 | ||||||
Noncontrolling interests | 1,356,151 | 1,394,515 | ||||||
Total stockholders’ equity | 37,153,238 | 37,949,926 | ||||||
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY | $ | 38,161,363 | $ | 38,337,695 |
See accompanying notes to theconsolidatedfinancial statements.
4 |
WONHE HIGH-TECH INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS AND OTHER COMPREHENSIVE (LOSS) INCOME
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2014 AND 2013 (UNAUDITED, IN U.S.$)
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||
2014 | 2013 | 2014 | 2013 | |||||||||||||
Sales | $ | - | $ | 4,896,263 | $ | - | $ | 24,659,281 | ||||||||
Cost of sales | - | (2,506,107 | ) | - | (12,621,288 | ) | ||||||||||
Gross profit | - | 2,390,156 | - | 12,037,993 | ||||||||||||
Operating expenses: | ||||||||||||||||
R & D expenses | 32,344 | 32,243 | 79,624 | 128,577 | ||||||||||||
Selling and marketing | 11,062 | 109,681 | 162,897 | 299,706 | ||||||||||||
General and administrative | 108,180 | 188,136 | 352,651 | 601,381 | ||||||||||||
Total operating expenses | 151,586 | 330,060 | 595,172 | 1,029,664 | ||||||||||||
(Loss) income from operations | (151,586 | ) | 2,060,096 | (595,172 | ) | 11,008,329 | ||||||||||
Interest income | 30,721 | 27,704 | 91,621 | 58,581 | ||||||||||||
(Loss) income before (benefit from) provision for income taxes | (120,865 | ) | 2,087,800 | (503,551 | ) | 11,066,910 | ||||||||||
Provision for (benefit from) income taxes | 5,061 | (2,946 | ) | 14,960 | (2,067,773 | ) |
See accompanying notes to theconsolidatedfinancial statements.
5 |
WONHE HIGH-TECH INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS AND OTHER COMPREHENSIVE (LOSS) INCOME
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2014 AND 2013 (UNAUDITED, IN U.S.$)
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||
2014 | 2013 | 2014 | 2013 | |||||||||||||
Net (loss) income | (125,926 | ) | 2,090,746 | (518,511 | ) | 13,134,683 | ||||||||||
Noncontrolling interests | 7,055 | (103,813 | ) | 28,170 | (654,549 | ) | ||||||||||
Net (loss) income attributable to common stockholders | $ | (118,871 | ) | $ | 1,986,933 | $ | (490,341 | ) | $ | 12,480,134 | ||||||
(Loss) earnings per common share, basic and diluted | $ | (0.00 | ) | $ | 0.05 | $ | (0.01 | ) | $ | 0.39 | ||||||
Weighted average shares outstanding, basic and diluted | 38,380,130 | 38,380,130 | 38,380,130 | 31,962,125 | ||||||||||||
Comprehensive (loss) income: | ||||||||||||||||
Net (loss) income | $ | (125,926 | ) | $ | 2,090,746 | $ | (518,511 | ) | $ | 13,134,683 | ||||||
Foreign currency translation adjustment | (326 | ) | 203,315 | (278,177 | ) | 521,892 | ||||||||||
Comprehensive (loss) income | (126,252 | ) | 2,294,061 | (796,688 | ) | 13,656,575 | ||||||||||
Comprehensive (loss) income attributable to noncontrolling interests | 7,072 | (110,891 | ) | 38,364 | (681,634 | ) | ||||||||||
Comprehensive (loss) income attributable to common stockholders | $ | (119,180 | ) | $ | 2,183,170 | $ | (758,324 | ) | $ | 12,974,941 |
See accompanying notes to theconsolidatedfinancial statements.
6 |
WONHE HIGH-TECH INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATEDSTATEMENT OFchanges inStockholders’EQUITY
FOR THENINE MONTHS ended SEPTEMBER 30, 2014 AND 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, 2013 | $ | 38,380 | $ | 17,011,131 | $ | 16,634,433 | $ | 1,835,144 | $ | 1,394,515 | $ | 1,036,323 | $ | 37,949,926 | ||||||||||||||
Net (loss) | - | - | (490,341 | ) | - | (28,170 | ) | - | (518,511 | ) | ||||||||||||||||||
Appropriation of statutory reserve | - | - | (13,435 | ) | 13,435 | - | - | - | ||||||||||||||||||||
Other comprehensive (loss) | - | - | - | - | (10,194) | (267,983) | (278,177 | ) | ||||||||||||||||||||
Balance, September 30, 2014 (Unaudited) | $ | 38,380 | $ | 17,011,131 | $ | 16,130,657 | $ | 1,848,579 | $ | 1,356,151 | $ | 768,340 | $ | 37,153,238 |
See accompanying notes to theconsolidatedfinancial statements.
