China Finance Online Co. Limited
September 7, 2006
CONFIDENTIAL
TO: Ms. Kristi Beshears
Staff Accountant
Division of Corporate Finance
Securities and Exchange Commission
450 Fifth Street N.W.
Washington, D.C. 20549
CC: Mr. Daniel L. Gordan
Branch Chief
Division of Corporate Finance
Securities and Exchange Commission
450 Fifth Street N.W.
Washington, D.C. 20549
RE: CHINA FINANCE ONLINE CO. LIMITED
FORM 20-F FOR THE YEAR ENDED DECEMBER 31, 2005
(FILE NO. 000-50975)
Dear Ms. Beshears,
I refer to your fax of July 28, 2006 to China Finance Online Co., Limited
(the "Company") regarding SEC comments on the Company's Form 20-F filed on May
23, 2006. Attached to this cover letter please find our responses to the SEC
comments, which we are filing via EDGAR.
Please direct any future correspondence with respect to this matter to the
Company as set forth below:
China Finance Online Co. Limited
9th Floor of Tower C, Corporate Square
No. 35 Financial Street
Xicheng District, Beijing 100032
People's Republic of China
Tel: +86 (10) 5832 5288
Fax: +86 (10) 5832 5200
Attention: Jun Wang
With a copy to:
Ms. Kristi Beshears and Mr. Daniel L. Gordan, September 7, 2006 - Page 2
O'Melveny & Myers LLP
Plaza 66, 37th Floor
1266 Nanjing Road West
Shanghai 200040
People's Republic of China
Tel: +86 (21) 2307-7068
Fax: +86 (21) 2307-7300
Attention: Todd Bissett, Esq.
I would appreciate your acknowledging receipt of this letter and our
responses to the SEC comments by emailing me at jwang@jrj.com.
Thank you for your assistance in this matter.
Very truly yours,
/s/ Jun Wang
----------------------------------------
Jun Wang
Chief Financial Officer
China Finance Online Co., Limited
cc: Howard Zhang, Esq.
David Lin, Esq.
Todd Bissett, Esq.
Ms. Kristi Beshears and Mr. Daniel L. Gordan, September 7, 2006 - Page 3
A. Selected Financial Data, Page 4
1. In future filings, please revise the table on page 5 to distinguish between
dividends declared per ordinary share and preference share. Please also
disclose the dividends declared per share denominated in renminbi. Refer to
Item 3.A of Form 20-F.
Response:
We will revise the table in future filings as advised.
Consolidated Statements of Cash Flows, Page F-6
2. Please tell us why the effect of exchange rate changes for each period is
the same as the foreign currency translation adjustment for each period.
Translation adjustments are solely a result of the translation process and
have no direct effect on reporting currency cash flows. Paragraph 146 of
SFAS 95 provides an example of how to calculate the effect of exchange rate
changes on cash.
Response:
Of the amounts of the effect of exchange rate changes, $(45), $0, and $26
were attributable to the effect of exchange rate changes on cash flows from
operating, financing and investing activities, respectively, for fiscal
year 2003; $(6,321), $0, and $4,751 were attributable to the effect of
exchange rate changes on cash flows from operating, financing and investing
activities, respectively, for fiscal year 2004; $(82,395), $0, and $3,186
were attributable to the effect of exchange rate changes on cash flows from
operating, financing and investing activities, respectively, for fiscal
year 2005. Since the amounts are not significant, we included such amounts
as part of effect of exchange rate changes on cash and cash equivalents on
the statements of cash flows.
In future filings, we will attribute the effect of exchange rate changes to
different activities of cash flows.
Notes to Consolidated Financial Statements
Note 2. Summary of Significant Accounting Policies
Revenue recognition, Page F-11
3. We note that you recognized VAT rebates as revenue. Please explain what VAT
rebate represent and advise us of your basis in US GAAP for this accounting
treatment. Please tell us how you determine this to be revenue and not a
reimbursement of expense.
Ms. Kristi Beshears and Mr. Daniel L. Gordan, September 7, 2006 - Page 4
Response:
In China, VAT taxpayers selling self-developed/produced software products,
though subject to VAT at 17%, are entitled to a refund upon payment for the
part of VAT exceeding a 3% de facto rate (resulting in a net VAT of 3%)
until 2010. The VAT rebate is well known to our customers and impacts our
negotiation of the sales price of software as explained below:
We enter into a contract with a customer who is fully aware that the
effective VAT rate is 3% and not the normal rate of 17%. The contract
agreed between us and the customer is based on a sales price, for example,
of $100, which is the fair value of the product, plus VAT at the effective
rate of 3%, resulting in a total stated contract price of $103. When we
issue the tax invoice to the customer, to comply with VAT regulations and
to allow the customer to receive a credit for the full 17% VAT input, we
prepare an invoice that shows VAT of $15 calculated at 17% ($103/117%x17%)
and the sales price on the invoice is reduced to $88 (=$103/%117) totaling
$103. We collect the VAT of $15 as part of $103 from the customer and then
we pay $15 to the government. At the same time, we file an application for
the VAT rebate of $12, and after one month, the government rebates us $12
that brings the VAT rate down to the effective rate of 3%. We record as
sales an amount of $88 plus $12 rebate which represents the total of the
agreed price of the product with the customer of $100.
