ITEM 1. BUSINESS
Background and Key Events
Our Predecessor Company
China Electronics Holdings, Inc (the “Company”, “We”, “Our”, “Us”), Formerly named Buyonate, Inc., was incorporated in the State of Nevada on July 9, 2007 to engage in developing user-friendly/child friendly interactive digital software for children between the ages of 5 to 12 years old. The Company was in the development stage through December 31, 2008. The year 2009 is the first year during which the Company is considered an operating company and is no longer in the development stage.
China Electronic Holdings, Inc. (“CEH Delaware”) was organized on November 15, 2007, as a Delaware corporation. Prior to February 10, 2010, CEHD Delaware was a development stage company attempting to manufacture and sell carbon and graphite electrodes and planning to manufacture and sell electronic products in the People’s Republic of China through its own stores and franchise stores.
Lu’an Guoying Electronic Sales Co., Ltd., a PRC corporation, (“Guoying”) was established on January 4, 2002 with share capital of RMB 1,000,000 (approximately $137,100). Guoying sells electronic products in the PRC through its company-owned stores, exclusive franchise stores and non-exclusive stores.
Share Transfer Agreement
Pursuant to the Share Transfer Agreement entered into on December 26, 2008 (the “2008 Share Transfer”) between the shareholders of Guoying (the “Guoying Shareholders”) and CEH Delaware, CEH Delaware acquired 40% of the outstanding equity securities of Guoying (the “Guoying Shares”) from all of the Guoying Shareholders in consideration for $60,000, equivalent to RMB 400,000. Pursuant to the Share Transfer Agreement entered into on February 2010 (the “2010 Share Transfer”) between Guoying Shareholders and CEH Delaware, CEH Delaware acquired remaining 60% of the outstanding equity securities of Guoying Shares from all of the Guoying Shareholders in consideration for RMB 600,000 and Guoying Shareholders transferred and contributed all of their Guoying Shares to CEH Delaware. Guoying Shareholders contributed the Purchase Price to Guoying for working capital and general corporate purpose and as a result of the 2008 and 2010 Share Transfers, Guoying became a wholly foreign-owned subsidiary (“WFOE”) of CEH Delaware.
Share Exchange Agreement
On July 9, 2010 we consummated the Share Exchange Agreement with certain Selling Stockholders. Pursuant to the Share Exchange Agreement, 10 former stockholders of our subsidiary, CEH Delaware, transferred to us 100% of the outstanding shares of common stock and preferred stock of CEH Delaware and 100% of the warrants to purchase common stock of CEH Delaware held by them, in exchange for an aggregate of 13,785,902 newly issued shares of our Common Stock and warrants to purchase an aggregate of 1,628,570 shares of our Common Stock. CEH Delaware’s outstanding Series A warrants were exchanged on a one-for-one basis for Series A warrants of the Company to purchase an aggregate of 314,285 shares of Common Stock, with an exercise price of $2.19 per share. CEH Delaware’s outstanding Series B warrants were exchanged on a one-for-one basis for Series B warrants of the Company to purchase an aggregate of 314,285 shares of Common Stock, with an exercise price of $2.63 per share. CEH Delaware’s outstanding $1.00 warrants were exchanged on a one-for-one basis for Series E warrants of the Company to purchase an aggregate of 1,000,000 shares of Common Stock, with an exercise price of $0.25 per share. In connection with the Share Exchange and pursuant to the Articles of Merger filed with the Nevada Secretary of State, Buyonate, Inc. changed its name to China Electronics Holdings, Inc. The merger and name change were approved by the Financial Industry Regulatory Authority (“FINRA”) and the Common Stock began trading under the symbol “CEHD.OB” on August 23, 2010.
Private Placement and Related Transactions
During the period from July 15, 2010 to August 17, 2010 we consummated a series of Private Placements of our Common Stock and warrants to purchase our Common Stock pursuant to a Subscription Agreement dated as of July 9, 2010 (the “Purchase Agreement”). Pursuant to the Purchase Agreement we sold to 105 investors for an aggregate gross purchase price of $5,251,548 an aggregate of (a) 1,989,211 shares of our Common Stock, (b) three year Series C Warrants to purchase an aggregate of 499,403 shares of our Common Stock for $3.70 per share and (c) three year Series D Warrants to purchase an aggregate of 499,403 shares of our Common Stock for $4.75 per share. Hunter Wise Securities, LLC acted as the lead placement agent and American Capital Partners, LLC acted as co-placement agent of the private placement.
Registration Rights Agreement
In connection with the private placement, we entered into Registration Rights Agreement (the “Registration Rights Agreement”) with the Investors which sets forth the rights of the Investors to have the shares of common stock sold pursuant to the Purchase Agreement and the shares of Common Stock underlying the Warrants issued in the private placement registered with the Securities and Exchange Commission (“SEC”) for public resale.
Corporate Name Change
Effective August 3, 2010, CEH Merger Corp., a Nevada corporation newly formed by the Company for the purpose of merging into the Company, merged into the Company. In connection with the merger and pursuant to the Articles of Merger filed with the Nevada Secretary of State, we changed our name to China Electronics Holdings, Inc.. No securities of the Company were issued in connection with the merger. The merger and name change were approved by the Financial Industry Regulatory Authority ("FINRA") and the Common Stock began trading under the symbol “CEHD.OB” on August 23, 2010.
Our Corporate Structure
As set forth in the following diagram, following our acquisition of CEH Delaware, CEH Delaware became and currently is our direct, wholly-owned subsidiary.
BUSINESS OF THE COMPANY
Overview
Through our subsidiary, Guoying, we are engaged in the wholesale and retail sale of consumer electronics and appliances in the People’s Republic of China (the “PRC”), such as solar heaters, refrigerators, air conditioners, televisions, and similar items. We sell such products in certain rural markets in Anhui province.
We started selling home appliances and electronics in 2002. As of December 31, 2011, approximately 61% of our revenue was due to the sale of solar water heaters (our sole solar power product), approximately 10% of our revenue was due to the sale of refrigerators and approximately 19% of our revenue was due to the sale of televisions.
We distribute merchandises through our company-owned stores, and to the exclusive franchise stores, and non-exclusive franchise stores. Company owned stores are stores directly owned and operated by us under Guoying brand that only sell merchandise that we provide. Exclusive franchise stores are stores that sell merchandise we provide to them as their exclusive wholesaler pursuant to cooperation franchise agreements and such merchandise includes Guoying branded products as well as products from major wholesalers such as Sony, Samsung and LG. Non-exclusive franchise stores are stores that we provide Guoying branded merchandise as a wholesaler or distributor to other stores to which we are a non-exclusive wholesaler of consumer electronics and appliances. As of December 31, 2011, approximately 9.42% of our revenue was from the sales by company-owned stores, approximately 45.3% of our 2011 revenue was from the sales to exclusive franchise stores and approximately 45.26% of our 2011 revenue was from sales to the non-exclusive stores.
Throughout this document, when we use terms “open” or “opened” in referring to an exclusive or non-exclusive franchise store, we mean that we had entered into a franchise agreement with such store and that it was in operation. When we use the term “close”, “closed” or “terminated” in reference to an exclusive or non-exclusive franchise store, we meant that we had terminated our agreement with such stores.
In the periods ended December 31, 2011 and 2010, we generated net revenues of approximately $104 million and approximately $ 144 million, respectively, and net income attributable to us of approximately $21.3 million and approximately $13.2 million, respectively. In the periods ended December 31, 2011 and 2010, we generated net revenues derived from sales to our exclusive franchise business of approximately $47.2 million and approximately $41.1 million respectively, representing 45.3% and 36% of our total net revenues; net revenues derived from sales to our non-exclusive stores of approximately $47,172,272 million and approximately $48, 576, 322 million, representing 45.3% and 42.5%, respectively, of our total revenues; and net revenues derived from sales by our company-owned stores of approximately $9,821,329 million and approximately $24,488,245 million, representing 9.42% and 21.4%, respectively, of our total revenues.
As of December 31, 2011, we operate 2 company-owned stores, both of which are located in Lu’an City, Anhui Province. During 2011, we closed two of our company-owned stores, Longhe and Guangcai, and opened our new headquarter store located in G-8 Guangcai Big Market in 2011. As of December 31, 2011, we had 346 exclusive franchise stores that operate under the Guoying brand name pursuant to cooperation agreements with us. We opened 93 new exclusive franchise stores and closed 233 exclusive franchise stores in 2011. As of December 31, 2011, there are 354 non-exclusive stores sold Guoying branded merchandise that we provide as a wholesaler or distributor. We opened 1 new non-exclusive franchise store and closed 362 non-exclusive franchise stores in 2011.
We purchase consumer electronics and appliances from well-known manufacturers or large distributors and sell them to the company-owned stores, the exclusive franchise stores and the non-exclusive stores. Guoying is a wholesaler in the Lu’an area for products under the brand names, Sony, LG, Samsung, Shanghai Shangling, Tsinghua Tongfng, Chigo, Huayang, Huangming and Oulin. Guoying is a general sales agency of Sino-Japan Sanyo electronic products, such as Sanyo televisions, air conditioners, washing machines and micro-wave ovens. Guoying has teamed up with Huangming and Huayang, the two largest manufacturers of solar thermal products in China, to be their large retail outlet in Lu’an. Some of their energy efficient, “green” products include solar thermal water heaters, solar panels (photovoltaic) and energy saving glass.
In addition to providing wholesale merchandise purchased from manufacturers or distributors, we provide refrigerators that are manufactured by one original equipment manufacturer (“OEM”), Shanghai Pengbai Electronic Co., Ltd. (“Pengbai”), under the Company’s trademark “Guoying”. Guoying refrigerators have “3C” quality national authentication certificates, which are mandatory in PRC for the sale of refrigerators. We entered into an OEM agreement with Pengbai in August 2007, pursuant to which Pengbai agreed to manufacture our private label brand refrigerators and Guoying agreed to provide loan to Pengbai in amount of RMB 80 million (approximately $12.12 million) in four installments of RMB 20 million each from 2006 to 2010. Pengbai agreed to repay the loan by October 2017, with payments in four equal installments of RMB 20 million (approximately $2.9 million) beginning in October 2013. The loan is secured by all the assets of Pengbai and is interest free. Guoying actually loaned Pengbai RMB63 million (approximately $9.8 million) as of December 2009 and the loan in amount of RMB42.6 million (approximately $6.63 million) has been received from Pengbai as of December 2011. We terminated our OEM agreement with Pengbai and stopped manufacturing “Guoying” brand refrigerators in 2011.
We have reserved a company name Lu An Guoying Opto-Electronics Technology Co., Ltd. with the Lu An Administration of Industry and Commerce on September 5, 2011 and valid until September 5, 2012 to engage in LED manufacturing business. We have advanced retainer fee to secure the land use right of a 300 Chinese acres land with Pingqiao Industrial Park where the LED manufacture and facilities will be built on. We filed our proposal to enter into LED manufacturing business with Reform and Development Commission of Yu An District, Lu An City on May 13, 2011 and we obtained planning permit for project and land construction issued by Housing and Urban-Rural Development Bureau of Yu An District, Lu An City on October 28, 2011. We are currently seeking business partners and financing to enter into LED manufacturing and wholesale business. We currently do not have a specific estimate how much we will spend on the LED manufacturing and wholesale business until we identify our business partner and implement a specific financing and budget plan.
Retail Operations
The same company-owned, exclusive and non-exclusive franchise stores are stores that were opened prior to 2009 and have been in continuance operation throughout the years 2009, 2010, and 2011 respectively (hereinafter referred to as the “Same Company-Owned Store”, the “Same Exclusive Franchise Store” and the “Same Non-Exclusive Franchise Store”). The new stores are stores that were opened in 2010 or 2011 that have been in continuance operation as of today (hereinafter referred to as the “New Company-Owned Store”, the “New Exclusive Franchise Store” and the “New Non-Exclusive Franchise Store”). The closed stores are stores that closed in either 2010 or 2011 (hereinafter referred to as the “Closed Company-Owned Store”, the “Closed Exclusive Franchise Store” and the “Closed Non-Exclusive Franchise Store”).
In August, 2011, the Board decided to terminate our exclusive and non-exclusive franchise agreements with a number of cares in order to strengthen and grow the Company’s business in the long term after concluding that the rapid growth of the company’s number of stores and aggressive business expansion had caused deficiencies in the company’s internal control and management. The following criteria has been used to determine which stores to close (i) exclusive franchise stores that sold merchandise supplied by other wholesalers in breach of the exclusive franchise agreement; (ii) exclusive and non-exclusive franchise stores that failed to obey the Company’s pricing and resulting in lower profit margins; (iii) stores located remotely Lu An City that result in higher transportation and logistics expenses to us; (iv) stores that sold brand of merchandise that not supplied by us and therefore terminate its franchise agreement with us.
The various types of stores are described below:
Company-owned stores
We now own and operate 2 company-owned stores, which sell Guoying branded products as well as other merchandise that we provide as the exclusive wholesaler. We owned and operated 3 company-owned stores as of December 2010 and closed two of our company-owned stores, Longhe and Guangcai, and opened our new headquarter store in 2011 located in G-08 Guangcai Market, Foziling West Road, Lu’An City, Anhui Province. Our company-owned stores focus on the sale of solar thermal products, refrigerators, air conditioners, televisions and other products. Our administrative offices are located on the second floor of our new headquarter store. We renewed our lease agreement of Haomen Store and entered into a new lease agreement of Guangcai Market Store with Mr. Haibo Liu, a director of our company in 2011 for a three years term of lease renewable subject to both parties’ consent. Our tabular rollfoward of company-owned stores for every quarter from 2009 to 2011 is presented as follows:
Exclusive Franchise Stores
As of December 31, 2011, there are 346 exclusive franchise stores operated under the Guoying brand name. We opened 93 new exclusive franchise stores and terminated our agreements with 233 exclusive franchise stores in 2011. The exclusive franchise stores are owned and operated by third parties under our brand name pursuant to cooperation agreements with the Company. Such stores sell both Guoying branded products and other products that we provide as the exclusive wholesaler. Guoying is the only wholesaler providing products to our exclusive franchise stores. The exclusive franchise stores are located in rural areas around Lu’an City, Anhui Province, and the primary customers of these stores are residents of the local towns and villages. The store owners arrange for or lease the operating space for the exclusive franchise stores. Guoying makes deliveries to each store and upon delivery, the stores pay in cash the wholesale price of the products provided. After receiving orders from such stores we are generally able to deliver the merchandise within two to three hours to stores located in or near Lu’an City or within three days to stores that are further away. Due to the PRC “Rural consumer electronics and appliances” plan, which is available to some of our stores, Guoying is able to offer the exclusive franchise stores certain discounts based on the quantity of their purchases.
We have signed cooperation agreements with each exclusive franchise store with a term ranging from 1 year to 3 years, subject to renewals. The average remaining term under most of the cooperation agreements is 1 year, and most of the agreements were renewed in November 2010. Pursuant to the cooperation agreements, we provide loans to store owners to facilitate the establishment of the exclusive franchise stores. The loans are interest free, unsecured loans, which are payable in a single installment no later than three years from the date of the loan. Each loan is made in the form of cash and products, in an amount of up to 40% of the cost of establishing the store. The average amount of each loan is approximately RMB 58,286 (approximately $8,967). However, the specific amount of each loan varies depending on factors including location of the store and the economy of the area, the consumption capacity of the store and the size of the store. The average value of products provided to the store owners in connection with the loans ranges from RMB 201,744 to RMB 341,548 (approximately $20,000 to $50,000) and varies based on the factors discussed above and the total amount of the loan. As of December 31, 2011, the total outstanding amount of such loans was RMB 53,901,436.11
(approximately $8,166,884). In consideration of the loans, the exclusive franchise stores exclusively purchase products from Guoying.