7 |
WONHE HIGH-TECH INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATEDSTATEMENT OFCASH FLOWS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2014 AND 2013 (UNAUDITED, IN U.S.$)
Nine Months Ended September 30, | ||||||||
2014 | 2013 | |||||||
Cash flows from operating activities: | ||||||||
Net (loss) income | $ | (518,511 | ) | $ | 13,134,683 | |||
Adjustment to reconcile net income to net cash provided by (used in) operating activities: | ||||||||
Depreciation and amortization | 65,889 | 65,860 | ||||||
Change in operating assets and liabilities: | ||||||||
Decrease in accounts receivable | - | 3,444,471 | ||||||
Decrease in other assets | 137 | |||||||
(Increase) decrease in inventory | (539,010 | ) | 75,954 | |||||
Decrease in advances to suppliers | - | 5,103,765 | ||||||
Decrease (increase) in prepaid expenses | 45,988 | (67,604 | ) | |||||
Decrease (increase) in prepaid income taxes | 19,329 | (2,619,017 | ) | |||||
Increase in accounts payable | 552,053 | 386 | ||||||
(Decrease) in payroll payable | (660 | ) | (6,554 | ) | ||||
Increase (decrease) in taxes payable | 16,935 | (747,043 | ) | |||||
Increase in accrued expenses and other payable | 47,933 | 37,242 | ||||||
Net cash (used in) provided by operating activities | (309,916 | ) | 18,422,143 | |||||
Cash flows from financing activities: | ||||||||
Stockholder loans | 5,000 | 40,000 | ||||||
Proceeds from issuance of common stock | - | 9,912,000 | ||||||
Net cash provided by financing activities | 5,000 | 9,952,000 | ||||||
Effect of exchange rate changes on cash | (275,298 | ) | 513,817 | |||||
Net Change in cash | (580,214 | ) | 28,887,960 | |||||
Cash, beginning | 35,146,245 | 5,215,738 | ||||||
Cash, ending | $ | 34,566,031 | $ | 34,103,698 | ||||
Supplemental disclosure of cash flow information: | ||||||||
Cash paid for income taxes | $ | - | $ | 1,165,885 | ||||
Cash paid for interest | $ | - | $ | - |
See accompanying notes to theconsolidatedfinancial statements
8 |
WONHE HIGH-TECH INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2014 AND 2013
(UNAUDITED, IN U.S.$)
1. | ORGANIZATION |
Wonhe High-Tech International, Inc. (the “Company” or “Wonhe High-Tech”) was incorporated in the State of Nevada on August 13, 2007. 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 acquired all of the outstanding capital stock of World Win International Holding Ltd. or “World Win” in exchange for 19,128,130 shares of the Company’s common stock (the “Share Exchange”).
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 is a Chinese entity established on November 16, 2010 with registered capital of $7,495,000. It specializes in the research and development, outsourced-manufacturing and trade of hi-tech products based on x86 (instruction set architecture based on Intel 8086 CPU) and ARM (32-bit reduced instruction set architecture). Current products still under research and development include a Smart Media Box (SMB), Home Smart Server (HSS), Mini PC (MPC), All in One PC (AIO-PC), Business PAD (B-PAD), and Portable PAD (P-PAD). The Company is located in Shenzhen, Guangdong Province, China.
On May 30, 2012, Shenzhen Wonhe entered into (i) an Exclusive Technical Service and Business Consulting Agreement, (ii) a Proxy Agreement, (iii) Share Pledge Agreement, and (iv) Call Option Agreement with Shengshihe Consulting. The foregoing agreements are collectively referred to as the “VIE Agreements.”
9 |
WONHE HIGH-TECH INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2014 AND 2013
(UNAUDITED, IN U.S.$)
1. | ORGANIZATION (continued) |
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 $8,140 (RMB 50,000) each month. The agreement has an unlimited term and can only be terminated by mutual agreement of the 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 by mutual agreement of the parties.
Share Pledge Agreement: Pursuant to the Share Pledge Agreement, the stockholders of Shenzhen Wonhe pledged their 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 $0.16 (RMB1.00) or the minimum amount required by PRC law or government practice. This Agreement remains effective until all the equity interests under the Agreement have been transferred to Shengshihe Consulting or its designee.
10 |
WONHE HIGH-TECH INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2014 AND 2013
(UNAUDITED, IN U.S.$)
1. | ORGANIZATION (continued) |
After the Share Exchange, the Company’s current organization structure is as follows:
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 consolidated financial statements as of and for the three and nine months ended September 30, 2014 and 2013 include Wonhe High-Tech, World Win, Kuayu, Shengshihe Consulting and its VIE, Shenzhen Wonhe. All significant intercompany accounts and transactions have been eliminated in consolidation.
The unaudited interim consolidated financial statements of the Company as of September 30, 2014 and for the three and nine months ended September 30, 2014 and 2013, 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.
11 |
WONHE HIGH-TECH INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2014 AND 2013
(UNAUDITED, IN U.S.$)
2. | SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued) |
Basis of Accounting and Presentation (continued)
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, 2013, 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, 2014 are not necessarily indicative of the results to be expected for future quarters or for the year ending December 31, 2014.
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 reporting entity if that reporting entity 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 reporting entity, through contractual arrangements, bears the risk of, and enjoys the rewards normally associated with ownership of the entity, and therefore the reporting entity is the primary beneficiary of the entity.
Under ASC 810, a reporting entity has a controlling financial interest in a VIE, and must consolidate that VIE, if the reporting entity has both of the following characteristics: (a) the power to direct the activities of the VIE that most significantly affect 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 reporting entity’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.
Through the VIE agreements disclosed in Note 1, the Company is deemed the primary beneficiary of Shenzhen Wonhe and, accordingly, the results of operations of Shenzhen Wonhe have been included in the accompanying consolidated financial statements. Shenzhen Wonhe has no assets that are collateral for or restricted solely to settle its obligations. The creditors of Shenzhen Wonhe do not have recourse to the general credit of Shengshihe Consulting or its parent entities.