The entries are as follows:
1) When VAT invoice is issued.
(Dr) Receivable 103
(Cr) Sales 88
(Cr) VAT payable 15
2) Payment of VAT to the government.
(Dr) VAT payable 15
(Cr) Cash 15
3) At the same time as 2), we are entitled to VAT rebate.
(Dr) VAT receivable 12
(Cr) Sales 12
4) One month after 3), cash is received from the government.
Ms. Kristi Beshears and Mr. Daniel L. Gordan, September 7, 2006 - Page 5
(Dr) Cash 12
(Cr) VAT receivable 12
Based upon the facts outlined above, we believe it is acceptable to record
the VAT rebate as sales which is in accordance with Regulation S-X
210.5-03.(b) 1.
Regulation S-X 210.5-03.(b) 1 states, in part:
If the total of sales and revenues reported under this caption includes
excise taxes in an amount equal to 1 percent or more of such total, the
amount of such excise taxes shall be shown on the face of the statement
parenthetically or otherwise.
Our customers are aware of the VAT rebate and expect us to pass on the
benefit to them, and in the absence of the rebate program, sales price
negotiated with the customers would be adjusted accordingly. Under such
circumstances, we consider that the government is subsidizing the sales and
VAT rebate, in essence, is part of the sales.
AICPA Technical Practice Aids - According and Auditing Publications,
Technical Questions and Answers, Section 5100 Revenue Recognition, No.11,
Excise Tax on Club Dues, states:
Inquiry - The members of certain private clubs must pay a federal
excise tax in addition to their annual dues. Should the clubs record,
as revenues, the dues net of the excise tax, or should revenues
include both dues and taxes?
Reply - A club, in collecting excise taxes on dues, is acting as no
more than an agent or conduit for the federal government. The amounts
paid to the club by members to be turned over as excise taxes should
not be construed as dues, and to show them as such on the income
statement is erroneous.
We do not include in sales, the effective 3% portion ($3) of VAT which is
the amount paid to the government and not subsidized. We do not believe
that the fact that 14% portion ($12) of the VAT is included in sales
contradicts the above Technical Questions and Answers, as the amount is
being subsidized from the government. It can also be argued that a subsidy
from the government is a separate transaction from the original sales
transaction and should not be included in sales. However, in addition to
the fact that we consider the VAT rebate essentially as sales, we believe
the above Regulation S-X provides support for including the amount in sales
as long as it is appropriately disclosed.
We have discussed such treatment with our independent registered public
accounting firm, Deloitte Touche Tohmatsu CPA Ltd., who consulted its US
National Office for the same issue for another client, and such treatment
was concurred with by its US National Office.
Ms. Kristi Beshears and Mr. Daniel L. Gordan, September 7, 2006 - Page 6
4. You state that the Company does not have sufficient vendor specific
objective evidence to allocate the revenue to the various elements of the
arrangement and therefore you recognize the revenue ratably over the life
of the arrangement. In your response, tell us what all of the elements of
the arrangement are and what allows you to recognize revenue ratably. For
reference see paragraph 12 of SOP 97-2.
Response (Based on a response already provided to Staff during the IPO
comment process where no subsequent comments were received from the Staff):
The elements included in our service arrangement are the downloadable
proprietary software research tools and the post contract support provided
to our customers which includes financial data and information services. We
do not believe we have sufficient VSOE in allocating the revenue between
the downloadable proprietary software research tools and the post contract
support provided to our customers which includes financial data and
information services as these elements are never sold separately nor does
management market them as separate elements. This is consistent with
paragraph 10 of SOP 97-2, which states in part:
Vendor-specific objective evidence of fair value is limited to the
following:
- The price charged when the same element is sold separately
- For an element not yet being sold separately, the price
established by management having the relevant authority; it must
be probable that the price, once established, will not change
before the separate introduction of the element into the
marketplace
Paragraph 12 of SOP 97-2 states that if sufficient vendor-specific
objective evidence does not exist for the allocation of revenue to the
various elements of the arrangement, all revenue from the arrangement
should be deferred until the earlier of the point at which (a) such
sufficient vendor-specific objective evidence does exist or (b) all
elements of the arrangement have been delivered. One of the exceptions is
that if the arrangement is in substance a subscription, the entire fee
should be recognized ratably. Our service arrangement allows the customers
to access to our financial data and information service during the service
period, which is in substance a subscription. Therefore we have recognized
the revenue ratably.
Note 4. Cost Investment
5. Tell us how you determine that this investment should be accounted for
under the cost method and not the equity method of accounting. How have you
determined that you do not exert significant influence over the investee?
For reference see APB 18.
On December 28, 2005, we entered into a Series B Preferred Share Purchase
Agreement (the "Purchase Agreement) with Moloon International Inc.