Our tabular rollfoward of exclusive franchise stores for every quarter from 2009 to 2011 is presented as follows:
Non-exclusive stores
As of December 31, 2011, we provided merchandise to 354 non-exclusive stores as a wholesaler. We opened 1 new non-exclusive franchise stores and terminated our agreements with 362 non-exclusive franchise stores in 2011. Such stores are owned and operated by third parties and are located in the rural areas around Lu’an City, Anhui province. These stores are retailers and sell both Guoying branded merchandise and other merchandise manufactured by other companies and sold to the stores by the Company pursuant to franchise agreements and sales agreements with the Company. These stores also buy merchandise from other wholesalers, including Guoying’s competitors. The non-exclusive stores pay the Company cash upon the Company’s delivery of products, or Guoying extends unsecured credit to such stores in the ordinary course of business but mitigates the associated risks by performing credit checks and actively pursuing past due accounts. Under the franchise agreements, each non-exclusive store pays Guoying an annual fee of RMB 5,000 (approximately $735).
Our tabular rollfoward of non-exclusive franchise stores for every quarter from 2009 to 2011 is presented as follows:
The below table lists company-owned stores, exclusive franchise stores and non-exclusive stores grouped by the province in the PRC in which they are located:
Our Leases
Warehouse Leases
We currently distribute products to company-owned stores, exclusive franchise stores and non-exclusive stores from two warehouses located within Lu’an city, which are leased by Guoying. We engage third parties to transport the products from our warehouses to the stores. We entered into a lease agreement with Youbang Pharmaceuticals Co., Ltd. on April 1, 2010 to lease the warehouse located in the development zone of east road of Jing Er, Foziling Road for one year and renewed the lease for another two years valid from April 1, 2011 to 2013. The rent for the lease is RMB138,000 per year. We entered into a lease agreement with Mr. Haibo Liu on January 1, 2008 to rent Wangpai warehouse of 808 square meters located in Liu Fo Road to storage Huangming solar products. The term of the lease is from 2008 to 2011 and the rent is RMB 6, 464 per year (RMB 8 per square meters).
Company-Owned Stores Leases
We currently lease for our two company-owned stores. We entered into a lease agreement for our Guangcai Big Market Store on October 30, 2008 for 3 years until 2011 at a rent of RMB20, 882 per year and renewed the lease on April 1, 2011 for another 3 years until 2014 subject to renewal at a rent of RMB 720,000 per year. We entered into a lease agreement with Mr. Haibo Liu in 2010 for our Hao Men store for one year and renewed our lease on March 15, 2011 for another 3 years until 2014 subject to renewal at a rent of RMB 68,000 per year.
For additional information concerning the location, area and terms of each of the Company’s self-owned stores and warehouse see “Description of Property” herein.
Land Use Right
Pingqiao Industrial Park Land
We entered into a Land Use Right Purchase Agreement on October 28, 2010 and a supplemental Deposit Agreement on December 28, 2010 with the management committee of Pingqiao Industrial Park (the “Pingqiao Committee”), under which the Pingqiao Committee granted us a land use right for 300 Chinese acres where our LED manufacturing facility will be built. 120 Chinese acres of this land is for commercial use and 180 Chinese acres of this land is for industrial use. We paid RMB 100 million (approximately $15.74 million) of the purchase price as of December 31, 2010. We are not obligated to pay the remaining $3.61 million until we receive the land use right certificate issued by relevant PRC government pursuant to the Land Use Right Purchase Agreement. We expect the land use right certificate to be transferred to us by December 2012. The Company believes that if the land use right certificate is not granted to the Company by the local government, the Company will get a refund of the retainer from Pingqiao Committee
Youbang Warehouse Land
We entered into a Land Use Right Purchase Agreement in 2010 with Youbang Pharmaceuticals Co., Ltd., under which Youbang Pharmaceuticals granted us a land use right for 200 Chinese acres for commercial use where Guoying department building and logistics center will be built. We paid RMB40 million (approximately $6,296,000) of the purchase price as of December 2010 and Youbang is obligated to deliver the land use right certificate and real estate property certificate by December 31, 2011 or no later than December 31, 2012, the latest. As it is expected that the land use right certificate of this parcel of land could not be transferred in 2011 due to change of local zoning regulations, the agreement was canceled and RMB10 million (approximately $1,574,000) was returned to the Company by September 2011. Both parties agreed that the remaining RMB30 million (approximately $4,722,000) will be returned to the Company in December 2012.
Guoying Agricultural and Forestry Land
We entered into a lease agreement with Yumin Village Committee in January 2011 to rent 387 Chinese acres land at RMB 1,200 per Chinese acre and 116 Chinese acres slope land at RMB 1,600 per Chinese acre located in Yumin Village, Sun Gang County, Jin An District, to grow Guoying agricultural and forestry business, mainly oil-tea camellia plants. The term of the lease is 20 years. We have advanced approximately $189, 000 for leasing the land as of January 2011. .
We entered into another lease agreement with Yumin Village Committee in August 2011 to rent 5,006 Chinese acres land located in Yumin Village, Sun Gang County, Jin An District, to grow Guoying agricultural and forestry business, mainly oil-tea camellia plants. The term of the lease is 30 years and the rent is RMB 1, 200 per Chinese acre. We have advanced approximately $961,000 as of December 2011.
For additional information concerning the location, area and terms of our lease agreement for agricultural and forestry business,see “Description of Property” below.
Our Private Label Brands
We entered into an OEM agreement with Pengbai in August 2007, pursuant to which Pengbai agreed to manufacture our private label brand refrigerators. These refrigerators are labeled with the Company’s trademark “Guoying”, and we distribute such refrigerators to our company-owned stores, exclusive franchise stores and non-exclusive stores. Guoying branded refrigerators have “3C” quality national authentication certificates, which are mandatory in PRC for the sale of refrigerators.
Pursuant to the OEM agreement, Guoying agreed to provide loan to Pengbai in amount of RMB 80 million (approximately $12.12 million) in four installments of RMB 20 million each from 2006 to 2010, and in consideration for the loan, Pengbai sells “Guoying” brand refrigerators to Guoying. Pengbai agreed to repay the loan by October 2017, with payments in four equal installments of RMB 20 million (approximately $2.9 million) beginning in October 2013. The loan is secured by all the assets of Pengbai and is interest free. Guoying actually loaned Pengbai RMB63 million (approximately $9.8 million) as of December 2009 and the loan in amount of RMB42.6 million (approximately $6.63 million) has been received from Pengbai as of December 2011. We have terminated our OEM agreement with Pengbai and stopped manufacturing “Guoying” brand refrigerators in 2011.
Industry Background
According to the 2010 PRC Census, more than 50% of China’s population resides in rural areas of China and they comprise the largest consumer group in China. After many years of economic reforms, the average income of people living in China’s rural areas has gradually increased, and according to the National Bureau of Statistics of China, the per capita net income of rural residents increased 10.9% in 2010. Based on this increase in average income, we believe that such area has significant growth potential, and it does not appear that many of the urban chains have expanded into the rural communities.
We believe that there are several reasons for the potential development of rural consumer electronics and appliances markets.
According to information published by China Economic News dated December 9, 2010, the central government has increased the income of the rural population by reducing the amount of tax paid by farmers. We believe that the increased income of consumers living in rural areas combined with continuing improvements in the rural power network, rural transportation, and rural communication make the rural market extremely favorable for home appliances and electronics.
Second, the Chinese government has initiated a rural home appliance and electronics rebate program, called the “Rural Consumer Electronics” plan. The plan provides that the maximum sales price of electronics is fixed at a price which is usually equal to the market price of the same products in urban areas, but allows rural consumers to receive a 13% rebate from the government on their purchases of electronics.
Third, the current consumer electronics and appliances markets in big PRC cities like Beijing, Shanghai, and Shenzhen are already saturated by electronics stores, which results in limited margins. While we have some competitors in the rural markets, we believe that the retail chains that exist in larger cities have not established any significant name recognition in the rural markets. Therefore, we believe that such stores’ success in larger cities will not necessarily result in success in the rural areas where we operate. We believe that significant opportunity remains due to the increased per capita income of rural residents.
Our Growth Strategies
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Partnering with well-known electric appliance manufacturers. We will negotiate with well-known brands in order to act as a wholesaler of these brands. We currently sell Samsung washing machines and Sony LCD televisions. We are negotiating with other well-known brands to sell their consumer electronics and appliances.
o
Developing LED Wholesale and Manufacturing Business. In the future, we plan to develop our own facility to manufacture LED products under the Guoying brand name. We are currently negotiating with other major electric appliance manufactures for sales of their products. We have entered into a significant sales agency agreement for LED electronic and solar lighting products with Shandong Huangming Solar Power Sales Co. (“Shandong Huangming”) in the Lu An area in 2011.
o
Developing LED Manufacturing. We plan to shift our business focus to LED manufacturing and wholesale. We are currently seeking business partners and financing to enter into LED manufacturing and wholesale business. We currently do not have a specific estimate how much we will spend on the LED manufacturing and wholesale business until we identify our business partner and implement a specific business plan with financing budget.
o
Exclusive Franchise Stores and Non-Exclusive Stores. We plan to terminate our relationship with (i) exclusive franchise stores that sell merchandise supplied by other wholesalers in breach of the exclusive franchise agreement; (ii) exclusive and non-exclusive franchise stores that fail to obey the Company’s pricing strategies and purchase merchandise from the Company’s competitors in violation of its franchise agreement and result in our lower profit margins; (iii) stores located remotely outside Lu An City that caused higher transportation and logistics expenses to us; (iv) stores that decide to sell brand of merchandise that not supplied by us and therefore terminate its franchise agreement with us. By focusing on profitable exclusive and non-exclusive franchise stores and by closing non-profitable exclusive and non-exclusive stores, we believe that the delivery and service quality of such stores will be enhanced due to the proximity of such stores to our distribution centers. Further, we plan to shift our business focus to LED wholesaling and manufacturing.
o
Company-Owned Stores. We closed two of our company-owned stores, Longhe and Guangcai, in 2010 and opened our new headquarter store in the centre business district of Lu’an City in 2011 that focuses on the sale of solar thermal products, refrigerators, air conditioners, televisions and other products.
We funded our growth strategy from our working capital and below are a summary of approximately how much we have spent in year 2011 to achieve our growth strategies:
We anticipate that we will not spend much from our working capital to develop our new company-owned stores, and expand the number of new exclusive franchise stores and new non-exclusive franchise stores in 2012. We have reserved the company name Lu An Guoying Opto-Electronics Technology Co., Ltd. with the Lu An Administration of Industry and Commerce on September 5, 2011 which is valid until September 5, 2012 to engage in LED manufacturing business. We have advanced the retainer fee to secure the land use rights to 300 Chinese acres land with Pingqiao Industrial Park where the LED manufacture and facilities will be built on. We filed our proposal to enter into LED manufacturing business with Reform and Development Commission of Yu An District, Lu An City on May 13, 2011 and we obtained planning permit for project and land construction issued by Housing and Urban-Rural Development Bureau of Yu An District, Lu An City on October 28, 2011. We are currently seeking business partners and financing to enter into LED manufacturing and wholesale business. We currently do not have a specific estimate how much we will spend on the LED manufacturing and wholesale business until we identify our business partner and implement a specific business plan with financing budget.
Raw Materials and Suppliers
Approximately 95% of the cost of sales is the purchase price of products.
Our principal suppliers of merchandise in 2011, in terms of cost to us, were:
Name of Supplier
Type of Products
Shangdong Huangming Solar Power Sales Co.
Solar Heaters
Haier Hefei Ririshun Sales Co.
Shanghai Shangling Electric Appliance Manufacturing Co., Ltd.
Televisions, refrigerators, washing machines, air conditioners
Shangling Refrigerator and washing machines
Shenzhen Tongfang Multimedia Technology Company
LCD Televisions
Jiangshu Huayang Solar Power Sales Co.
Solar Heaters
Our principal suppliers of merchandise in 2010, in terms of cost to us, were:
Name of Supplier
Type of Products
Shandong Huangming Solar Power Sales Co.
Huangming Solar Power
Jiangsu Huayang Solar Power Sales Co.
Huayang Solar Power
Yangzhou Huiyin Co.,Ltd.
SONY LCD
We receive all of our merchandise from our suppliers, which are often the manufacturers, through deliveries to our two warehouses located within Lu’an city.
Marketing, Sales, and Distribution
We have a staff of 27 employees who take orders and provide customer service to each exclusive franchise store and non-exclusive store in assigned geographical areas. We advertise in many ways, including using television advertisements, advertisements on buses and walls, fliers distributed on the streets by our promotion personnel and general promotions, including discounts. We base our advertising on our analysis of the market and our competitors. We are responsible for cost of marketing of our Guoying brand products and Guoying franchise brand. Under contracts we have with our suppliers, our suppliers are responsible for the costs of all discounts and promotions of sales and distribution of products sold from the suppliers to us.
Customers and Pricing
Our customer strategy is to offer products to the rural market where there is less competition.
Our customers pay different prices for our products depending on where they live.
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In general, most of the products sold in the franchise stores are under the regulation of the national “Rural Consumer Electronics” plan. The plan provides that the maximum sales price of electronics is fixed at a price which is usually equal to the market price of the same products in urban areas. The plan allows rural consumers to receive a 13% rebate from the government on their purchases of electronics.
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Some of the products sold by our company-owned stores to the residents in Lu’an city are sold at the market price for urban areas.
Most customers pay for their purchases in cash.
In recent years, the pricing of our merchandise has changed as the price charged by our vendors has changed. For example, due to inflation in recent years, the market price of consumer electronics and appliances has risen. Due to the Rural Consumer Electronics Plan, our rural customers are not affected by such inflation as greatly as urban customers. However, the selling prices of some older models of products have decreased since such models are being discontinued.
Employees
As of December 31, 2011, Guoying had 60 full-time employees, including 15 management and supervisory personnel, 27 sales and marketing personnel and 5 after sale support personnel.
Seasonality
Approximately 30% of our sales of products are made in the first quarter, because the Chinese Spring Festival, the traditional shopping time, is during the first quarter. The fourth quarter is our second busiest season.
Competition
We believe our main competitor is Guosheng Electronic (“Guosheng”), which is a state-owned enterprise in Anhui Province. Guosheng is the third biggest retailer of consumer electronics and appliances in Anhui Province and runs several franchise stores in small cities and towns. Guosheng also has stores in Lu’an city.
Compared to Guosheng, our competitive disadvantages are:
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Funding. We need more capital than larger wholesalers in order to expand. As a state-owned enterprise, it is easier for Guosheng to obtain bank loans.
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Exclusive Representative Rights. Currently we are smaller than Guosheng and it is easier for Guosheng to be the exclusive representative of certain major brands because it is larger.
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Brand Recognition. As a smaller wholesaler, we need to invest more in advertising in order to make our brand as competitive as larger wholesalers such as Guosheng.
Compared to Guosheng, our competitive advantages are:
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Rural Market. We have relationships with hundreds of exclusive franchise stores and non-exclusive stores in rural markets, which are markets that have a high potential volume of sales, but which markets are ignored by the big retail chain stores.
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Flexibility. We make deliveries quickly and consistently. After receiving an order, we are able to deliver products within 2 hours to stores within or close to Lu’an city. Large state-owned retail stores, such as Guosheng, typically take 2-3 days to deliver products after the receipt of orders.
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Sales Networking. We have 27 sales persons visiting the exclusive franchise stores and non-exclusive stores each week, which allows us to maintain good relationships with the stores.