12 |
WONHE HIGH-TECH INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2014 AND 2013
(UNAUDITED, IN U.S.$)
2. | SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued) |
Variable Interest Entity (continued)
Principally almost of the assets recorded on the balance sheets of the Company 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, 2014 | December 31, 2013 | ||||||
(Unaudited, In U.S. $) | (In U.S. $) | |||||||
Current assets: | ||||||||
Cash | $ | 34,366,321 | $ | 35,007,670 | ||||
Inventory | 704,417 | 165,407 | ||||||
Prepaid expenses | 19,628 | 65,616 | ||||||
Total current assets | 35,090,366 | 35,238,693 | ||||||
Fixed assets | 486,217 | 489,810 | ||||||
Less: accumulated depreciation | (268,758 | ) | (209,301 | ) | ||||
Fixed assets, net | 217,459 | 280,509 | ||||||
Other assets: | ||||||||
Intangible assets | 10,827 | 17,451 | ||||||
Other assets – principally security deposits | 27,206 | 27,343 | ||||||
Prepaid income taxes | 2,615,795 | 2,635,124 | ||||||
Total other assets | 2,653,828 | 2,679,918 | ||||||
TOTAL ASSETS | $ | 37,961,653 | $ | 38,199,120 |
13 |
WONHE HIGH-TECH INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2014 AND 2013
(UNAUDITED, IN U.S.$)
2. | SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued) |
Variable Interest Entity (continued)
LIABILITIES | ||||||||
Current liabilities: | ||||||||
Payable to WFOE(1) | $ | 19,191,267 | $ | 19,191,267 | ||||
Due to Wonhe High-Tech International, Inc.(2) | 9,876,518 | 9,949,498 | ||||||
Accounts payable | 566,770 | 14,717 | ||||||
Payroll payable | 19,474 | 20,123 | ||||||
Taxes payable | 413 | 561 | ||||||
Accrued expenses and other payables | 264,833 | 178,740 | ||||||
Total current liabilities | 29,919,275 | 29,354,906 | ||||||
TOTAL LIABILITIES | $ | 29,919,275 | $ | 29,354,906 |
(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 and monthly payments of RMB 50,000 (approximately US$8,140). The monthly payments have been paid in full as of September 30, 2014. |
(2) | Payable for issuance of common stock represents cash received by Shenzhen Wonhe for the sale of 14,480,000 common shares issued by Wonhe High-Tech International, Inc. on May 2, 2013 at $0.68 each (total approximately US$9,800,000). |
Three Months Ended September 30, | NineMonths Ended | |||||||||||||||
2014 | 2013 | 2014 | 2013 | |||||||||||||
(Unaudited) | (Unaudited) | (Unaudited) | (Unaudited) | |||||||||||||
(In U.S. $) | (In U.S. $) | (In U.S. $) | (In U.S. $) | |||||||||||||
Sales | $ | - | $ | 4,896,263 | $ | - | $ | 24,659,281 | ||||||||
Net (loss) income(3) | $ | (141,108 | ) | $ | 2,076,258 | $ | (563,391 | ) | $ | 13,090,975 |
(3) | Under the Exclusive Technical Service and Business Consulting Agreement, 95% of the net income is to be remitted to the WFOE. |
14 |
WONHE HIGH-TECH INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2014 AND 2013
(UNAUDITED, IN U.S.$)
2. | SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued) |
Variable Interest Entity (continued)
Nine Months Ended | ||||||||
2014 | 2013 | |||||||
(Unaudited) | (Unaudited) | |||||||
(In U.S. $) | (In U.S. $) | |||||||
Net cash (used in) provided by operating activities | $ | (450,261 | ) | $ | 28,250,160 | |||
Net cash provided by financing activities | 5,000 | 40,000 | ||||||
Effect of exchange rate changes on cash | (196,088 | ) | 536,520 | |||||
Net change in cash | $ | (641,349 | ) | $ | 28,826,680 |
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.
15 |
WONHE HIGH-TECH INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2014 AND 2013
(UNAUDITED, IN U.S.$)
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 (loss).
The exchange rates used to translate amounts in RMB into US dollars for the purposes of preparing the consolidated financial statements are as follows:
September 30, 2014 | December 31, 2013 | September 30, 2013 | ||||||||||
Balance sheet items, except for stockholders’ equity, as of period end | 0.1624 | 0.1636 | N/A | |||||||||
Amounts included in the statements of operations, statements of changes in stockholders’ equity and statements of cash flows | 0.1626 | N/A | 0.1607 |
16 |
WONHE HIGH-TECH INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2014 AND 2013
(UNAUDITED, IN U.S.$)
2. | SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued) |
Foreign Currency Translation (continued)
For the three months ended September 30, 2014 and 2013, foreign currency translation adjustments of $(326) and $203,315, respectively; for the nine months ended September 30, 2014 and 2013, foreign currency translation adjustments of $(278,177) and $521,892, 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 customer, which is the date the products are picked up by the customer at the Company’s location or delivered to the designated locations by Company employees and accepted by the customer and the previously discussed requirements are met. The customer’s 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 its 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.
17 |
WONHE HIGH-TECH INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2014 AND 2013
(UNAUDITED, IN U.S.$)
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 the 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:
● | 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 the Home Media Center Model 660 (the “HMC660”) and is responsible for all of its specifications. |
● | Shenzhen Wonhe has physical inventory loss 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 by Shenzhen Wonhe.
During the last quarter of 2013, the Company discontinued the production of HMC660 pending the introduction of a second generation HMC660, which is being developed in order to meet government purchasing standards in additional provinces, and thus allow the expansion of the market for the second generation HMC660. There were no sales during the three and nine months ended September 30, 2014.
18 |
WONHE HIGH-TECH INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2014 AND 2013
(UNAUDITED, IN U.S.$)
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.
Advertising Costs
Advertising costs are paid to an advertising agency for market analysis and strategic planning and are charged to operations when incurred. Advertising costs were $0 and $97,028 for the three months ended September 30, 2014 and 2013, respectively; and $130,080 and $259,137 for the nine months ended September 30, 2014 and 2013, respectively.
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 $32,344 and $32,243 for the three months ended September 30, 2014 and 2013, respectively; $79,624 and $128,577 for the nine months ended September 30, 2014 and 2013, respectively.