("Moloon"). Pursuant to the
Ms. Kristi Beshears and Mr. Daniel L. Gordan, September 7, 2006 - Page 7
agreement, we purchased nine million eight hundred thousand (9,800,000)
Series B Preferred Shares at a per share price of US$1.53 for an aggregate
consideration equal to fifteen million U.S. dollars (US$15,000,000). Our
investment has been accounted for under the cost method.
According to the Purchase Agreement and shareholders of Moloon's written
resolution, we are entitled to certain voting rights which enable us to
exercise significant influence to Moloon's operation. In addition, we have
the ability to elect one Board Member of total 7 members. Through the
membership in Board of Directors, we are able to participate in Moloon's
operation as long as any Preferred Shares remains outstanding.
We are also entitled to the following liquidation preference:
1. Before any distribution or payment shall be made to the holders of any
Junior Shares, an amount shall be paid with respect to each Preferred
Share equal to the Original Series A Issue Price or Original Series B
Issue Price, as the case may be, plus all dividends declared and
unpaid.
2. After distribution or payment of any liquidation preference
distributable or payable on any Preferred Shares, the Preferred Shares
(treated on an as-if converted basis) shall be entitled to receive,
together with the holders of Common Shares similarly entitled, a
ratable portion of the assets of the Company remaining for
distribution.
We have accounted for such investment under the cost method based on the
guidance under EITF 02-14, "Whether an Investor Should Apply the Equity
Method of Accounting to Investments Other Than Common Stock" ("EITF
02-14"). According to EITF 02-14, it states in parts:
"an investor that has the ability to exercise significant influence over
the operating and financial policies of the investee should apply the
equity method of accounting only when it has an investment(s) in common
stock and/or an investment that is in-substance common stock.
If the investor determines that any one of the following characteristics
indicates that an investment in an entity is not substantially similar to
an investment in that entity's common stock, the investment is not
in-substance common stock.
a. Subordination. An investor should determine whether the investment has
subordination characteristics that are substantially similar to that
entity's common stock. If an investment has a substantive liquidation
preference over common stock, it is not substantially similar to the
common stock. However, certain liquidation preferences are not
substantive. Accordingly, an investor should determine whether a
liquidation preference is substantive. For example, if the investment
has a stated liquidation preference that is not significant in
Ms. Kristi Beshears and Mr. Daniel L. Gordan, September 7, 2006 - Page 8
relation to the purchase price of the investment, the liquidation
preference is not substantive. Further, a stated liquidation
preference is not substantive if the investee has little or no
subordinated equity (for example, common stock) from a fair value
perspective. The Task Force believes that a liquidation preference in
an investee that has little or no subordinated equity from a fair
value perspective is nonsubstantive because, in the event of
liquidation, the investment will participate in substantially all of
the investee's losses."
We believe we meet the criteria in (a) above and accordingly we do not need
to discuss the criteria in (b) and (c).
In relation to criteria (a), we considered whether the Preferred Shares'
liquidation preferences are substantive. If the investment has a
liquidation preference that is significant in relation to the purchase
price of the investment, the liquidation preference is substantive.
According to the written resolution, Series B shareholders are entitled to
the distribution in the amount of the original issuance Series B Preferred
Shares price plus all dividend declared and unpaid. Since the total
liquidation preference (issuance price plus all dividend declared and
unpaid) is equal or greater than the total investment depending on whether
dividends are declared, we believe the liquidation preference is
substantive and significant in relation to the original purchase price of
the Moloon investment.
This is further illustrated through Example 2 in EITF 02-14, in which case,
the fair value of the preferred stock is $10 Million while investee's
common stock is $15 Million. EITF 02-14 concludes that the investee has
adequate subordinated equity from a fair value perspective to indicate that
the liquidation preference is substantive.
We analogize Example 2 to our case as follows:
According to its Amended and Restated Memorandum of Association, Moloon has
an authorized capital of 70,000,000 ordinary shares, with 20,000,000 shares
issued and outstanding. The total estimated fair value of the common shares
would be $30.6 Million assuming the fair value of the common share was
$1.53 (Series B shares original issuance price), which was based on an
arm's length negotiation between us and Moloon. Accordingly the fair value
of our preferred shares is $15 Million while Moloon's common stock is $30.6
Million. Therefore we concluded that Moloon has adequate subordinated
equity from a fair value perspective.
Therefore based on the above analysis and example in the EITF 02-14, we
believe that Moloon has adequate subordinated equity and its Preferred
Shares investment is not in-substance common stock. Accordingly our
investment should be accounted for under the cost method.
Ms. Kristi Beshears and Mr. Daniel L. Gordan, September 7, 2006 - Page 9
Note 14. Segment and Geographic Information, Page F-25
6. We note that advertising revenues have become material to total revenues.
In future filings please disclose revenues from external customers for each
product and service or each group of similar products and services in
accordance with paragraph 37 of SFAS 131.
Response:
We will include such disclosure in future filings. Based on our current
year financial information, our advertising revenues has become material to
total revenue and we will disclose revenues from our subscription fee and
advertising services in accordance with paragraph 37 of SFAS 131.