Intellectual Property
Mr. Hailong Liu, our CEO, owns the following trademarks:
(i)
Trademark Registration No:
Owned Trademark:
GUOYING(国鹰)
Clarification No:
Term:
May 7, 2009 to May 6, 2019
Issued by:
Trademark Office, State Administration for Industry and Commerce
(ii)
Trademark Registration No:
Owned Trademark:
GUOYING(国鹰)
Clarification No:
Term:
April 28, 2009 to April 27 2019
Issued by:
Trademark Office, State Administration for Industry and Commerce
By written agreement, Mr. Liu has granted Guoying the right to use the trademarks from January 1, 2008 to December 31, 2012 at no cost to us.
Regulation
We are subject to a wide range of regulations covering every aspect of our business. The most significant of these regulations are set forth below. Management believes it is in material compliance with applicable regulations.
Chain Stores Management
In March 1997, the Domestic Trade Ministry issued and enforced the Standard Opinions on the Operation and Management of Chain Stores (the “Opinions”), to regulate and administrate the forms, management models, composition, business area and other requirements of chain stores. The Opinions discuss three forms of chain stores: regular chain, franchise chain and voluntary chain. The Opinions stipulate that franchise chain and voluntary chain stores must execute relevant cooperation contracts including certain clauses including but not limited to licensed use of trademarks, product quality management, centralized purchase and sales promotion policies.
In May 1997, the State Administration of Industry and Commerce issued the Circular of the Relevant Issues for the Administration of Registration of Chain Stores , which provides the conditions for the establishment of chain stores and branches, the procedures and documents for application for registration with the administration of industry and commerce, and the names of chain stores, to regulate registration issues relating to chain stores.
Regulations relating to consumer protection
On October 31, 1993, the Standing Committee of the National People’s Congress issued and enforced the Law on the Protection of the Rights and Interests of Consumers, or the Consumer Protection Law, revised in 2009. The State Administration of Industry and Commerce also issued the notice regarding Handling of Acts of Infringement of Rights of Consumers or the Notice in March 2004. Under the Consumer Protection Law and the Notice, a business operator providing a commodity or service to a consumer shall first undertake certain responsibilities of the manufacturers relating to products. These liabilities include restoring the consumer’s reputation, eliminating the adverse effects suffered by the consumer, and offering an apology and compensation for any losses incurred. The following penalties may also be imposed upon business operators for the infraction of these obligations: issuance of a warning, confiscation of any illegal income, imposition of a fine, an order to cease business operation, revocation of its business license or imposition of criminal liabilities under circumstances that are specified in laws and statutory regulations.
Regulations on commercial franchising
On May 1, 2007, the State Council issued and enforced the Regulations for Administration of Commercial Franchising, to supervise and administrate the Franchise activities. The Regulations for Administration of Commercial Franchising were later supplemented by the Administrative Measures for Archival Filing of Commercial Franchise and the Administrative Measures for Information Disclosure of Commercial Franchise, both of which were issued by the Ministry of Commerce. Under these regulations, Franchisors are required to file franchise contracts with the Ministry of Commerce or its local counterparts; and franchise contracts shall include certain required provisions, such as terms, termination rights and payments. Franchisors are also required to satisfy certain requirements including, without limitation, having mature business models and the capacity to provide operation guidance, technical support and training to franchisees. Franchisors engaged in franchising activities without satisfying the above requirements may be subject to administrative penalties.
Regulations on trademarks
The State Council issued the PRC Trademark Law in 1982, revised in 2001, and the Implementation Regulation of the PRC Trademark Law in 2002, to protect the owners of registered trademarks and trade names. The Trademark Office handles trademark registrations and grants a term of ten years to registered trademarks. Trademark license agreements must be filed with the Trademark Office or its regional counterpart.
Home appliance sales on the rural market
On April 16, 2009, the Ministry of Commerce, the Ministry Of Finance, the Industry and Information Technology, National Development and Reform Committee, the Ministry of Environmental Protection, State Administration of Industry and Commerce and State Administration of Quality Supervision promulgated the Implementation Rules of Home Appliance Sales on the Rural Market, or the Implementation Rules to stimulate domestic demand and promote economic development. According to the Implementation Rules, the local government authority would make its decision concerning the qualification of home appliance selling enterprises based on the process of public bidding and tendering. Such enterprises shall satisfy certain requirements, including having measures on dispatching, price management, after-sale service and sales channels. Such enterprises are also required to file with the local commerce bureau for sale of home appliances and shall provide good service. The qualification of sales enterprises to sell home appliances in rural areas may be cancelled in the event of any serious violation of commitments or duties as set forth in the Implementation Rules.
DESCRIPTION OF PROPERTY
Set forth below is a table containing certain information concerning the location and area of our company-owned stores and warehouses and the terms under which such properties are leased.
Set forth below is a table containing certain information concerning the use right of land we acquired and the terms of the land use right agreement we entered into.
We believe that the foregoing properties are adequate for our present needs.
ITEM 1A.
ITEM 1A. RISK FACTORS
An investment in our Common Stock involves a high degree of risk. You should carefully consider the risks described below, together with all of the other information included in this Annual Report on Form 10-K, before making an investment decision. If any of the following risks actually occurs, our business, financial condition or results of operations could suffer. In that case, the trading price of our common stock could decline, and you may lose all or part of your investment.
RISKS RELATED TO OUR BUSINESS
Our sales revenues are derived primarily from our exclusive franchise stores and non-exclusive stores, and should any of them perform poorly or cease purchasing wholesale merchandise from us, our sales results, revenues, net income, reputation and competitive position would suffer.
We sell most of our products through exclusive franchise stores and non-exclusive stores. Though our sales persons visit the stores regularly, third party store managers make decisions about order quantities and are responsible for the daily operations of the stores. If factors either in or out of a store manager’s control cause harm to a store’s business, the store’s income could decrease, which would negatively impact our sales. If an exclusive franchise store bearing our brand name performs poorly or is run improperly by such third party store managers, our reputation could be adversely affected. Additionally, if a large number of exclusive franchise stores and non-exclusive franchise stores choose to cease purchasing products from us, we could experience a material decrease in revenues and net income. There is no termination provision in, or expiration of the term of, the exclusive franchise agreements.
We depend heavily on large suppliers and if any of our largest suppliers cease to provide products to us, our business could be adversely affected.
All of the products purchased by the Company during the fiscal year ended December 31, 2011 were provided by twelve vendors, with three major vendors, Shandong Huangming, Hier Hefei Ririshun Sales Co. and Shenzhen Tongfang Multimedia Technology Co., accounting for 45%, 10% and 9% of our total purchases, respectively. All of the products purchased by the Company during the fiscal year ended December 31, 2010 were provided by seven vendors, with three major vendors, Shandong Huangming, Jiangshu Huayang Solar Power Sales Co. and Yangzhou Huiyin Co., Ltd. accounting for 43.5%, 16.5% and 12.6% of our total purchases, respectively. If any of these vendors cease doing business with us, we will experience significant reductions in our sales and income.
We may not be able to effectively control and manage our growth, and a failure to do so could adversely affect our operations and financial condition.
We also plan to expand our company-owned stores and develop manufacturing capabilities for our new LED business. Planned expenditures for the stores and manufacturing capabilities are $8-10 million. Even if we are able to secure the funds necessary to implement our growth strategies (of which there can be no assurance), we will face management, resource and other challenges in expanding our current facilities, integrating acquired assets or businesses with our own, and managing expanding product offerings. Failure to effectively deal with increased demands on our resources could interrupt or adversely affect our operations and cause production backlogs, longer product development time frames and administrative inefficiencies. Other challenges involved with expansion, acquisitions and operation include:
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unanticipated costs;
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the diversion of management’s attention for unanticipated business concerns;
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potential adverse effects on existing business relationships with suppliers and customers;
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obtaining sufficient working capital to support expansion;
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expanding our product offerings and maintaining the high quality of our products;
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maintaining adequate control of our expenses and accounting systems;
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successfully integrating any future acquisitions;
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anticipating and adapting to changing conditions in the electronics retail industry, whether from changes in government regulations, mergers and acquisitions involving our competitors, technological developments or other economic, competitive or market dynamics; and
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outsourcing the manufacture and production of our refrigerators to OEMs may not give us sufficient control over the quality of those products.
Even if we do experience increased sales due to expansion, there may be a lag between the time when the expenses associated with an expansion or acquisition are incurred and the time when we recognize such benefits, which would affect our earnings.
We may not be able to hire and retain qualified personnel to support our growth and if we are unable to do so, our ability to implement our business objectives could be limited. Difficulties with hiring, employee training and other labor issues could disrupt our operations.
Our operations depend on the work of our sales persons and other employees. We may not be able to retain those employees, successfully hire and train new employees or integrate new employees into the Company. Any such difficulties would reduce our operating efficiency and increase our costs of operations, and could harm our overall financial condition.
Our operations also depend in significant part upon the continued contributions of our key technical and senior management personnel, including Mr. Hailong Liu, and upon our ability to attract and retain additional qualified management, technical, marketing and sales and support personnel for our operations. If one or more of our senior executives or other key personnel are unable or unwilling to continue in their present positions, we may not be able to replace them within a reasonable time, which could result in disruption of our business and an adverse effect on our financial condition and results of operations. None of our senior management personnel have signed employment agreements. Significant turnover in our senior management could significantly deplete the institutional knowledge held by our existing senior management team. We depend on the skills and abilities of these key employees in managing the technical, marketing and sales aspects of our business, which could be harmed by turnover in the future. Competition for senior management and personnel is intense, the pool of qualified candidates is very limited, and we may not be able to retain the services of our senior executives or senior personnel, or attract and retain high-quality senior executives or senior personnel in the future. This failure could limit our future growth and reduce the value of our common stock.
The consumer electronics and appliances retail industry in the PRC is competitive and, unless we are able to compete effectively with competitor retailers, our profits could suffer.
The consumer electronics and appliances retail industry in the PRC has become highly and increasingly competitive. Large national retailers such as Suning Appliance and Guomei Appliance have expanded, and local and regional competition has increased. Some of these companies have substantially greater financial, marketing, personnel and other resources than we do.
Our competitors could adapt more quickly to evolving consumer preferences or market trends, have greater success in their marketing efforts, control supply costs and operating expenses more effectively, or do a better job in formulating and executing expansion plans. Increased competition may also lead to price wars, counterfeit products or negative brand advertising, all of which may adversely affect our market share and profit margins. Existing or new competitors could receive contracts for which we compete due to events and factors beyond our control, and expansion of large retailers into new locations may limit the locations into which we may profitably expand. To the extent that our competitors are able to take advantage of any of these factors, our competitive position and operating results may suffer.
Because we face intense competition, we must anticipate and quickly respond to changing consumer demands more effectively than our competitors. In order to succeed in implementing our business plan, we must achieve and maintain favorable recognition of our private label brands (i.e. our Guoying branded products, company-owned stores and exclusive franchise stores operating under our brand name), effectively market our products to consumers, competitively price our products, and maintain and enhance a perception of value for consumers. We must also source and distribute our merchandise efficiently. Failure to accomplish these objectives could impair our ability to compete with larger retailers and could adversely affect our growth and profitability.
We do not maintain product liability insurance or business interruption insurance, and our property and equipment insurance does not cover the full value of our property and equipment.
We currently do not carry any product liability or other similar insurance or business interruption insurance. If product liability litigation becomes more commonplace in the PRC, we could be exposed to additional liability. Moreover, we may have increased product liability exposure as we expand our sales into international markets, like the United States, where product liability claims are more prevalent.
We may be required from time to time to recall products entirely or from specific markets or batches. We do not maintain recall insurance. Additionally, our property and equipment insurance does not cover the full value of our property and equipment. In the event we do experience product liability claims or a product recall, or suffer from a natural or other unexpected disaster, business or government litigation, or any uncovered risks of operation, our financial condition and business operations could be materially adversely affected.
As all of our operations and personnel are in the PRC, we may have difficulty establishing adequate western style management, legal and financial controls.
The PRC has not adopted a Western style of management and financial reporting concepts and practices. We may have difficulty in hiring and retaining a sufficient number of qualified employees to work in the PRC. As a result, we may experience difficulty in establishing accounting and financial controls, collecting financial data, budgeting, managing our funds and preparing financial statements, books and records and instituting business practices that meet Western standards.
Our lack of familiarity with Western practices generally and Section 404 specifically may unduly divert management’s time and resources, which could have a material adverse effect on our operating results. In addition, our lack of familiarity with U.S. generally accepted accounting principles and lack of accounting personnel who have experience with U.S. generally accepted accounting principles may cause our internal control over financial reporting to be deficient. If material weaknesses in our internal controls over financial reporting are identified, this could result in a loss of investor confidence in our financial reports, have an adverse effect on our stock price and/or subject us to sanctions or investigation by regulatory authorities.
We do not presently have a Chief Financial Officer with U.S. public company experience.
We do not presently have a Chief Financial Officer that is familiar with the accounting and reporting requirements of a U.S. publicly-listed company. Currently we do not have sufficient in-house expertise in US GAAP reporting. Instead, we rely on the expertise and knowledge of external financial advisors in US GAAP conversion who help us prepare and review the consolidated financial statements. The position of Chief Financial Officer of a U.S. publicly-listed company is critical to the operations of such a company, and our failure to fill this position in a timely and effective manner will negatively impact our business.
RISKS RELATED TO DOING BUSINESS IN CHINA
The Company faces the risk that changes in the policies of the PRC government could have a significant impact upon the business that the Company may be able to conduct in the PRC and the profitability of such business.
The PRC economy is in a transition from a planned economy to a market oriented economy subject to five-year and annual plans adopted by the government that set national economic development goals. Policies of the PRC government can have significant effects on the economic conditions of the PRC. The PRC government has confirmed that economic development will follow the model of a market economy, but there can be no assurance that this will be the case. A change in policies by the PRC government could adversely affect the Company’s interests due to factors such as changes in laws, regulations or the interpretation thereof, confiscatory taxation, restrictions on currency conversion, imports or sources of supplies, or the expropriation or nationalization of private enterprises. There can be no assurance that the government will continue to pursue economic reform policies or that such policies may not be significantly altered, especially in the event of a change in leadership, social or political disruption, or other circumstances affecting the PRC political, economic and social life.
The PRC laws and regulations governing the Company’s business operations are sometimes vague and uncertain. Any changes in such PRC laws and regulations may have a material and adverse effect on the Company’s business.
There are substantial uncertainties regarding the interpretation and application of PRC laws and regulations, including but not limited to the laws and regulations governing the Company’s business, or the enforcement and performance of the Company’s arrangements with customers in the event of the imposition of statutory liens, death, bankruptcy and criminal proceedings. The Company and any future subsidiaries are considered foreign persons or foreign funded enterprises under PRC laws, and as a result, the Company is required to comply with PRC laws and regulations. These laws and regulations are sometimes vague and may be subject to future changes, and their official interpretation and enforcement may involve substantial uncertainty.
The effectiveness of newly enacted laws, regulations or amendments may be delayed, resulting in detrimental reliance by foreign investors. New laws and regulations that affect existing and proposed future businesses may also be applied retroactively. The Company cannot predict what effect the interpretation of existing or new PRC laws or regulations may have on the Company’s businesses.
New labor laws in the PRC may adversely affect our results of operations.
On January 1, 2008, the PRC government promulgated the Labor Contract Law of the PRC, or the New Labor Contract Law. The New Labor Contract Law imposes greater liabilities on employers and significantly impacts the cost of an employer’s decision to reduce its workforce. Further, it requires certain terminations to be based upon seniority and not merit. In the event we decide to significantly change or decrease our workforce, the New Labor Contract Law could adversely affect our ability to enact such changes in a manner that is most advantageous to our business or in a timely and cost effective manner, thus materially and adversely affecting our financial condition and results of operations.