19 |
WONHE HIGH-TECH INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2014 AND 2013
(UNAUDITED, IN U.S.$)
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.
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 for estimated unmarketable inventories. Inventory amounts are reported net of such allowances. The allowance for slow-moving and obsolete inventory was $181,195 and $182,534 for computer components as of September 30, 2014 and December 31, 2013.
Fixed Assets and Depreciation
Fixed assets are recorded at cost, less accumulated depreciation. Cost includes the price paid to acquire the asset, and any expenditure that substantially increases the asset’s value or extends the useful life of an existing asset. Leasehold improvements are amortized over the lesser of the term of the related lease or the estimated useful lives of the improvements. Depreciation is computed using the straight-line method over the estimated useful lives of the assets. Major repairs and betterments that significantly extend original useful lives or improve productivity are capitalized and depreciated over the periods benefited. Maintenance and repairs are generally expensed as incurred.
The estimated useful lives for fixed asset categories are as follows:
Office equipment | 5 years |
Motor vehicles | 5 years |
Leasehold improvements | Shorter of the length of the lease or life of the improvements |
20 |
WONHE HIGH-TECH INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2014 AND 2013
(UNAUDITED, IN U.S.$)
2. | SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued) |
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, Shengshihe Consulting and the VIE are required to transfer 10% of their net income, as determined under PRC accounting rules and regulations, to a statutory reserve fund until such reserve balance reaches 50% of their 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, 2014, $1,848,579 had been transferred from retained earnings to the statutory reserve fund.
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. As of September 30, 2014, the deferred tax asset was $70,424, recognized for net operating loss carryforwards of Shenzhen Wonhe. A full valuation allowance against this deferred tax asset was established due to the uncertainty in realizing its benefits.
21 |
WONHE HIGH-TECH INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2014 AND 2013
(UNAUDITED, IN U.S.$)
2. | SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued) |
Income Taxes (continued)
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 these tax positions. As of September 30, 2014 and December 31, 2013, the Company did not record any liabilities for unrecognized tax benefits.
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 taxes 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, 2014 and 2013.
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 50% exemption in the third year commencing January 1, 2014. 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. Payments were made of approximately $2,600,000 (RMB 16,107,000) based upon 2012 income while the local tax bureau reviewed the Company’s financial results. The National Tax Bureau determined that the Company had realized a profit in 2012. Since the Company has now been declared exempt from tax with respect to 2012, the payments will be applied to future income taxes due. The payments have been reflected as prepaid income taxes on the balance sheet as of September 30, 2014 and December 31, 2013.
22 |
WONHE HIGH-TECH INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2014 AND 2013
(UNAUDITED, IN U.S.$)
2. | SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued) |
Income Taxes (continued)
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 previous periods presented have been reclassified to conform to the current periods financial statement presentation.
3. | Recently Issued Accounting Standards |
In June 2014, FASB issued ASU No. 2014-12,“Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period”. ASU 2014-12 requires a reporting entity to treat a performance target that affects vesting and that could be achieved after the requisite service period as a performance condition. It is effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2015. Early adoption is permitted.This accounting standard update is not expected to have a material impact on the Company’s consolidated financial statements.
23 |
WONHE HIGH-TECH INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2014 AND 2013
(UNAUDITED, IN U.S.$)
3. | RECENTLY ISSUED ACCOUNTING STANDARDS (continued) |
In May 2014, the FASB issued ASU No. 2014-09,“Revenue from Contracts with Customers”, which supersedes the revenue recognition requirements in ASC 605,“Revenue Recognition”. The core principle of this updated guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The new rule also requires additional disclosure about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and changes in judgments and assets recognized from costs incurred to obtain or fulfill a contract. This guidance is effective for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period. Companies are permitted to adopt this new rule utilizing either a full or modified retrospective approach. Early adoption is not permitted. The Company has not yet determined the potential impacts of this updated authoritative guidance on its consolidated financial statements
4. | fixed assets |
Fixed assets at September 30, 2014 and December 31, 2013 are summarized as follows:
September 30, 2014 | December 31, 2013 | |||||||
(Unaudited) | ||||||||
Office equipment | $ | 157,654 | $ | 158,819 | ||||
Motor vehicles | 219,284 | 220,905 | ||||||
Leasehold improvements | 109,279 | 110,086 | ||||||
486,217 | 489,810 | |||||||
Less: Accumulated depreciation | (268,758 | ) | (209,301 | ) | ||||
Fixed assets, net | $ | 217,459 | $ | 280,509 |
Depreciation expense charged to operations for the three months ended September 30, 2014 and 2013 was $20,306 and $20,212, respectively; Depreciation expense charged to operations for the nine months ended September 30, 2014 and 2013 was $61,067 and $59,432, respectively.
24 |
WONHE HIGH-TECH INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2014 AND 2013
(UNAUDITED, IN U.S.$)
5. | INTANGIBLE ASSETS |
Intangible assets at September 30, 2014 and December 31, 2013 are summarized as follows:
September 30, 2014 | December 31, 2013 | |||||||
(Unaudited) | ||||||||
Software | $ | 25,984 | $ | 26,176 | ||||
Less: Accumulated amortization | (15,157 | ) | (8,725 | ) | ||||
Intangible assets, net | $ | 10,827 | $ | 17,451 |
Software was purchased in December 2012, and is being amortized over three years, beginning in January 2013. Amortization expense charged to operations for the three months ended September 30, 2014 and 2013 was $2,162 and $2,159, respectively; Amortization expense charged to operations for the nine months ended September 30, 2014 and 2013 was $6,504 and $6,428, respectively.