A slowdown or other adverse developments in the PRC economy may materially and adversely affect the Company’s customers, demand for the Company’s products and the Company’s business.
All of the Company’s operations are conducted in the PRC and all of its revenue is generated from sales in the PRC and we cannot assure you that our historic growth will continue. In addition, the PRC government exercises significant control over PRC economic growth through the allocation of resources, controlling payment of foreign currency-denominated obligations, setting monetary policy and providing preferential treatment to particular industries or companies. Efforts by the PRC government to slow the pace of growth of the PRC economy could result in reduced demand for our products. A slowdown in overall economic growth, an economic downturn or recession or other adverse economic developments in the PRC may materially reduce the demand for our products and materially and adversely affect our business.
Inflation in the PRC could negatively affect our profitability and growth.
In recent years, the Chinese economy has experienced periods of rapid expansion and highly fluctuating rates of inflation. During the past ten years, the rate of inflation in China has been as high as 20.7% and as low as -2.2%. These factors have led to the adoption by the Chinese government, from time to time, of various corrective measures designed to restrict the availability of credit or regulate growth and contain inflation. High inflation may in the future cause the Chinese government to impose controls on credit and/or prices, or to take other action, which could inhibit economic activity in China, reduce demand, materially increase our costs, and harm the market for our products and our Company.
Governmental control of currency conversion may affect the value of an investment in the Company and may limit our ability to receive and use our revenues effectively.
At the present time, the Renminbi, the currency of the PRC, is not a freely convertible currency. We receive all of our revenue in Renminbi, which may need to be converted to other currencies, primarily U.S. dollars, in order to be remitted outside of the PRC. The PRC government imposes controls on the convertibility of Renminbi into foreign currencies and, in certain cases, the remittance of currency out of the PRC. Any future restrictions on currency exchanges may limit our ability to use revenue generated in Renminbi to fund any future business activities outside China or to make dividend or other payments in U.S. dollars.
Effective July 1, 1996, foreign currency “current account” transactions by foreign investment enterprises are no longer subject to the approval of State Administration of Foreign Exchange (“SAFE,” formerly, “State Administration of Exchange Control”), but need only a ministerial review, according to the Administration of the Settlement, Sale and Payment of Foreign Exchange Provisions promulgated in 1996 (the “FX regulations”). “Current account” items include international commercial transactions, which occur on a regular basis, such as those relating to trade and provision of services. Distributions to joint venture parties also are considered “current account transactions.” Non-current account items, including direct investments and loans, known as “capital account” items, remain subject to SAFE approval and companies are required to open and maintain separate foreign exchange accounts for capital account items. There are other significant restrictions on the convertibility of Renminbi, including that foreign-invested enterprises may only buy, sell or remit foreign currencies after providing valid commercial documents, at those banks in China authorized to conduct foreign exchange business. Under current regulations, we can obtain foreign currency in exchange for Renminbi from swap centers authorized by the government. While we do not anticipate problems in obtaining foreign currency to satisfy our requirements, we cannot be certain that foreign currency shortages or changes in currency exchange laws and regulations by the PRC government will not restrict us from freely converting Renminbi in a timely manner.
The fluctuation of the Renminbi may materially and adversely affect investments in the Company and the value of our securities.
As the Company relies principally on revenues earned in the PRC, any significant revaluation of the Renminbi may materially and adversely affect the Company’s cash flows, revenues and financial condition, and the price of our common stock may be harmed. The value of the Renminbi depends to a large extent on PRC government policies and the PRC’s domestic and international economic and political developments, as well as supply and demand in the local market. Since 1994, the official exchange rate for the conversion of Renminbi to the U.S. dollar had generally been stable and the Renminbi had appreciated slightly against the U.S. dollar. However, on July 21, 2005, the PRC government changed its policy of pegging the value of Renminbi to the U.S. dollar. Under the new policy, Renminbi may fluctuate within a narrow and managed band against a basket of certain foreign currencies. It is possible that the PRC government could adopt a more flexible currency policy, which could result in more significant fluctuation of Renminbi against the U.S. dollar. We can offer no assurance that Chinese Renminbi will be stable against the U.S. dollar or any other foreign currency.
For example, to the extent that the Company needs to convert U.S. dollars it receives from an offering of its securities into Renminbi for the Company’s operations, appreciation of the Renminbi against the U.S. dollar could have a material adverse effect on the Company’s business, financial condition and results of operations. Conversely, if the Company decides to convert its Renminbi into U.S. dollars for the purpose of making payments for dividends on its common stock or for other business purposes and the U.S. dollar appreciates against the Renminbi, the U.S. dollar equivalent of the Renminbi that the Company converts would be reduced. In addition, the depreciation of significant U.S. dollar denominated assets could result in a charge to the Company’s income statement and a reduction in the value of these assets.
The application of Chinese regulations relating to the overseas listing of Chinese domestic companies is uncertain, and we may be subject to penalties for failing to request approval of the Chinese authorities prior to listing our shares in the U.S.
On August 8, 2006, six Chinese government agencies, namely, the Ministry of Commerce, or MOFCOM, the State Administration for Industry and Commerce, or SAIC, the China Securities Regulatory Commission, or CSRC, the State Administration of Foreign Exchange, or SAFE, the State Assets Supervision and Administration Commission, or SASAC, and the State Administration for Taxation, or SAT, jointly issued the Regulations on Mergers and Acquisitions of Domestic Enterprises by Foreign Investors, which we refer to as the “New M&A Rules”, which became effective on September 8, 2006. The New M&A Rules purport, among other things, to 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. The Company has not sought any approvals under the New M&A Rules.
There are substantial uncertainties regarding the interpretation, application and enforcement of the New M&A Rules and CSRC has yet to promulgate any written provisions or formally declare or state whether the overseas listing of a China-related company structured similar to ours is subject to the approval of CSRC. Any violation of these rules could result in fines and other penalties on our operations in China, restrictions or limitations on remitting dividends outside of China, and other forms of sanctions that may cause a material and adverse effect to our business, operations and financial conditions.
The new mergers and acquisitions regulations also established additional procedures and requirements that are expected to make merger and acquisition activities by foreign investors more time-consuming and complex, including requirements in some instances that the Ministry of Commerce be notified in advance of any change-of-control transaction in which a foreign investor takes control of a Chinese domestic enterprise that owns well-known trademarks or China’s traditional brands. We may grow our business in part by acquiring other businesses. Complying with the requirements of the new mergers and acquisitions regulations in completing this type of transactions could be time-consuming, and any required approval processes, including CSRC approval, may delay or inhibit our ability to complete such transactions, which could affect our ability to expand our business or maintain our market share.
PRC regulations relating to the establishment of offshore special purpose companies by PRC residents may subject our PRC resident shareholders or our PRC subsidiary to penalties, limit our ability to distribute capital to our PRC subsidiary, limit our Chinese subsidiary’s ability to distribute funds to us, or otherwise adversely affect us.
The PRC State Administration of Foreign Exchange (“SAFE”) issued a public notice in October 2005, or the SAFE Circular No. 75, requiring PRC residents to register with the local SAFE branch before establishing or controlling any company outside of China for the purpose of capital financing with assets or equities of PRC companies, referred to in the SAFE Circular No. 75 as special purpose vehicles, or SPVs. PRC residents who are shareholders of SPVs established before November 1, 2005 were required to register with the local SAFE branch before June 30, 2006. Further, PRC residents are required to file amendments to their registrations with the local SAFE branch if their SPVs undergo a material event involving changes in capital, such as changes in share capital, mergers and acquisitions, share transfers or exchanges, spin-off transactions or long-term equity or debt investments.
Our current shareholders and/or beneficial owners may fall within the ambit of the SAFE notice and be required to register with the local SAFE branch as required under the SAFE notice. If so required, and if such shareholders and/or beneficial owners fail to timely register their SAFE registrations pursuant to the SAFE notice, or if future shareholders and/or beneficial owners of our company who are PRC residents fail to comply with the registration procedures set forth in the SAFE notice, this may subject such shareholders, beneficial owners and/or our PRC subsidiary to fines and legal sanctions and may also limit our ability to contribute additional capital to our PRC subsidiary, limit our PRC subsidiary’s ability to distribute dividends to our company, or otherwise adversely affect our business. To date, our current shareholders and beneficial owners have not made any filings with the applicable SAFE branch.
We face uncertainty from the Circular on Strengthening the Administration of Enterprise Income Tax on Non-resident Enterprises' Share Transfer, or Circular 698, released in December 2009 by China's State Administration of Taxation, or the SAT, effective as of January 1, 2010.
Pursuant to the Circular 698, where a foreign investor transfers the equity interests of a Chinese resident enterprise indirectly via disposing of the equity interests of an overseas holding company, which we refer to as an Indirect Transfer, and such overseas holding company is located in a tax jurisdiction that: (i) has an effective tax rate less than 12.5% or (ii) does not tax foreign income of its residents, the foreign investor shall report such Indirect Transfer to the competent tax authority of the Chinese resident enterprise. The Chinese tax authority will examine the true nature of the Indirect Transfer, and if the tax authority considers that the foreign investor has adopted an abusive arrangement in order to avoid Chinese tax, they will disregard the existence of the overseas holding company and re-characterize the Indirect Transfer and as a result, gains derived from such Indirect Transfer may be subject to Chinese withholding tax at the rate of up to 10%. Circular 698 also provides that, where a non-Chinese resident enterprise transfers its equity interests in a Chinese resident enterprise to its related parties at a price lower than the fair market value, the competent tax authority has the power to make a reasonable adjustment to the taxable income of the transaction.
Since Circular 698 became effective on January 1, 2010, we cannot assure you that our reorganization will not be subject to examination by Chinese tax authorities or that any direct or indirect transfer of our equity interests in our Chinese subsidiary via our overseas holding companies will not be subject to a withholding tax of 10%.
We may be exposed to liabilities under the Foreign Corrupt Practices Act, and any determination that we violated the Foreign Corrupt Practices Act could harm our business.
Although we are currently not subject to these regulations, we anticipate that we will be subject to the United States Foreign Corrupt Practices Act, or FCPA, and other laws that prohibit U.S. companies from engaging in bribery or other prohibited payments to foreign officials for the purpose of obtaining or retaining business. Our activities in China create the risk of unauthorized payments or offers of payments by one of the employees, consultants, sales agents or distributors of our Company, even though these parties are not always subject to our control. It is our policy to implement safeguards to discourage these practices by our employees. However, our existing safeguards and any future improvements may prove ineffective, and the employees, consultants, sales agents or distributors of our Company may engage in conduct for which we might be held responsible. Violations of the FCPA may result in severe criminal or civil sanctions, and we may be subject to other liabilities, which could adversely impact our business, operating results and financial condition.
Because the Company’s principal assets are located outside of the United States and the Company’s officers and directors reside outside of the United States, it may be difficult for investors to enforce their rights in the U.S. based on U.S. federal securities laws against the Company and the Company’s officers and directors or to enforce U.S. court judgments against the Company or them in the PRC.
The Company is located in the PRC and substantially all of its assets are located outside of the United States. The PRC does not have a treaty with United States providing for the reciprocal recognition and enforcement of judgments of courts. It may therefore be difficult for investors in the United States to enforce their legal rights based on the civil liability provisions of the United States federal securities laws against us in the courts of either the United States or the PRC and, even if civil judgments are obtained in courts of the United States, to enforce such judgments in PRC courts. Further, it is unclear if extradition treaties now in effect between the United States and the PRC would permit effective enforcement against us or our officers and directors of criminal penalties, under the United States federal securities laws or otherwise.
There are substantial uncertainties regarding the interpretation and application of PRC laws and regulations governing the validity and legality of call options which are held by our Chairman and others and there can be no assurance that the call options are not in breach of such laws and regulations.
Under a call option agreement with our Chairman Hailong Liu, Sherry Li, the holder of 11,556,288 shares of our Common Stock, has granted to Mr. Liu an option to purchase all of her shares over the course of two years in installments upon achievement of certain performance milestones by the Company. While we believe that this arrangement is not governed by PRC laws and regulations, there are substantial uncertainties regarding the interpretation and application of current or future PRC laws and regulations, including regulations governing the validity and legality of call options. Accordingly, we cannot assure you that PRC government authorities will not determine that the call option agreement is subject to PRC laws and regulations. If the call option agreement is deemed to be governed by PRC laws and regulations, our Chairman may be required to register with the local SAFE branch for his overseas direct investment in the Company. Failure to make such SAFE registration may subject our Chairman to fines and legal sanctions, and may also limit his ability to receive dividends from our PRC subsidiary and remit his proceeds from their overseas investment into the PRC as a result of foreign exchange control under PRC laws and regulations.
The cessation of tax exemptions and deductions by the Chinese government may affect our profitability.
On March 16, 2007, the National People’s Congress of China enacted a new tax law, or the New Tax Law, whereby both foreign investment enterprises, or FIEs, and domestic companies will be subject to a uniform income tax rate of 25%. On November 28 2007, the State Council of China promulgated the Implementation Rules of the New Tax Law, the “Implementation Rules”. Both the New Tax Law and the Implementation Rules have become effective on January 1, 2008. Both the New Tax Law and the Implementation Rules provide that companies not entitled to tax exemption or relevant preferential tax treatment shall be subject to 17% value added tax. The Company recognizes its revenues net of value-added taxes (“VAT”). The Company is subject to VAT which is levied at a fixed annual amount. Currently, the Company is charged at a fixed annual amount of approximately $1,200 to cover all types of taxes including income taxes and VATs. This is approved by the PRC tax department. In the future, if the relevant tax authorities determine that the Company is not eligible for preferential treatment of VAT, loss of such preferential treatment may materially and adversely affect our profits, business and financial performance.
RISKS RELATED TO OUR COMMON STOCK
Our common stock is quoted on the OTCQB which may have an unfavorable impact on our stock price and liquidity.
Our common stock is quoted on the OTCQB. The OTCQB is a significantly more limited market than the New York Stock Exchange or NASDAQ. The quotation of our shares on the OTCQB may result in a less liquid market for our common stock, could depress the trading price of our common stock, could cause high volatility and price fluctuations, and could have a long-term adverse impact on our ability to raise capital in the future.
There is a limited trading market for our common stock.
There is currently a limited trading market on the OTCQB for our common stock, and there can be no assurance that a more active trading market will develop or be sustained.
Certain of our existing stockholders will control the outcome of matters requiring stockholder approval, and their interests may not be aligned with the interests of our other stockholders.
Sherry Li is our majority stockholder, holding 11,556,288 shares of our Common Stock (approximately 68.9 % of the outstanding shares of Common Stock as of April 16, 2012. As more particularly described in footnote (3) and (4) to the table contained in Item 12 of this Annual Report on Form 10-K, Ms. Li has entered into a voting trust agreement with, and granted options to, our Chairman, Hailong Liu, to vote or purchase all 11,556,288 of her shares. As a result, Mr. Liu will have the ability to control the election of our directors and the outcome of corporate actions requiring stockholder approval, such as changes to our articles of incorporation and by-laws and a merger or a sale of our company or a sale of all or substantially all of our assets. This concentration of voting power and control could have a significant effect in delaying, deferring or preventing an action that might otherwise be beneficial to our other stockholders and be disadvantageous to our stockholders with interests different from those of our officers, directors and affiliates. . Additionally, this significant concentration of share ownership may adversely affect the trading price for our Common Stock because investors often perceive disadvantages in owning stock in companies with controlling stockholders.
The elimination of monetary liability of the Company’s directors and officers under the Nevada law and the existence of indemnification rights of the Company’s directors, officers and employees may result in substantial expenditures by the Company and may discourage lawsuits against the Company’s directors and officers.
Under Nevada law, a corporation may indemnify its directors, officers, employees and agents under certain circumstances, including indemnification of such persons against liability under the Securities Act of 1933, as amended (the “Securities Act”). In addition, a corporation may purchase or maintain insurance on behalf of its directors, officers, employees or agents for any liability incurred by him in such capacity, whether or not the corporation has the authority to indemnify such person. We do not currently maintain such insurance.
These provisions may eliminate the rights of the Company and its stockholders (through stockholder’s derivative suits on behalf of the Company) to recover monetary damages against a director, officer, employee or agent for breach of fiduciary duty. Insofar as indemnification for liabilities arising under the Securities Act may be provided for directors, officers, employees, agents or persons controlling an issuer pursuant to the foregoing provisions, the opinion of the Commission is that such indemnification is against public policy as expressed in the Securities Act, and is therefore unenforceable.
Shares eligible for future sale may adversely affect the market price of our common stock, as the future sale of a substantial amount of outstanding stock in the public marketplace could reduce the price of our common stock.
As of April 16, 2012, there were issued and outstanding (i) 16,775,113 shares of our Common Stock, and (ii) immediately exercisable warrants to purchase an aggregate of 2,903,528 shares of our Common Stock. We currently have obligation to register the resale of an aggregate of 2,623,178 shares of our Common Stock, including shares issuable upon exercise of warrants. Future sales of substantial amounts of our Common Stock in the trading market could adversely affect market price of our Common Stock.
Our holding company structure may limit the payment of dividends.
We have no direct business operations, other than ownership of our subsidiaries. While we have no current intention of paying dividends, should we decide to do so in the future, as a holding company, our ability to pay dividends and meet other obligations depends upon the receipt of dividends or other payments from our operating subsidiaries and other holdings and investments. In addition, our operating subsidiaries may be subject to restrictions on their ability to make distributions to us, including restrictions resulting from restrictive covenants in loan agreements, restrictions on the conversion of local currency into U.S. dollars or other hard currency and other regulatory restrictions discussed below. If future dividends are paid in RMB, fluctuations in the exchange rate for the conversion of RMB into U.S. dollars may reduce the amount received by U.S. stockholders upon conversion of the dividend payment into U.S. dollars.
The Wholly-Foreign Owned Enterprise Law (1986), as amended, the Wholly-Foreign Owned Enterprise Law Implementing Rules (1990), as amended and the Company Law of China (2006) contain the principal regulations governing dividend distributions by wholly foreign-owned enterprises. Under these regulations, wholly foreign-owned enterprises may pay dividends only out of their accumulated profits, if any, determined in accordance with Chinese accounting standards and regulations. Our subsidiary in China is also required to set aside a certain amount of its accumulated profits each year, if any, to fund certain reserve funds. These reserves are not distributable as cash dividends except in the event of liquidation and cannot be used for working capital purposes. The Chinese government also imposes controls on the conversion of RMB into foreign currencies and the remittance of currencies out of China. We may experience difficulties in completing the administrative procedures necessary to obtain and remit foreign currency for the payment of dividends from the profits of our subsidiary in China.
Furthermore, if our subsidiaries in China incur debt in the future, the instruments governing the debt may restrict its ability to pay dividends or make other payments. If we are unable to receive all of the revenues from our operations through these contractual or dividend arrangements, we may be unable to pay dividends on our common stock. In addition, under current PRC law, we must retain a reserve equal to 10 percent of net income after taxes each year, with the total amount of the reserve not to exceed 50 percent of registered capital. Accordingly, this reserve will not be available to be distributed as dividends to our shareholders.
Provisions in our Articles of Incorporation could prevent or delay stockholders’ attempts to replace or remove current management or otherwise adversely affect the rights of the holders of our Common Stock.
Under our Articles of Incorporation, our Board of Directors is authorized to issue “blank check” preferred stock, with any designations, rights and preferences they may determine. Any shares of preferred stock that are issued are likely to have priority over our common stock with respect to dividend or liquidation rights. If issued, preferred stock could be used under certain circumstances as a method of discouraging, delaying or preventing a change in control, which could have discourage bids to acquire us and thereby prevent shareholders from receiving the maximum value for their shares. Though we have no present intention to issue any additional shares of preferred stock, there can be no assurance that preferred stock will not be issued at some time in the future.
ITEM 2.
ITEM 2. PROPERTIES
Set forth below is a table containing certain information concerning the location and area of each of our company-owned stores and warehouses and the terms under which such properties are leased.
We believe that the foregoing properties are adequate for our present needs.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
From time to time, we may become involved in various lawsuits and legal proceedings which arise in the ordinary course of business. However, litigation is subject to inherent uncertainties, and an adverse result in these or other matters may arise from time to time that may harm our business. We are currently not aware of any such material legal proceedings or claims that we believe will have a material adverse affect on our business, financial condition or operating results.
PART II
ITEM 5.
ITEM 5. MARKET FOR THE REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Market Information
Our Common Stock is quoted on the OTCQB under the symbol “CEHD.QB.” There were no reported quotations for our Common Stock during calendar year 2009.
The following table sets forth the high and low sales prices, without retail mark-up, mark-down or commission, of our Common Stock during each calendar quarter in the fiscal year ending December 31, 2010 and the four quarters of the fiscal year ending December 31, 2011,and may not represent actual transactions.
As of March 30, 2012, there were 16,775,113 shares of our Common Stock outstanding. Our shares of Common Stock are held by approximately 108 stockholders of record. The number of record holders was determined based on the records of our transfer agent and does not include beneficial owners of Common Stock whose shares are held in the names of various securities brokers, dealers, and registered clearing agencies.
Securities Authorized for Issuance under Equity Compensation Plans
We do not have any equity compensation plans.
Dividend Policy
There are no restrictions in our Articles of Incorporation or By-laws that prevent us from declaring dividends. The Nevada Revised Statutes, however, prohibit us from declaring dividends where after giving effect to the distribution of the dividend:
1.
we would not be able to pay our debts as they become due in the usual course of business, or
2.
our total assets would be less than the sum of our total liabilities plus the amount that would be needed to satisfy the rights of shareholders who have preferential rights superior to those receiving the distribution.
Because we are a holding company, we rely entirely on dividend payments from our direct wholly owned subsidiary, CEH Delaware, and in turn, the various direct and indirect subsidiaries of CEH Delaware, who may, from time to time, be subject to certain additional restrictions on its ability to make distributions to us. PRC accounting standards and regulations currently permit payment of dividends only out of accumulated profits, a portion of which must be set aside to fund certain reserve funds. Our inability to receive all of the revenues from our subsidiaries’ operations may create an additional obstacle to our ability to pay dividends on our Common Stock in the future. Additionally, because the PRC government imposes controls on the convertibility of RMB into foreign currencies and, in certain cases, the remittance of currency out of the PRC, shortages in the availability of foreign currency may occur, which could restrict our ability to remit sufficient foreign currency to pay dividends.
We currently intend to retain any future earnings to finance the development and growth of our business and do not anticipate paying cash dividends on our Common Stock in the foreseeable future, but will review this policy as circumstances dictate. If in the future we are able to pay dividends and determine it is in our best interest to do so, such dividends will be paid at the discretion of the Board of Directors after taking into account various factors, including our financial condition, operating results, capital requirements, restrictions contained in any future financing instruments and other factors the Board of Directors deems relevant.
Securities Authorized for Issuance under Equity Compensation Plans
We do not have any equity compensation plans.
ITEM 7.
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis of financial condition and results of operations relates to the operations and financial condition reported in the audited consolidated financial statements of the Company for the fiscal years ended December 31, 2011 and 2010, and should be read in conjunction with such consolidated financial statements and related notes included in this annual report. Those statements in the following discussion that are not historical in nature should be considered to be forward looking statements that are inherently uncertain. Actual results and the timing of the events may differ materially from those contained in these forward looking statements due to a number of factors, including those discussed in the “Cautionary Note on Forward Looking Statements” set forth elsewhere in this annual report.
Overview
China Electronics Holdings, Inc (the “Company”, “We”, “Our”, “Us”), formerly named Buyonate, Inc., was incorporated in the State of Nevada on July 9, 2007 to engage in developing user-friendly/child friendly interactive digital software for children. The Company was in the development stage through December 31, 2008. The year 2009 is the first year during which the Company is considered an operating company and is no longer in the development stage.
China Electronic Holdings, Inc. (“CEH Delaware”) was organized on November 15, 2007, as a Delaware corporation. Prior to February 10, 2010, CEH Delaware was a development stage company attempting to manufacture and sell carbon and graphite electrodes and planning to manufacture and sell electronic products in the People’s Republic of China through its own stores and franchise stores.
Lu’an Guoying Electronic Sales Co., Ltd., a PRC corporation, (“Guoying”) was established on January 4, 2002. Guoying sells electronic products in the PRC through its company-owned stores, exclusive franchise stores and non-exclusive stores.
Pursuant to the Share Transfer Agreement entered into on December 26, 2008 (the “2008 Share Transfer”) between the shareholders of Guoying (the “Guoying Shareholders”) and CEH Delaware, CEH Delaware acquired 40% of the outstanding equity securities of Guoying (the “Guoying Shares”) from all of the Guoying Shareholders in consideration for $60,000, equivalent to RMB 400,000. Pursuant to the Share Transfer Agreement entered into on February 2010 (the “2010 Share Transfer”) between Guoying Shareholders and CEH Delaware, CEH Delaware acquired the remaining 60% of the outstanding equity securities of Guoying from all of the Guoying Shareholders in consideration for RMB 600,000 and the Guoying Shareholders transferred and contributed all of their Guoying Shares to CEH Delaware. The Guoying Shareholders contributed the cash portion of the price for their shares to Guoying for working capital and general corporate purpose and as a result of the 2008 and 2010 Share Transfers, Guoying became a wholly foreign-owned subsidiary (“WFOE”) of CEH Delaware.
On July 9, 2010 we consummated the Share Exchange Agreement with certain Selling Stockholders. Pursuant to the Share Exchange Agreement, 10 former stockholders of our subsidiary, CEH Delaware, transferred to us 100% of the outstanding shares of common stock and preferred stock of CEH Delaware and 100% of the warrants to purchase common stock of CEH Delaware held by them, in exchange for an aggregate of 13,785,902 newly issued shares of our Common Stock and warrants to purchase an aggregate of 1,628,570 shares of our Common Stock. CEH Delaware’s outstanding Series A warrants were exchanged on a one-for-one basis for Series A warrants of the Company to purchase an aggregate of 314,285 shares of Common Stock, with an exercise price of $2.19 per share. CEH Delaware’s outstanding Series B warrants were exchanged on a one-for-one basis for Series B warrants of the Company to purchase an aggregate of 314,285 shares of Common Stock, with an exercise price of $2.63 per share. CEH Delaware’s outstanding $1.00 warrants were exchanged on a one-for-one basis for Series E warrants of the Company to purchase an aggregate of 1,000,000 shares of Common Stock, with an exercise price of $0.25 per share. In connection with the Share Exchange and pursuant to the Articles of Merger filed with the Nevada Secretary of State, Buyonate, Inc. changed its name to China Electronics Holdings, Inc. The merger and name change were approved by the Financial Industry Regulatory Authority (“FINRA”) and the Common Stock began trading under the symbol “CEHD.OB” on August 23, 2010.
Results of Operations
We operated 3 company owned stores as of December 31, 2010. In the second quarter of 2011, we opened our headquarters company owned store located in Guangcai Big Market. We closed one company owned store in each of the second and fourth quarters of 2011. As of December 31, 2011, we have signed exclusive franchise agreements with 346 stores operating under the Guoying brand name (the “Exclusive Franchise Stores”). We entered into franchise agreements with 225 exclusive franchise stores prior to 2009 that operate under our brand name. We entered into franchise agreements with 247 new exclusive franchise stores in 2009, 61 new franchise stores in 2010 and 93 new exclusive franchise stores in 2011. We terminated our exclusive franchise agreement with 47, 0 and 233 exclusive franchise stores in 2009, 2010 and 2011, respectively. Both our Company-owned stores and our exclusive franchise stores only sell merchandise that we provide to them as their exclusive wholesaler, and such merchandise includes Guoying branded products as well as products from major wholesalers such as Sony, Samsung and LG. As of December 31, 2011, we have signed non-exclusive franchise agreements with 354 stores (the “Non-Exclusive Franchise Stores”) to which we provide Guoying branded merchandise on a non-exclusive wholesale basis. There are 80 non-exclusive franchise stores that entered into franchise agreements prior to 2009. We entered into 111 non-exclusive franchise agreements in 2009, 557 non-exclusive franchise agreements in 2010 and 1 non-exclusive franchise store in 2011. We terminated our agreements with 15, 18 and 362 non-exclusive franchise stores in 2009, 2010 and 2011, respectively.
When we use the terms "open" or "opened" in referring to an exclusive or non exclusive franchise store, we mean that we had entered into a franchise agreement with such store and that it was in operation. When we use the terms "close," "closed" or "terminated" in reference to an exclusive or non-exclusive franchise store we mean that we had terminated our agreement with such store.
Year Ended December 31, 2011 Compared with Year Ended December 31, 2010
Revenues
Our net revenue for the year ended December 31, 2011 was $104,215,403, a decrease of 8.7%, or $9,956,043, from $114,171,446 for the year ended December 31, 2010.
For the 2011 year, net revenue from exclusive franchise stores was $47,221,802, an increase of 14.9%, or $6,114,923, from $41,106,879 for the year 2010. There were 346 exclusive franchise stores as of December 31, 2011, 140 or 28%, fewer than the 486 exclusive franchise stores as of December 31, 2010. The Company entered into franchise agreements with 93 exclusive stores and terminated its agreement with 233 exclusive stores in 2011.
For the 2011 year, net revenue from non-exclusive stores was $47,172,272, a decrease of 2.9%, or $1,404,050, from $48,576,322 for the year 2010. There were 354 non-exclusive stores as of December 31, 2011, 361 or 50% fewer than the 715 non-exclusive stores as of December 31, 2010. The Company entered into a non-exclusive franchise agreement with 1 non-exclusive store and terminated its agreement with 362 non-exclusive stores in 2011.
For the 2011 year, net revenue from company owned stores was $9,821,329, a decrease of 59.9%, or $14,666,916, from $24,488,245 for the year, 2010. The decreased revenue from company-owned stores was mainly because the Company opened one but closed two stores in the year ended December 31, 2011. The two company owned stores closed were operating at approximately 0% gross profit rate in 2010.
Revenue Classified by Store Type
Our disaggregation of revenue and cost of sales by each store type in the past two years as of December 31, 2011 and 2010 are as follows:
Sales and Average Per Store Sales of Same Stores
Same Stores are defined as stores that we opened or entered into franchise agreements with prior to 2010 and that have been in continuous operation as of December 31, 2011 and excludes stores that were newly opened or closed or with which we entered into or terminated franchise agreements in 2010 or 2011. Same Store Sales are defined as sales from the Same Stores.
Same Stores Sales in 2010 and 2011, and the increase or decrease experienced as a percentage of Same Store Sales are as follows:
The primary reason for the increase in Same Stores Sales was the increase in sales from non-exclusive stores (“Same Non-Exclusive Franchise Stores”) offset by the decrease in sales from exclusive franchise stores (“Same Exclusive Franchise Stores”). The increase in our sales in Same Non-Exclusive Franchise stores is a result of the company’s many efforts in assisting such stores to increase their sales of Company supplied products. For example, the Company increased promotion and marketing for its brands in media with broader coverage, providing more support to such stores. The decrease in our sales in Same Exclusive Franchise Stores is because he decreased per store sales for Same Exclusive Franchise Stores due to the reason that the Company did not have sufficient experienced staff to manage the same exclusive stores.