6. | LEASE OBLIGATIONS |
The Company leased its prior offices in Shenzhen from an unrelated third party at a monthly rental of $15,800 under an operating lease expiring on February 28, 2019. The Company terminated the lease on September 30, 2013 without incurring any penalties. On September 30, 2013, the Company entered into another lease agreement with an unrelated third party at a monthly rental of $9,651 per month. The lease expired on August 31, 2014. On September 1, 2014, the Company renewed the lease agreement at the same rent per month for 12 months. It expires on August 31, 2015.
Rent expense for the three months ended September 30, 2014 and 2013 was $31,847 and $31,475, respectively; rent expense for the nine months ended September 30, 2014 and 2013 was $96,042 and $137,089, respectively.
7. | RELATED PARTY TRANSACTIONS |
From time to time, a stockholder/officer has loaned money to the Company, primarily to meet the non-RMB cash requirements of the parent and subsidiaries. The loans are non-interest bearing, and the balance due was $147,317 and $143,222 at September 30, 2014 and December 31, 2013, respectively. Approximately $110,000 of the loan represents professional and legal fees incurred in the U.S. paid by the stockholder and approximately $36,000 of operating expenses for Wonhe High-Tech and Shengshihe Consulting since their inception. The balance is reflected as loan from the stockholder.
25 |
WONHE HIGH-TECH INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2014 AND 2013
(UNAUDITED, IN U.S.$)
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, 2014 and December 31, 2013, 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.
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.
26 |
WONHE HIGH-TECH INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2014 AND 2013
(UNAUDITED, IN U.S.$)
9. | INCOME TAXES (continued) |
The provision for (benefit from) income taxes consisted of the following for the three and nine months ended September 30, 2014 and 2013:
Three months ended September 30, | Nine months ended September 30, | |||||||||||||||
2014 | 2013 | 2014 | 2013 | |||||||||||||
(Unaudited) | (Unaudited) | (Unaudited) | (Unaudited) | |||||||||||||
Current | $ | 5,061 | $ | (2,946 | ) | $ | 14,960 | $ | (2,067,773 | ) | ||||||
Deferred | (17,747 | ) | - | (70,424 | ) | - | ||||||||||
Change in valuation allowance | 17,747 | - | 70,424 | - | ||||||||||||
$ | 5,061 | $ | (2,946 | ) | $ | 14,960 | $ | (2,067,773 | ) |
The following is a reconciliation of the statutory rate with the effective income tax rate for the three and nine months ended September 30, 2014 and 2013.
Three Months Ended September 30, 2014 | Nine Months Ended September 30, 2014 | |||||||||||||||
Tax Provision | Rate of Tax | Tax Provision | Rate of Tax | |||||||||||||
Tax at statutory rate | $ | (15,217 | ) | 12.50 | % | $ | (62,944 | ) | 12.50 | % | ||||||
VIE tax holiday | - | - | - | - | ||||||||||||
Valuation allowance | 17,747 | (14.58 | )% | 70,424 | (13.99 | )% | ||||||||||
Foreign tax rate differential | 2,531 | (2.08 | )% | 7,480 | (1.49 | )% | ||||||||||
Tax at effective tax rate | $ | 5,044 | (4.16 | )% | $ | 14,960 | (2.97 | )% |
27 |
WONHE HIGH-TECH INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2014 AND 2013
(UNAUDITED, IN U.S.$)
9. | INCOME TAXES (continued) |
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 | 25.00 | % | $ | 2,766,727 | 25.00 | % | ||||||||
VIE tax holiday | (524,896 | ) | (25.14 | )% | (4,834,500 | ) | (48.00 | )% | ||||||||
Tax at effective tax rate | $ | (2,946 | ) | (0.14 | )% | $ | (2,067,773 | ) | (23.00 | )% |
The following presents the aggregate dollar and per share effects of the Company’s VIE tax holidays:
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||
2014 | 2013 | 2014 | 2013 | |||||||||||||
Aggregate dollar effect of tax holiday | $ | - | $ | (524,896 | ) | $ | - | $ | (4,834,500 | ) | ||||||
Per share effect, basic and diluted | $ | - | $ | (0.01 | ) | $ | - | $ | (0.15 | ) |
The Company’s PRC tax filings for the tax year ended December 31, 2013 was examined by the tax authorities in May, 2014. The examinations were completed and resulted in no adjustments.
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, and for the year ended December 31, 2013. 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.
28 |
WONHE HIGH-TECH INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2014 AND 2013
(UNAUDITED, IN U.S.$)
9. | INCOME TAXES (continued) |
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, 2014. 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.
All of the Company’s operations are conducted in the PRC. At September 30, 2014, the Company’s unremitted foreign earnings of its PRC subsidiaries totaled approximately $16.1 million and the Company held approximately $34.5 million of cash and cash equivalents in the PRC. These unremitted earnings are planned to be reinvested indefinitely into the operations of the Company in the PRC. While repatriation of cash held in the PRC may be restricted by local PRC laws, most of the Company’s foreign cash balances could be repatriated to the United States but, under current U.S. income tax laws, would be subject to U.S. federal income taxes less applicable foreign tax credits. Determination of the amount of unrecognized deferred U.S. income tax liability on the unremitted earnings is not practicable because of the complexities associated with this hypothetical calculation, and as the Company does not plan to repatriate any cash in the PRC to the United States during the foreseeable future, no deferred tax liability has been accrued.
10. | CONTINGENCIES |
As disclosed in Note 9, the Company was delinquent in filing certain tax returns with the U.S. Internal Revenue Services. 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, 2013 and 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 $10,000 for each of its foreign bank accounts. The Company has not determined the amount of any penalties that may be assessed at this time and believes that penalties, if any, that may be assessed would not be material to the consolidated financial statements.
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WONHE HIGH-TECH INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2014 AND 2013
(UNAUDITED, IN U.S.$)
11. | CONCENTRATION OF CREDIT RISK |
Cash and cash equivalents
Substantially all of the Company’s bank accounts are in banks located 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.
Major customers
During the three and nine months ended September 30, 2014, the Company had no sales.
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. As of September 30, 2013, seven major customers accounted for 100% of accounts receivable.
12. | 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 the Company 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
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2014 AND 2013
(UNAUDITED, IN U.S.$)
12. | CONTRIBUTIONS TO MULTI-EMPLOYER WELFARE PROGRAMS (continued) |
Total contributions to employee welfare programs for the three and nine months ended September 30, 2014 and 2013 were as follow:
For the Three Months ended September 30, | For the Nine Months ended September 30, | |||||||||||||||
2014 | 2013 | 2014 | 2013 | |||||||||||||
Total contributions | $ | 3,477 | $ | 5,455 | $ | 16,039 | $ | 21,481 |
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ITEM 2. | MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONS AND RESULTS OF OPERATIONS |
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 (US$8,130). 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. |
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(3) | Proxy Agreement by the Shenzhen Wonhe Shareholders pursuant to which they each authorize Shengshihe Consulting to designate someone to exercise all of their 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 they own 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. |
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 treated as a variable interest entity (“VIE”). 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 since January 1, 2012.
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.
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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, 2014 and 2013, and the percentage change between comparable numbers recorded in 2014 and 2013.
Three Months Ended September 30, | Percentage Increase/ | |||||||||||
2014 | 2013 | (Decrease) | ||||||||||
Sales | $ | - | $ | 4,896,263 | (100 | )% | ||||||
Gross profit | - | 2,390,156 | (100 | )% | ||||||||
Operating (loss) income | (151,586 | ) | 2,060,096 | (107 | )% | |||||||
Net (loss) income attributable to common stockholders | $ | (118,871 | ) | $ | 1,986,933 | (106 | )% |
Nine Months Ended September 30, | Percentage Increase/ | |||||||||||
2014 | 2013 | (Decrease) | ||||||||||
Sales | $ | - | $ | 24,659,281 | (100 | )% | ||||||
Gross Profit | - | 12,037,993 | (100 | )% | ||||||||
Operating (loss) Income | (595,172 | ) | 11,008,329 | (105 | )% | |||||||
Net (loss) income attributable to common stockholders | $ | (490,341 | ) | $ | 12,480,134 | (104 | )% |
Sales. We started sales of our HMC 660 products in December 2011 and the first quarter of 2012 was our first profitable quarter. When we initiated sales at the end of 2011, we engaged an advertising company 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 years ended December 31, 2013 and 2012, sales of $25,474,097 and $25,181,823 represented 53,476 and 53,920 units of HMC 660, respectively.
Sales of the HMC660 continued to grow through the first six months of 2013. During the third quarter, however, we announced that we were developing the second generation of the HMC660. The reason for this development project is to expand our potential market. To date we have focused our sales effort in Guangdong Province. We want to expand our customer base, but have been informed that in order to achieve successful entry into other provinces, our product will have to meet the purchasing standards of the local State Administration of Radio Film and Television (“SARFT”), as the customer group that does not receive service through SARFT is dominated by local media companies. The changes being implemented in the second generation product, therefore, are changes needed to meet SARFT purchasing standards.
As a result of our announcement that a second generation product was being developed, demand for our first generation product fell significantly. Sales in the third quarter of 2013 fell by 27% from the third quarter of 2012; sales in the fourth quarter of 2013 were only $814,816. Toward the end of 2013 we terminated production of the HMC660. The overall result was that sales for year ended December 31, 2013 increased by only $292,274 compared with sales during the year ended December 31, 2012.
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In the third quarter of 2014, our second generation of HMC 660 was successfully developed, which is called HMC 720. It passed the stability test by Dongguan Yueshi Electronic Products Test Co., Ltd on October 15, 2014. As the new product is not permitted to be sold before the stability test is successfully completed, for the three and nine month periods ended September 30, 2014, we did not have any sales.
Income from Operations. Our operating expenses for the three and nine months ended September 30, 2014 decreased to $151,586 and $595,172 from $330,060 and $1,029,664, compared with the three and nine months ended September 30, 2013, respectively. The primary reason for the decrease was the significant decrease in sales. The components of our operating expenses were:
● | Research and development expenses. Research and development expenses are primarily comprised of salaries for R&D employees. In the three months ended September 30, 2014 and 2013, our research and development expenses were $32,344 and $32,243, respectively. In the nine months ended September 30, 2014 and 2013, our research and development expense were $79,624 and $128,577, respectively. For the nine months ended September 30, 2014, it decreased by $48,953 or 38%. The primary reason for the decrease was that we were substantially completed with the research and development of the HMC720 and were preparing for the stability test. |
● | Selling and Marketing Expenses. Selling and marketing expenses were primarily comprised of salaries and advertising expenses. Even though we terminated selling the HMC660 in 2013, we are hopeful that the new second generation HMC720 will gain market share and that our new product will piggy-back on our prior momentum, so we continued minimal promotions in order to maintain our visibility, causing promotion expenses to decrease. Selling and marketing expenses decreased by 90% to $11,062 and by 46% to $162,897 for the three and nine months ended September 30, 2014 from $109,681 and $299,706 for the three and nine months ended September 30, 2013, respectively. |
● | General and Administrative Expenses. Our general and administrative (“G&A”) expenses were primarily comprised of rent, administrative employees’ salaries, rent, professional fees and other expenses incurred for G&A functions. G&A expenses decreased to $108,180 and $352,651 for the three and nine months ended September 30, 2014 from $188,136 and $601,381 for the three and nine months ended September 30, 2013, representing a 42% and 41% decrease, respectively. The decrease was principally due to cost containment efforts as a result of the decrease in sales. |
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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 into these employee welfare plans.