The number of Same Stores included in the calculation of average sales of per-store Same Stores is as follows:
The average sales per-store of Same Stores and its trend up or down are as follows:
Sales and Average Per Store Sales of New Stores
New Stores are defined as stores that were newly opened or with which we entered into a franchise agreement in either 2011 or 2010 that are in existence under normal business operations as of December 31, 2011 and excluding stores that closed in 2011 or 2010 (“New Stores”). New Store Sales are defined as sales from the New Stores. 2010 New Store Sales refer to the sales from New Stores opened or with which we entered into a franchise agreement in 2010 and not closed in 2011. 2011 New Store Sales refer to the sales generated in 2011 from both New Stores opened or with which we entered into a franchise agreement in 2010 and 2011 that have not closed as of the end of 2011 . New Stores Sales operating in both 2010 and 2011, and the change experienced as a percentage of New Store Sales are as follows:
The New Stores are defined as sales from stores that were newly opened in either 2011 or 2010 and are in existence under normal business operations as of today and excluding stores that closed in 2011 or 2010 (the “New Stores”). The New Store Sales are defined as sales from the New Stores. 2010 New Store Sales refer to the sales from New Stores opened in 2010 and not closed in 2011. 2011 New Store Sales refer to the sales generated in 2011 from both New Stores opened in 2010 and New Stores opened in 2011 that are not closed.
New Stores Sales operating in both 2010 and 2011, and the increase experiences at a percentage are as follows:
The primary reason for the increase in New Stores Sales was the increase of sales from new non-exclusive franchise stores (the “New Non-Exclusive Franchise Stores”) and from new exclusive stores (the “New Exclusive Franchise Stores”), offset by the decrease of sales from new company-owned stores (the “New Company-Owned Stores”). The increase of sales from New Non-Exclusive Stores is due to the fact that the Company entered into franchise agreements with 214 New Non-Exclusive Stores in 2010 and 1 in 2011. The average sales of the New Non-Exclusive Stores sales increased in 2011 compared to 2010 because most of the New Non Exclusive Stores were opened or entered into agreements with the Company in the 2nd half of 2010 and were not fully operational until 2011. The increase of sales from exclusive stores is due to the fact that the new exclusive stores opened in 2010 did not operate for all of 2010 as compared to 2011 when they were open for the complete year. The decrease in sales for the New Company Owned Stores is because the Company opened two new Company-Owned Stores, Hao Men and Guangcai stores, in 2010, and had more discounted promotions in 2010 to attract customers, thus the sales in 2010 were higher than n 2011. Further, the Company closed two Company-Owned Stores, Longhe and Guangcai, in 2011.
The number of new stores included in the calculation of average per store sales of New Stores is as follows:
The average sales per-store of New Stores and its trend as a percentage of New Store Sales are as follows:
Sales and Average Per Store Sales of Closed Stores
Closed Stores are defined as stores that were closed or with which the Company terminated its agreement in either 2011 or 2010 (the “Closed Stores”). Closed Store Sales are defined as sales from the Closed Stores. 2010 Closed Store Sales refer to sales generated in 2010 from stores whose franchise agreements were terminated or which closed in 2010 or 2011. 2011 Closed Store Sales refer to sales generated in 2011 from stores whose franchise agreements were terminated or which closed in 2011.
Closed Store Sales in 2010 and 2011, and the change experienced as a percentage are as follows:
The decrease in Closed Store Sales results from the fact that Stores whose franchise agreements were terminated or which closed in 2010 generated no sales for the Company in 2011. The Company resolved to close (i) exclusive franchise stores that sold merchandise supplied by other wholesalers in breach of the exclusive franchise agreement; (ii) exclusive and non-exclusive franchise stores that failed to obey the Company’s pricing strategies, resulting in lower profit margins; (iii) stores located remotely from Lu An City that resulted in higher transportation and logistics expenses to us; and (iv) stores that sold brands of merchandise not supplied by us. The Company closed two Company-owned stores to concentrate its resources in managing Company-owned stores.
The number of closed stores included in the calculation of average per-store sales of Closed Stores is as follows:
The average per-store sales of Closed Stores and its trend of increase or decrease are as follows:
Other information
The following is a summary of revenue by product line for the years ended December 31, 2011 and 2010:
The increased revenue from new product lines carried in 2011 was $17,109,142, of this amount our exclusive franchise stores, non-exclusive stores and company-owned stores increased revenue from new product lines by $8,881,859, $5,502,104 and $2,725,179, respectively.
The increased revenue in 2011 from new exclusive franchise stores whose franchise agreements were executed or which opened in 2011 was $10,040,717. The increased revenue in 2011from new non-exclusive stores whose franchise agreements were executed or which opened in 2011 was $114,215. The increased revenue from new company-owned stores opened in 2011 was $5,386,411 for the year ended December 31, 2011.
The increase in sales of televisions is due to increased sales of Qinghuatongfang TVs (approximately $6.01 million), LG TVs (approximately $2.88 million), Haier Tongshuai TVs (approximately $1.95 million) and Sanyang TVs offset by the decrease in sales of Sony TVs in 2011 as compared to 2010. The increase in sales of refrigerators, approximately $3,27 millioin, was primarily due to a new brand, Haier, that we started to carry in 2011. Our sales of solar power products decreased in 2011 because of increased market competition and decreased market demands for solar power products.
Solar-powered products sales decreased from $17,344,483, or 24.72%, from $70,163,637 in 2010 to $52,819,154 in 2011. The decrease is mainly due to decreased solar-powered products sales of Huayang Brand. The decrease is due to increased market competition of solar-powered products and Huayang’s failure to increase its sales in the market.
Cost of Goods Sold
Our cost of goods sold for the year ended December 31, 2011 was $88,523,429, an increase of $2,930,349, or 3.4%, compared to $85,593,080 for the year ended December 31, 2010. The decrease was mainly due to the decrease in sales.
For the year 2011, cost of goods sold from non-exclusive stores was $40,051,142, an increase of 8.1%, or $2,997,187, from $37,053,955 for the year 2010. The increase was because in 2011 the non-exclusive stores carried higher cost brands.
For the year 2011, cost of goods sold from company-owned stores was $8,115,988, a decrease of 47.2%, or $7,240,632, from $15,356,620 for the year , 2010. The decrease was in line with the decrease in sales from company-owned stores.
For the year 2011, cost of goods sold from exclusive franchise stores was $40,356,299, an increase of 21.6%, or $7,173,794, from $33,182,505 for the year 2010. The increase was in line with the increase in revenue.
The increased cost of goods sold resulting from new product lines carried in 2011 was $14,739,295. For the year 2011, the increased cost of goods sold from new product lines carried by exclusive franchise stores, non-exclusive stores and company-owned stores was $7,762,951, $4,748,337 and $2,228,008, respectively.
The increased cost of goods sold resulting from new exclusive franchise stores opened in 2011 was $8,794,902. The increased cost of goods sold resulting from new non-exclusive stores opened in 2011 was $96,584. The increased cost of goods sold resulting from new company-owned stores opened in 2011 was $4,489,268.
Gross Profit
Gross profit for the year 2011 was $15,691,974, a decrease of $12,886,292, or approximately 45.1%, compared to $28,578,366 for the year 2010.
For the year 2011, gross profit for non-exclusive stores was $7,121,131, a decrease of 38.20%, or $4,401,236, from $11,522,367 for the year 2010. The decrease was due to the increased cost of goods sold from non-exclusive stores.
For the year 2011, gross profit for exclusive franchise stores was $6,865,502, a decrease of 13.36%, or $1,058,872, from $7,924,374 for the year ended December 31, 2010. The decrease was mainly because the increase in cost of goods sold was more than the increased revenue generated from exclusive stores in 2011.
For the year 2011, gross profit for company-owned stores was $1,705,341, a decrease of 81.3%, or $7,426,284, from $9,131,625 for the year 2010. The decrease was due to decreased sales for company-owned stores in 2011 than 2010 and we closed two company-owned stores in each of the second and fourth quarters of 2011.
The increased gross profit from new product lines carried in 2011 was $2,369,847. For the year 2011, the increased gross profit from new product lines carried by exclusive franchise stores, non-exclusive stores and company-owned stores was$1,118,908, $753,768 and $497,171, respectively.
The increased gross profit for 2011 from products sold by new exclusive franchise stores opened or with which we entered into agreements in 2011 was $1,245,815. The increased gross profit for 2011 from products sold by new non-exclusive stores opened or with which we entered into an agreement in 2011 was $17,631. The increased gross profit for 2011 from products sold by new company-owned stores opened in 2011 was $897, 144.
Gross Profit Rate
Gross profit rate for 2011 was 15.06%, a decrease of approximately 39.85%, compared to 25.03% for the year 2010. The decrease was mainly due to to the fact that in 2011, we sold more products with higher cost and lower markups compared to 2010.
For the year 2011, gross profit rate for exclusive franchise stores was 14.54%, a decrease of 24.58% compared to 19.28% for the year 2010. The decrease in gross profit rates was mainly due to to the fact that in 2011, we sold more products with higher cost and lower markups compared to 2010. The Company continues to expand its sales network as well as products offered, which continuously requires us to review pricing on existing products and existing sales channels. We expect that our pricing strategies will continue to evolve to market conditions and expect improvements to have a marginalizing effect on the noted increase in gross profit rates at exclusive franchise stores as changes in product offerings mature along with their related pricing strategies.
For the year ended December 31, 2011, gross profit rate for non-exclusive stores was 15.10%, a decrease of 36.36%, compared to 23.72% for the year ended December 31, 2010. The decrease in gross profit rates was mainly due to the fact that in 2011, we sold more products with higher cost and lower markups compared to 2010.
For the year ended December 31, 2011, gross profit rate for company-owned stores was 17.36%, a decrease of 19.93%, compared to 37.29% for the year ended December 31, 2010. The decrease was due to the fact that the fact that in 2011, we sold more products with higher cost and lower markups compared to 2010.
Gross profit rate in 2011from new product lines carried in 2011 was 13.85%. Gross profit rate in 2011 from new product lines carried in 2011 sold by exclusive franchise stores was 12.60%. Gross profit rate in 2011 from new product lines carried in 2011 sold by non-exclusive stores was approximately 13.70%. Gross profit rate in 2011 from new product lines carried in 2011 sold by company-owned stores was 18.24%.
Gross profit rate in 2011 from new stores opened in 2011 was 13.90%. Gross profit rate in 2011 from new exclusive franchise stores opened in 2011 was 12.41%. Gross profit rate in 2011from new non-exclusive stores opened in 2011 was 15.44% for the year ended December 31, 2011. Gross profit rate from new company-owned stores opened in 2011 was 16.66%.
Operating Expenses
Operating expenses for the year ended December 31, 2011 were $(2,509,344), a decrease of $8,486,919, or 142.0%, from $5,977,575 for the year ended December 31, 2010.
Selling expenses for the year ended December 31, 2011 were $3,625,882, a decrease of $415,317, or 10.3%, from $4,041,199 for the year ended December 31, 2010. The decrease of selling expenses relates primarily to decreases in shipping and handling expenses (55% of the year-over-year increase).
General and administrative expenses for the year ended December 31, 2011were $2,523,208, an increase of $818,670, or 48.0%, from $1,704,538 for the year ended December 31, 2010. The increase is due to increased expenses in PRC such as increased $1.15 million amortization expenses for intangible assets, increased $153,000 salary expense, $318,000 maintenance expenses, and $229,000 consulting expenses, offset by decreased professional fees in US of approximately $850,000 as a result of becoming a public company in 2010
During the year ended December 31, 2011, recovery of debt expenses of $6,603,000 was recorded as a reduction of operating expenses in 2011. During 2011, we received $6,603,000 from the collection of a past due receivable that was written off in 2009 as we determined that the receivable was not collectible at that time. Bad debt expenses amounted to $11,383,383 for the year ended December 31, 2010.
Forgiveness of employee bonuses for the year ended December 31, 2011 was $0 compared to a reduction of operating expenses of $1,834,144 for the year ended December 31, 2010. On December 31, 2008, Guoying’s board approved a resolution granting RMB 12,401,245 ($1,834,144) as bonus payable to certain employees. However, in May 2010, the Guoying board passed a resolution canceling the bonus. The reversal of the bonus payable to employees has been recorded as a reduction of operating expenses in 2010. There is no such recovery in 2011.
Net Operating Income
Our net operating income for the year ended December 31, 2011 was $16,145,884, an increase of $2,862,793, or 21.6%, from $13,283,092 for the same period in 2010. The increase was mainly due to decreased sales, offset by increased costs of goods sold, and recovery of the bad debt in 2011.
Net Income
Our net income for the year ended December 31, 2011 was $16,130,370, an increase of $2,894,954, or 21.9%, from $13,235,416 for the same period in 2010. The increase resulted from recovery of the bad debt in 2011.
Income Taxes Expense
Under the Income Tax Laws of the PRC, the Company’s subsidiaries are generally subject to an Enterprise Income Tax (EIT) at a standard rate of 25% on income reported in the statutory financial statements after appropriate tax adjustments. The State Tax Bureau of Lu’An City, Anhui province issued an income tax benefit approval to Guoying on December 10, 2011 providing that Guoying is subject to income tax and VAT benefit treatment out of a reduced rate of RMB 7,500 tax payment per year (including income tax and VAT) valid from December 1, 2011 until December 31, 2013 subject to Guoying's option to pay more in taxes should it elect to do so. Therefore, currently, Guoying is charged at a fixed annual reduced tax rate no less than RMB7, 500 per year that changes every year to cover all types of taxes including income taxes. The income tax expenses for the years ended December 31, 2011 and 2010 are $1,255 and $4,073, respectively. There were no significant book and tax basis differences.
Off-Balance Sheet Arrangements
There were no off-balance sheet arrangements during the year ended December 31, 2011 or during the year ended December 31, 2010 that have, or are reasonably likely to have, a current or future material effect on our financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.
Liquidity and Capital Resources
As of December 31, 2011, we had cash and cash equivalents of $171,838. We have historically funded our working capital needs with amounts from operations, advance payments from customers, bank borrowings, and capital from shareholders. Our working capital requirements are influenced by the level of our operations, and the timing of accounts receivable collections.
The following table sets forth a summary of our cash flows for the periods indicated:
Net cash provided by operating activities was $1,353,575 for the year ended December 31, 2011, compared to net cash provided by operating activities was $17,875,958 for the year ended December 31, 2010, a decrease of $16,522,383. The decrease of net cash provided by operating activities was primarily due to increased recovery of bad debt expenses, increased accrued expenses and increased advances, offset by decreased other receivable and zero cancellation of bonus payable in 2011 compared to 2010.
We funded our growth strategy from our working capital and below are a summary of approximately how much we have spent in year 2011 to achieve our growth strategies:
We anticipate that we will not spend much from our working capital to develop our new company-owned stores, and expand the number of exclusive franchise stores and non-exclusive franchise stores in 2012. We have reserved the company name Lu An Guoying Opto-Electronics Technology Co., Ltd. with the Lu An Administration of Industry and Commerce on September 5, 2011 which is alid until September 5, 2012 to engage in LED manufacturing business. We have advanced the retainer fee to secure the land use rights to 300 Chinese acres with Pingqiao Industrial Park where the LED manufacture and facilities will be built. We filed our proposal to enter into the LED manufacturing business with the Reform and Development Commission of Yu An District, Lu An City on May 13, 2011 and we obtained planning permit for the project and land construction issued by Housing and Urban-Rural Development Bureau of Yu An District, Lu An City on October 28, 2011. We are currently seeking business partners and financing to enter into the LED manufacturing and wholesale business. We currently do not have a specific estimate as to how much we will spend on the LED manufacturing and wholesale business until we identify our business partner and implement a specific business plan with financing budget.
Investing Activities
Net cash used in investing activities was $5,388,620 for the year ended December 31, 2011, compared $20,858,995 used in investing activities for the year ended December 31, 2010, a decrease of $15,470,375, or 74.17%. The decrease of cash used in investing activities was mainly because approximately $20 million was used to acquire intangible rights in 2010 and no comparable use of cash occurred in 2011, though the Company did advance to acquire land use right during 2011.
Financing Activities
Net cash provided by financing activities was $2,902,172 for the year ended December 31, 2011, compared to $4,091,803 for the year ended December 31, 2010. The decrease was mainly due to the $4,154,069 in cash that was received through share issuance during the year ended December 31, 2010.
Inflation and Changing Prices
While inflation has increased in China over the past two years, such inflation has not had a material effect on the Company’s net revenues because the Rural Consumer Electronics Plan grants a government sponsored rebate to our rural customers. Pursuant to the terms of the policy, our prices are competitive with the prices of the same goods in urban areas, however our customers are not required to pay a market driven price. As a result of this rebate, the actual cost incurred by our customers has not materially increased despite inflation.
Contractual Obligations
Our significant contractual obligations as of December 31, 2011 are as follows:
Obligations for Land Use Rights
The Company entered into a Land Use Right Purchase Agreement on October 28, 2010 and a supplemental Deposit Agreement on December 28, 2010 with the management committee of Pingqiao Industrial Park (the “Pingqiao Committee”), under which the Pingqiao Committee granted the Company a land use right for 300 Chinese acres where our LED manufacturing facility will be built. 120 Chinese acres of this land is for commercial use and 180 Chinese acres of this land is for industrial use. The Company paid RMB 100 million (approximately $15.74 million) of the purchase price as of December 31, 2010. The Company is not obligated to pay the remaining $3.7 million until it receive the land use right certificate issued by relevant PRC government pursuant to the Land Use Right Purchase Agreement. The Company expects the land use right certificate to be transferred to the Company by December 2012. The Company believes that if the land use right certificate is not granted to the Company by the local government, the Company will get a refund of the retainer paid from Pingqiao Committee.
Application of Critical Accounting Policies
Our financial statements and accompanying notes are prepared in accordance with accounting principles generally accepted in the United States (“U.S. GAAP”). Preparing financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, and expenses. These estimates and assumptions are affected by management’s application of accounting policies. Critical accounting policies for us include revenue recognition, contingencies, income taxes, and stock-based compensation.
See Note 2, Summary of Significant Accounting Policies, to the Notes to Consolidated Financial Statements for a complete discussion of related accounting policies.
Revenue Recognition - Product Sales
The Company receives revenue from sale of electronic products. The Company's revenue recognition policies are in compliance with ASC 605 (previously Staff Accounting Bulletin 104). The Company recognizes all product sales revenue at the date of shipment to customers, when a formal arrangement exists, the price is fixed or determinable, the delivery is completed, no other significant obligations of the Company exist and collectability is reasonably assured. The Company recognizes product sales revenue from exclusive franchise stores and non-exclusive franchise stores when the products are delivered to the respective store. Product sales to all franchise stores are recorded at the gross amount billed to the store as we have determined that we are principal to the transaction because we are the primary obligor in the arrangement.
No return rights are granted to franchise stores if they are unable to sell purchased inventories to end users. Additionally, our product sales from company-owned stores are covered by the respective manufacturers’ return and warranty policies and we receive full reimbursement for any costs associated with returns and warranty payments. As such, we do not estimate deductions or allowance for sales returns.
Our sales are covered by the manufacturers’ return and warranty policies and we receive a full reimbursement for costs associated with returns and warranty payments. Therefore, we do not estimate deductions or allowance for sales returns. The Company’s revenue from sales is presented as gross revenue. Payments received before all of the relevant criteria for revenue recognition are satisfied are recorded as customer deposit.
Our products delivered to customers are checked on site by the customers and, once the products are accepted by customers, they sign the acceptance notice. Rewards or incentives given to our customers are an adjustment of the selling prices of our products; therefore, the consideration is characterized as a reduction of revenue in our income statement.
The Company recognizes its revenues net of value-added taxes (“VAT”).
Revenue Recognition - Franchise Fees
Franchise fees, including area development and initial franchise fees, continuing fees, and royalties (collectively referred to as “franchise fees”) received from exclusive franchise stores and non-exclusive franchise stores for the right to establish new stores and royalties are charged to franchisees based on a percentage of a franchised store’s sales.
Franchise fees are accrued as unearned franchise revenue when received and are recognized as revenue when the respective franchised store opens, which is generally when we have fulfilled all significant obligations to the franchisee. Continuing fees and royalties are recognized in the period earned.
Currently, in connection with promotional efforts aimed at network growth, the Company has ceased charging franchise fees, continuing fees and royalties to our franchisees.
Legal and Other Contingencies
The outcomes of legal proceedings and claims brought against us are subject to significant uncertainty. An estimated loss from a loss contingency such as a legal proceeding or claim is accrued by a charge to income if it is probable that an asset has been impaired or a liability has been incurred and the amount of the loss can be reasonably estimated. Disclosure of a contingency is required if there is at least a reasonable possibility that a loss has been incurred. In determining whether a loss should be accrued we evaluate, among other factors, the degree of probability of an unfavorable outcome and the ability to make a reasonable estimate of the amount of loss. Changes in these factors could materially impact our financial statements.
Income Taxes
The objectives of accounting for income taxes are to recognize the amount of taxes payable or refundable for the current year and deferred tax liabilities and assets for the future tax consequences of events that have been recognized in an entity’s financial statements or tax returns. We 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 should be measured based on the largest benefit that has a greater than 50% likelihood of being realized upon ultimate settlement. Accounting literature also provides guidance on derecognition of income tax assets and liabilities, classification of current and deferred income tax assets and liabilities, accounting for interest and penalties associated with tax positions, and income tax disclosures. Judgment is required in assessing the future tax consequences of events that have been recognized in our financial statements or tax returns. Variations in the actual outcome of these future tax consequences could materially impact our financial statements.
Stock-Based Compensation
Stock-based compensation cost is measured at the grant date based on the fair value of the award and is recognized as expense over the requisite service period. Determining the fair value of stock-based awards at the grant date requires judgment, including estimating expected dividends. In addition, judgment is also required in estimating the amount of stock-based awards that are expected to be forfeited. If actual results differ significantly from these estimates, stock-based compensation expense and our results of operations could be impacted.
Recent Accounting Pronouncements
In December 2011, the FASB issued guidance on offsetting (netting) assets and liabilities. Entities are required to disclose both gross information and net information about both instruments and transactions eligible for offset in the statement of financial position and instruments and transactions subject to an agreement similar to a master netting arrangement. The new guidance is effective for annual periods beginning after January 1, 2013.
In September 2011, the FASB issued guidance on testing goodwill for impairment. The new guidance provides an entity the option to first perform a qualitative assessment to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If an entity determines that this is the case, it is required to perform the currently prescribed two-step goodwill impairment test to identify potential goodwill impairment and measure the amount of goodwill impairment loss to be recognized for that reporting unit (if any). If an entity determines that the fair value of a reporting unit is less than its carrying amount, the two-step goodwill impairment test is not required. The new guidance will be effective for us beginning July 1, 2012.
In June 2011, the FASB issued guidance on presentation of comprehensive income. The new guidance eliminates the current option to report other comprehensive income and its components in the statement of changes in equity. Instead, an entity will be required to present either a continuous statement of net income and other comprehensive income or in two separate but consecutive statements. The new guidance will be effective for us beginning July 1, 2012 and will have financial statement presentation changes only.
In May 2011, the FASB issued guidance to amend the accounting and disclosure requirements on fair value measurements. The new guidance limits the highest-and-best-use measure to nonfinancial assets, permits certain financial assets and liabilities with offsetting positions in market or counterparty credit risks to be measured at a net basis, and provides guidance on the applicability of premiums and discounts. Additionally, the new guidance expands the disclosures on Level 3 inputs by requiring quantitative disclosure of the unobservable inputs and assumptions, as well as description of the valuation processes and the sensitivity of the fair value to changes in unobservable inputs. The new guidance will be effective for us beginning January 1, 2012. Other than requiring additional disclosures, we do not anticipate material impacts on our financial statements upon adoption.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements and supplementary data of China Electronics Holdings, Inc. required by this item are described in Item 15 of this Annual Report on Form 10-K and are presented beginning on page.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
We changed our independent registered public accounting firm effective September 29, 2010 from GBH CPAs, PC (“GBH”) to Kabani & Company, Inc. (“Kabani”). Information regarding the change in the independent registered public accounting firm was disclosed in our Current Report on Form 8-K filed with the Commission on October 4, 2010. There were no disagreements with GBH, or any reportable events requiring disclosure under Item 304(b) of Regulation S-K.
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
The Company maintains disclosure controls and procedures as required under Rule 13a-15(e) and Rule 15d-15(e) promulgated under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), that are designed to ensure that information required to be disclosed in the Company’s Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and that such information is accumulated and communicated to the Company’s management, including its Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.
As of December 31, 2011, the Company’s management carried out an evaluation, under the supervision and with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of its disclosure controls and procedures. Based on the foregoing, its Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective as of December 31, 2011.
As of December 31, 2010, the Company’s management carried out an evaluation, under the supervision and with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of its disclosure controls and procedures. Based on the foregoing, its Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were not effective as of December 31, 2010.
As of the end of 2010, management concluded that our internal control and procedures were not effective because there is a lack of segregation of duties due to the small number of employees dealing with general administrative and financial matters. The management has decided that considering the employees involved, the control procedures in place, and the outsourcing of certain financial functions, and the risks associated with such lack of segregation are high and the potential benefits of adding additional employees to clearly segregate duties shall outweigh the expenses associated with such increases. Management will periodically reevaluate this situation. 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.
A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Because of the inherent limitations in all control systems no evaluation of controls can provide absolute assurance that all control issues, if any, within a company have been detected. Such limitations include the fact that human judgment in decision-making can be faulty and that breakdowns in internal control can occur because of human failures, such as simple errors or mistakes or intentional circumvention of the established process.
Management’s Annual Report on Internal Control Over Financial Reporting.
History
Substantially all of the internal control over financial reporting that existed prior to July 15, 2010 no longer exists and has been replaced by the internal control over financial reporting of CEHD Nevada, which we acquired in a reverse acquisition on that date.
Management Report on Internal Control Over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is defined in Rule 13a-15(f) and 15d-15(f) promulgated under the Exchange Act as a process designed by, or under the supervision of, our principal executive officer and principal financial officer and effected by our Board of Directors, management, and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles and includes those policies and procedures that:
●
Pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the Company;
●
Provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and
●
Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of our assets that could have a material effect on the financial statements.
Because of its inherent limitations, our internal control over financial reporting may not prevent or detect misstatements. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation. Projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Fiscal Year Ended December 31, 2011
As of December 31, 2011, the Company’s management conducted an assessment of the effectiveness of the Company’s internal control over financial reporting as of December 31, 2011, based on criteria for effective internal control over financial reporting described in “ Internal Control-Integrated Framework “ issued by the Committee of Sponsoring Organizations of the Treadway Commission. Management’s assessment included an evaluation of the design of the Company’s internal control over financial reporting and testing of the operational effectiveness of its internal control over financial reporting.
Based on this assessment, management determined that, as of December 31, 2011, the Company maintained effective internal control over financial reporting, although we did recognize a significant deficiency. A significant deficiency is a deficiency, or a combination of deficiencies, that is less severe than a material weakness, yet important enough to merit attention by those responsible for oversight of the registrant’s financial reporting.
Although currently we do not identify any material weaknesses in the process of self assessment, we have recognized a significant deficiency in our internal controls. Currently we do not have sufficient in-house expertise in US GAAP reporting. Instead, we rely on the expertise and knowledge of external financial advisors in US GAAP conversion who helped prepare and review the consolidated financial statements. Although we have not identified any material errors with our financial reporting or any material weaknesses with our internal controls, no assurances can be given that there are no such material errors or weaknesses existing. In addition, we do not believe we have sufficient documentation with our existing financial processes, risk assessment and internal controls. We plan to work closely with external financial advisors to document the existing financial processes, risk assessment and internal controls systematically.
Fiscal Year Ended December 31, 2010
As of December 31, 2010, the Company’s management conducted an assessment of the effectiveness of the Company’s internal control over financial reporting as of December 31, 2010, based on criteria for effective internal control over financial reporting described in “ Internal Control-Integrated Framework “ issued by the Committee of Sponsoring Organizations of the Treadway Commission. Management’s assessment included an evaluation of the design of the Company’s internal control over financial reporting and testing of the operational effectiveness of its internal control over financial reporting.
Based on the assessment, management determined that, as of December 31, 2010, the Company had made material adjustments to our financial statements as of December 31, 2010 in order for them to be in conformity with Generally Accepted Accounting Principles. The prevalence and significance of these adjustments resulted in our concluding that we have a material weakness in our internal controls over financial reporting as of December 31, 2010, and that our internal controls over financial reporting were not effective. In addition, as substantially all of the internal control over financial reporting exists after July 15, 2010 after we acquired Guoying through reverse merger on July 15, 2010, our management believes that there was a relatively short period of time between the date of the business combination and the end of our fiscal year on December 31, 2010 during which our management could make an assessment of the acquired company's internal control over financial reporting;
Changes in Internal Control Over Financial Reporting
Since the first quarter of our 2011 fiscal year, we began to implement the remedial measures, including but without limitations to: standardizing the Company’s definitions of each type of stores, time of signing franchise agreement and beginning of time of generation of revenue from stores; standardizing our non-accounting information system into electronic format; hiring financial professionals and supporting staff in both U.S. and China; intensifying the interaction and cooperation between our U.S. and China offices; enhancing the design and documentation of our internal control policies and procedures to ensure appropriate controls over our financing reporting.
Except as described above, there were no changes in the Company’s internal control over financial reporting that occurred during 2011 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
ITEM 9B.
ITEM 9B. OTHER INFORMATION
None.
ART III
ITEM 10.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
Directors and Executive Officers
The following table sets forth the name and position of each of our current executive officers and directors.
Name
Age
Position
Hailong Liu
Chairman, President, CEO and CFO
Haibo Liu
Director and Vice President
Hailong Liu became our Chairman, President, CEO and CFO on July 15, 2010. Mr. Liu has been the CEO of Lu’an Guoying Electronic Sales Co., Ltd. since May 2007. From 2004 to 2007, Mr. Liu was the general manager of Guoying (Formerly named as Lu’an Dongshen Electronic Sales Co., Ltd.). From 2001 to 2003, Mr. Liu was the general manager of Lu’an Xianglong Electronic Sales Co., Ltd. From 1997 to 2001, Mr. Liu was the associate manager of Operation Department of Lu’an Xianglong Electronic Sales. From 1994 to 1996, Mr.Liu was the manager of Nanjing Branch of Shanghai Kaili Company. From 1990 to 1994, Mr. Liu was the manager of Shenzhen Branch of Shanghai Kaili Company. Hailong Liu and Haibo Liu are brothers. Mr. Liu got his Executive MBA Degree on Marketing and Sales from Beijing University in 2005. He is currently studying for his Ph.D. degree in economics at Tsinghua University in China.