After deducting these operating expenses, for the three and nine months ended September 30, 2014 we realized an operating loss of $(151,586) and $(595,172), a decrease of $2,211,682 and $11,603,501 or 107% and 105%, from operating income of $2,060,096 and $11,008,329 that we reported in the three and nine months ended September 30, 2013,respectively.
Interest Income. We earned interest income on our bank balances, from which we gained $30,721 and $91,621 for the three and nine months ended September 30, 2014, and $27,704 and $58,581 for the three and nine months ended September 30, 2013,respectively. The Company’s strong cash position and its reduced operations enabled the investment of its available cash.
Provision for Income Taxes.
The Enterprise Income Tax rate in China is 25%. Beginning in 2013, however, Shenzhen Wonhe received a preferential tax treatment from the PRC State Administration of Taxation. It is entitled to a two-year 100% exemption commencing January 1, 2012, of the Enterprise Income Tax followed by a three year 50% exemption in its Enterprise Income Tax rate. On May 10, 2013, we were informed by local tax bureau that the income tax paid as of the date of notification of RMB 16,107,114 ($2,615,795) could be utilized to offset against our future income tax liability after the tax exemption period.The 100% income tax exemption expired on December 31, 2013. From Jan 1, 2014, the 50% exemption of the Enterprise Income Tax will be taken in the following 3 years.
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A tax provision of $5,061 and $14,960 was recorded for the three and nine months ended September 30, 2014 which principally related to the tax on the consulting fee paid to Shengshen Consulting. Consolidated tax returns are not allowed in the PRC.
Net Income (loss). We reported net (loss) income of ($125,926) and $2,090,746 for the three months ended September 30, 2014 and 2013, and $(518,511) and $13,134,683 for the nine months ended September 30, 2014 and 2013, respectively. The VIE agreements assign to Shengshihe Consulting only 95% of the net earnings from Shenzhen Wonhe. For that reason, we allocated a ”non-controlling interest” of ($7,055) and ($28,170) for three and nine months ended September 30, 2014 and deducted a “non-controlling interest” of $103,813 and $654,549 for three and nine months ended September 30, 2013 before recognizing net income attributable to the common stockholders’ on our Consolidated Statements of Operations and Comprehensive Income. After that, our net (loss) income attributable to the common stockholders’ for the three months ended September 30, 2014 and 2013 was $(118,871), ($.00) per share and $1,986,933, $.05 per share, and for the nine months ended September 30, 2014 and 2013 was $(490,341), ($0.01) per share and $12,480,134 , $0.39 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 months ended September 30, 2014 and 2013, foreign currency translation adjustments of ($326) and $203,315, for the nine months September 30, 2014 and 2013, foreign currency translation adjustments of ($278,177) and $521,892, 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 on hand generated from cash flows from operations, equity contributions by our shareholders and a private placement. As a result, at September 30, 2014, our debt consisted of $147,317 that we have borrowed from stockholders, primarily in order to obtain U.S. Dollars to pay the expenses of our parent corporation and professional expenses. At September 30, 2014, our working capital totaled$34,281,951, a decrease of $707,548 since December 31, 2013.
Our cash of $34,566,031 primarily consist of cash on hand and demand deposits. That entire amount is held in the PRC: $199,710 by our subsidiary and $34,366,321 by Shenzhen Wonhe, our VIE. Our ability to repatriate those amounts to the United States will be limited by the factors discussed below in “Restrictions on Transfer of Funds.”
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In addition to cash, our working capital included $704,417 in inventory and $19,628 in advances to suppliers. In 2013, we recorded an inventory allowance for estimated unmarketable inventory. Inventory amounts are reported net of such allowances. The allowance for slow-moving and obsolete inventory was $181,195 as of September 30, 2014. During the nine months ended September 30, 2014, we wrote-off unmarketable inventory of finished goods by RMB 73,500 ($11,922). Inventory amounts are reported net of this wrote-off.
Because we previously outsourced almost all of our manufacturing operations, our cash flows can be dedicated to working capital. During the nine months ended September 30, 2014 we made no capital investments. Due to the successful development of our second generation product, we outsourced the manufacturing to commence production and causing an increase in payables to vendor of $552,053 and an increase in inventory of $539,010.
The following table summarizes our cash flows for the periods indicated:
Nine Months September 30, | Nine Months Ended September 30, 2013 | |||||||
Net cash (used in) provided by operating activities | $ | (309,916 | ) | $ | 18,422,143 | |||
Net cash provided by investing activities | - | - | ||||||
Net cash provided by financing activities | 5,000 | 9,952,000 | ||||||
Effects of Exchange Rate Changes on Cash | (275,298 | ) | 513,817 | |||||
Net Change in Cash and Cash Equivalents | (580,214 | ) | 28,887,960 | |||||
Cash and Cash Equivalents at Beginning of the Period | 35,146,245 | 5,215,738 | ||||||
Cash and Cash Equivalent at End of the Period | $ | 34,566,031 | $ | 34,103,698 |
Operating activities
Our operations used $309,916 and provided $18,422,143 in cash during the nine months ended September 30, 2014 and 2013. This is less than our net loss of $518,511.
Investing activities
There were no investing transactions during the nine months endedSeptember 30, 2014 and 2013. Unless we expand our business activities in the future, investing activities will involve insignificant amounts of cash.
Financing activities
The net cash provided by financing activities of $5,000 for the nine months ended September 30, 2014 represented a loan from related parties to allow us to pay professional fees in the U.S.
We believe that our cash on hand and cash flow from operations will meet our cash needs for the next 12 months.
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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.
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, 2014 – Shenzhen Wonhe | $ | 19,349,006 | $ | 19,349,006 | ||||
Net income for the nine months ended September 30, 2014 – Shenzhen Wonhe | (563,391 | ) | (563,391 | ) | ||||
Accumulated profit as of September 30, 2014 – Shenzhen Wonhe | 18,785,615 | 18,785,615 | ||||||
Appropriation of statutory reserves - Shenzhen Wonhe* | 1,931,731 | |||||||
Accumulated profit available for dividend as of September 30, 2014 – Shenzhen Wonhe | 16,853,884 | 18,785,615 | ||||||
Accumulated profit as of September 30, 2014 – WFOE | 132,903 | 132,903 | ||||||
Appropriation of statutory reserves-WOFE | 13,435 | |||||||
Noncontrolling interest - Shenzhen Wonhe** | (842,694 | ) | (935,781 | ) | ||||
Accumulated profit as of September 30, 2014 - consolidated | $ | 16,130,658 | $ | 17,982,737 |
* Appropriation of statutory reserves is calculated as 10% of Shenzhen Wonhe’s accumulated profit.
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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, 2014, an aggregate amount of $1,931,731 has been appropriated from retained earnings and set aside for the statutory reserve by Shenzhen Wonhe.
Critical Accounting Policies and Estimates
In preparing our financial statements we are required to formulate working policies regarding valuation of our assets and liabilities and to develop estimates of those values. In our preparation of the financial statements for the three and nine months ended September 30, 2014, there was one estimate made which was (a) subject to a high degree of uncertainty and (b) material to our results. This was the determination reflected in Note 2 to the financial statements to consolidate the balance sheet and historical financials of our variable interest entity, Shenzhen Wonhe.
Through the VIE agreements, our subsidiary, Shengshihe Consulting, is deemed the primary beneficiary of Shenzhen Wonhe. Shenzhen Wonhe has no assets that are collateral for or restricted solely to settle its own obligations. The creditors of Shenzhen Wonhe do not have recourse to the Company’s general credit. Shenzhen Wonhe’s actual stockholders do not hold any kick-out rights that will affect the consolidation determination. Accordingly, the financials of Shenzhen Wonhe have been included in the accompanying consolidated financial statements.
There is a degree of uncertainty as to whether the VIE agreements would be enforceable within the Chinese legal system if, for any reason, we found it necessary to seek legal enforcement. To date, there has been very limited judicial comment on such agreements, and nothing that would serve as binding precedent if the enforceability of our VIE agreements were to be adjudicated. We believe that, if adjudicated, each of the four VIE agreements would be found enforceable by the Chinese legal system. Our bases for this conclusion are:
● | The Exclusive Technical Service and Business Consulting Agreement provides an exchange of money for services that is a fair and reasonable exchange and does not violate any principal of Chinese law. |
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● | The Call Option Agreement is, essentially, a stand-still agreement under which the parties agree to take no action that would prejudice the other pending an acquisition of Shenzhen Wonhe by Shengshihe Consulting on terms that comply with Chinese law. A standstill agreement, in contemplation of a subsequent transfer is commonly enforced in China, where the transfer process can be lengthy. | |
● | The Proxy Agreement conforms to Chinese corporate law that permits equity holders to appoint proxies to exercise their voting rights. | |
● | The Share Pledge Agreement conforms to Chinese law that permits a pledge of equity to secure obligations. |
The most likely challenge to the VIE agreements would arise under the New M&A Rules, which are designed to regulate foreign acquisitions of Chinese entities. Our analysis of the New M&A Rules, however, indicates that the New M&A Rules do not invalidate our VIE Agreements. The New M&A Rules require offshore “special purpose vehicles,” that are (1) formed for the purpose of overseas listing of the equity interests of Chinese companies via acquisition and (2) are controlled directly or indirectly by Chinese companies and/or Chinese individuals, to obtain the approval of the CSRC prior to the listing and trading of their securities on overseas stock exchanges. Based on our review of the New M&A Rules, we believe that this provision does not apply to our Company. We reached that conclusion by observing that:
i. | Shengshihe Consulting was incorporated by a foreign investor and therefore has no Chinese shareholders; | |
ii. | the share exchange between World Win and the Company, Wonhe High-Tech International Inc., is between two offshore companies and is not deemed as a transaction to acquire equity or assets of a “Chinese domestic company” as defined under the New M&A Rules; and | |
iii | no provision in the New M&A Rules clearly classifies the contractual arrangements between Shengshihe Consulting and Shenzhen Wonhe as a type of transaction falling within the New M&A Rules. |
We believe, therefore, that under prevailing laws and policies our VIE Agreements are enforceable in Chinese courts. Consideration must be given, however, to the possibility that the Chinese government will express a policy adverse to such arrangements, which would be likely to affect future adjudication of the enforceability of entrusted-management-type arrangements. Moreover, as there are no judicial decisions known to us regarding the enforceability of VIE agreements, it is possible that our analysis of their enforceability may not prevail in a Chinese court. There is a risk, therefore that if it occurred that the counterparties to the VIE agreements failed to abide by the VIE agreements, we would be unable to secure effective relief in the Chinese legal system. In that eventuality, we would be required to de-consolidate Shenzhen Wonhe from the Company’s financial statements, and the Company would report no revenue nor earnings and only nominal assets.
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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, 2014. 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, 2014.
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, 2013. | |
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 2014. | |
(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 2014. | |
Item 3. | Defaults Upon Senior Securities. |
None. | |
Item 4. | Mine Safety Disclosures. |
Not Applicable. | |
Item 5. | Other Information. |
None. | |
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 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 19, 2014 | 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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