Haibo Liu became our Director and Vice President on July 15, 2010. Mr.Liu has been the general manager of sales of Lu’an Guoying Electronic Sales Co., Ltd. since September 2007. From January 2004 to September 2007, Mr. Liu was the shareholder and general manager of Guoying. From 2000 to 2003, Mr. Liu was the general manager of Lu’an Shengtang Sales Co., Ltd. From 1992 to 1999, Mr. Liu established Lu’an Haifeng Sales Operation Department. Haibo Liu and Hailong Liu are brothers. Mr. Liu has been enrolled as a part-time student in Shenzhen Jucheng Business School since October 2007, majoring in marketing and sales.
Employment Agreements
We have not entered into employment agreements with any of our officers or other key employees.
Code of Ethics
Our board of directors will adopt a new code of ethics that applies to all of our directors, officers and employees, including our principal executive officer, principal financial officer and principal accounting officer. The new code will address, among other things, honesty and ethical conduct, conflicts of interest, compliance with laws, regulations and policies, including disclosure requirements under the federal securities laws, confidentiality, trading on inside information, and reporting of violations of the code.
Audit Committee
We currently do not have a standing audit committee. Currently, our entire board of directors is responsible for the functions that would otherwise be handled by this committee. We intend, however, to establish an audit committee of the board of directors as soon as practicable. We envision that the audit committee will be primarily responsible for reviewing the services performed by our independent auditors, evaluating our accounting policies and our system of internal controls.
Our board of directors has not made a determination as to whether any member of our board of directors is an audit committee financial expert. Upon the establishment of an audit committee, the board will determine whether any of the directors qualify as an audit committee financial expert.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
Summary Compensation Table
Our former executive officers did not receive any compensation. Our current executive officers do not receive any compensation for serving as executive officers for China Electronics; however, they are compensated by and through Guoying. The following table sets forth information concerning cash and non-cash compensation paid by Guoying to our named executive officers for the periods indicated, respectively. None of our executive officers received compensation in excess of $100,000 for either of those two years.
The Company does not have any equity compensation plans. The Company does not currently pay any compensation to its non-officer directors.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The following table sets forth information regarding beneficial ownership of our Common Stock as of April 16, 2012 (i) by each person who is known by us to beneficially own more than 5% of our Common Stock; (ii) by each of the officers and directors of the Company and (iii) by all of officers and directors of the Company as a group.
(1) Unless otherwise provided, the address of each person is G-8, Guangcai Big Market, Foziling West Road, Lu’An City, Anhui Provice, 237001.
(2) Beneficial Ownership is determined in accordance with the rules of the Securities and Exchange Commission (the “SEC” or the “Commission”) and generally includes voting or investment power with respect to securities. The percent of class has also been determined in accordance with rules of the Commission. For purposes of computing such percentage, as of April 16, 2012, there were 16,775,113 shares of our Common Stock outstanding.
(3) Hailong Liu is the Voting Trustee under a Voting Trust Agreement dated as of July 9, 2010 between Sherry Li and Hailong Liu pursuant to which Hailong has the right to vote an aggregate of 11,556,288 shares of Common Stock which were issued to Sherry Li.
(4) Ms. Sherry Li is the nominee shareholder on behalf of Mr. Hailong Liu. Pursuant to that certain Call Option Agreement between Ms. Sherry Li and Hailong Liu, Hailong Liu has been granted an option, subject to the satisfaction of certain conditions, to purchase from Ms. Li over the course of approximately 2 years for $0.0001 per share, up to 11,556,288 shares of our Common Stock held by Ms. Li. The conditions and the percentage of the total number of shares subject to the option that would vest upon satisfaction of the condition are as follows:
o
Filing of a Quarterly Report on Form 10-Q with SEC following the execution of the Share Exchange Agreement - 50%
2 years after the filing of Form 10-Q - 50%
The first condition was satisfied on August 23, 2010 and 5,778,144 Option Shares have been assigned to Mr. Liu from Sherry Li. The second condition will be satisfied on August 23, 2012.
(5) Under a Stock Option Agreement dated as of July 9, 2010, Hailong Liu has granted to American Capital Partners, LLC an option to purchase an aggregate of 757,576 shares of Common Stock at an exercise price of $2.64 per share. The option becomes exercisable in two installments of 378,788 shares each, the first installment of which is exercisable from October 9, 2010 to April 8, 2011 and the second installment of which is exercisable from April 9, 2011 to October 8, 2011. To date, no options have been exercised under the Stock Option Agreement.
(6) Includes 1,000,000 shares issuable upon exercise of currently exercisable warrants.
Changes in Control
Except for the Call Option Agreement described in footnote (4) to the table contained in the section of this prospectus entitled “Security Ownership of Certain Beneficial Owners and Management,” there are currently no arrangements that may result in a change in control of the Company.
Equity Compensation Plans
The Company does not have any equity compensation plans.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
Transactions with Related Persons
On July 9, 2010, Hailong Liu (“Mr. Liu”), our Chairman, President, Chief Executive Officer and Chief Financial Officer, entered into a Call Option Agreement with Sherry Li (the “Ms. Li”), the holder of 11,556,288 shares of our Common Stock (the “Option Shares”). Under the Call Option Agreement, the Mr. Liu shall have right and option to acquire 50% of Option Shares upon first filing of a quarterly report on Form 10-Q with the SEC on August 23, 2010 following the execution of the Share Exchange Agreement and 50% of the remaining Option Shares 2 years after such filing by August 23, 2012. Pursuant to the terms of the Call Option Agreement, Sherry Li transferred to Mr. Liu 5,778,144 Option Shares in August 2010.
We entered into a lease agreement with Mr. Haibo Liu on January 1, 2008 to rent Wangpai warehouse of 808 square meters located in Liu Fo Road to storage Huangming solar products. The term of the lease is from 2008 to 2011 and the rent is RMB 6, 464 per year (RMB 8 per square meters).
We currently lease for our two company-owned stores. We entered into a lease agreement with Mr. Haibo Liu to rent first floor for our Guangcai Big Market Store on October 30, 2008 for 3 years until 2011 at a rent of RMB 20, 882 per year. We renewed the lease to rent all four floors for our Guangcai Big Market Store on April 1, 2011 for another 3 years until 2014 subject to renewal at a rent of RMB 720,000 per year. We entered into a lease agreement with Mr. Haibo Liu in 2010 for our Hao Men store for one year and renewed our lease on March 15, 2011 for another 3 years until 2014 subject to renewal at a rent of RMB 68,000 per year.
Director Independence
We currently do not have any independent directors, as the term “independent” is defined by the Rule 5605(a)(2) of the Marketplace Rules of the NASDAQ Stock Market.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The following table sets forth the aggregate fees billed to the Company for the fiscal years ended December 31, 2011 and 2010 by its independent registered public accounting firm, Kabani & Company, Inc.
____________
(1)
Audit fees represent the aggregate fees billed or to be billed for professional services rendered for the audit of our annual consolidated financial statements and review of interim quarterly financial statements included in our quarterly reports on Form 10-Q.
Policy on Audit Committee Pre-Approval of Services Provided by Independent Registered Public Accounting Firm
We currently do not have a standing audit committee. Currently, our entire board of directors is responsible for the functions that would otherwise be handled by this committee. The board of directors pre-approves all audit and non-audit services provided by the independent registered public accounting firm, other than de minimis non-audit services, and does not engage the independent registered public accounting firm to perform the specific non-audit services proscribed by law or regulation.
PART IV
ITEM 15.
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
(a)
The financial statements beginning on page are filed as a part of this report.
(b)
See the Exhibit Index attached hereto for a list of the exhibits filed or incorporated by reference as a part of this report.
CHINA ELECTRONICS HOLDINGS, INC AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Report of Independent Registered Public Accounting Firm
Board of Directors and Stockholders of
China Electronics Holdings, Inc. and Subsidiaries
We have audited the accompanying balance sheets of China Electronics Holdings, Inc. and Subsidiaries as of December 31, 2011 and 2010, and the related statements of income, stockholders' equity, and cash flows for the two years period ended December 31, 2011. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of China Electronics Holdings, Inc. and Subsidiaries as of December 31, 2011 and 2010, and the results of their operations and their cash flows for the two years period ended December 31, 2011, in conformity with U.S. generally accepted accounting principles.
As discussed in Note #18, the company has restated its earnings per share calculations for the year ended December 31, 2010.
/s/ Kabani & Company, Inc.
Certified Public Accountants
Los Angeles, California
April 16, 2012
The accompanying notes are an integral part of this consolidated statement.
The accompanying notes are an integral part of this consolidated
The accompanying notes are an integral part of this consolidated statement.
The accompanying notes are an integral part of this consolidated statement.
CHINA ELECTRONIC HOLDINGS, INC AND SUBSIDIARIES
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
December 31, 2011 and 2010
1.
Nature of Operations
China Electronics Holdings, Inc (the “Company” or “CEHD Nevada”), formerly named Buyonate, Inc., was incorporated in the State of Nevada on July 9, 2007 to engage in developing user-friendly/child friendly interactive digital software for children between the ages of 5 to 12 years old.
China Electronic Holdings, Inc (“CEH Delaware”) was organized on November 15, 2007, as a Delaware corporation.
Pursuant to the Share Transfer Agreement entered into on December 26, 2008 (the “2008 Share Transfer”) between the shareholders of Guoying (the “Guoying Shareholders”) and CEH Delaware, CEH Delaware acquired 40% of the outstanding equity securities of Guoying (the “Guoying Shares”) from all of the Guoying Shareholders in consideration for $60,000, equivalent to RMB 400,000. Pursuant to the Share Transfer Agreement entered into on February 2010 (the “2010 Share Transfer”) between Guoying Shareholders and CEH Delaware, CEH Delaware acquired the remaining 60% of the outstanding equity securities of Guoying Shares from all of the Guoying Shareholders in consideration for RMB 600,000 and Guoying Shareholders transferred and contributed all of their Guoying Shares to CEH Delaware. Guoying Shareholders contributed the Purchase Price to Guoying for working capital and general corporate purpose and as a result of the 2008 and 2010 Share Transfers, Guoying became a wholly foreign-owned subsidiary (“WFOE”) of CEH Delaware. The exchange of shares pursuant to the 2008 and 2010 Share Transfers was accounted for as a reverse acquisition at historical costs since the stockholders of Guoying obtained control of CEH Delaware and the management of Guoying became the management of CEH Delaware with the appointment of Mr. Hailong Liu (Chief Executive Officer of Guoying) as CEH Delaware’s sole director, Chief Executive Officer, Chief Financial Officer, Secretary and Treasurer. Accordingly, the merger of Guoying into CEH Delaware was recorded as a recapitalization of Guoying, with Guoying being treated as the continuing entity. The historical financial statements presented are the financial statements of Guoying.
The Company entered into a Share Exchange Agreement, dated as of July 9, 2010 (the “Share Exchange Agreement”) with CEH Delaware and certain stockholders and warrant holders of CEH Delaware (the “CEH Delaware Stockholders”). Pursuant to the Share Exchange Agreement, on July 15, 2010, 10 CEH Delaware Stockholders transferred 100% of the outstanding shares of common stock and preferred stock and 100% of the warrants to purchase common stock of CEH Delaware held by them, in exchange for an aggregate of 13,785,902 newly issued shares of the Company’s Common Stock (including 13,665,902 shares of common stock issued pursuant to the Share Exchange Agreement dated July 22, 2010, and 120,000 shares of common stock issued to consultants related to their professional services) and warrants to purchase an aggregate of 1,628,570 shares of our Common Stock. The shares of the Company’s common stock acquired by the CEH Delaware Stockholders in such transactions constitute approximately 86% of the Company’s issued and outstanding Common Stock giving effect to the share and warrant exchange and the sale of the Company’s Common Stock pursuant to the Subscription Agreement, but not including any outstanding purchase warrants to purchase shares of the Company’s common stock, including the warrants issued pursuant to the Subscription Agreement. In connection with the closing of the Share Exchange Agreement, CEH Delaware purchased from the former principal stockholder of Buyonate an aggregate of 4 million shares of our common stock and then agreed to the cancellation of such shares.
The Share Exchange resulted in (i) a change in our control with a shareholder of CEH Delaware owning approximately 82.2%of issued and outstanding shares of the Company’s common stock, including the shares of common stock sold to PIPE investors pursuant to the Subscription Agreement, (ii) CEH Delaware becoming our wholly-owned subsidiary, and (iii) appointment of Mr. Hailong Liuas as the Company’s sole director, Chief Executive Officer, Chief Financial Officer, Secretary and Treasurer.
In connection with the July 9, 2010 Share Exchange transactions, Hailong Liu, the officer, director and majority shareholder of Guoying and CEO and president of CEHD Nevada entered into a call option agreement (the “Call Option Agreement”) and voting trust agreement (the “Voting Trust Agreement”) with Sherry Li, the founder of CEH Delaware and nominee shareholder on behalf of Mr. Hailong Liu of CEH Delaware and CEHD Nevada, dated July 9, 2010. Pursuant to the Call Option Agreement, Mr. Liu received two-year options exercisable for 11,556,288 shares of common stock (the Option Shares) from Sherry Li and Mr. Liu shall have right and option to acquire 50% of Option Shares upon first filing of a quarterly report on Form 10-Q with the SEC on August 23, 2010 following the execution of the Share Exchange Agreement and 50% of the remaining Option Shares 2 years after such filing by August 23, 2012. Pursuant to the Voting Trust Agreement, Sherry Li, the nominee shareholder, has not decision power to vote or dispose of the Option Shares without Mr. Liu’s consent. Pursuant to the terms of the Call Option Agreement, Mr. Liu received 5,778,144 shares in August 2010 from Ms. Sherry Liu pursuant to the vesting schedule set forth in the Call Option Agreement. Upon exercise of the options, Mr. Liu may purchase each share for $0.001 and if Mr. Liu exercises all of his options, he will own a majority of the Company’s outstanding shares of Common Stock. The Call Option Agreement provides that Ms. Sherry Li shall not vote or dispose of the respective portion of the shares of common stock without Mr. Liu’s prior written consent.
The exchange of shares pursuant to the July 10, 2010 Share Exchange was accounted for as a reverse acquisition at historical cost since the controlling stockholder and beneficial owner of CEH Delaware obtained control of the Company and the management of CEH Delaware became the management of the Company. Mr, Liu, who maintained control of Guoying prior to the mergers and subsequently, obtained control of CEH Delaware pursuant to 2008 and 2010 Share Transfers, effectively obtained control of the Company upon completion of Share Exchange subject to the Voting Trust Agreement and Call Option Agreement. Accordingly, the merger of CEH Delaware into the Company was recorded as a recapitalization of CEH Delaware, with CEH Delaware being treated as the continuing entity. The historical financial statements presented are the financial statements of CEH Delaware which are in essence the financial statements of Guoying
2.
Summary of Significant Accounting Policies
Basis of Presentation
In the opinion of management, the accompanying balance sheets and related interim statements of income and comprehensive income, and cash flows include all adjustments, consisting only of normal recurring items, necessary for their fair presentation in conformity with accounting principles generally accepted in the United States of America (“U.S. GAAP”). All significant inter-company transactions and accounts have been eliminated in the consolidation. The functional currency is the Chinese Renminbi (“RMB”); however the accompanying financial statements have been translated and presented in United States Dollars (“USD”).
Economic and Political Risks
The Company faces a number of risks and challenges as a result of having primary operations and marketing in the PRC. Changing political climates in the PRC could have a significant effect on the Company’s business.
Principles of Consolidation
The consolidated financial statements include the financial statements of the company, its wholly owned subsidiary CEH Delaware, and its wholly owned subsidiary Guoying. The financial statements of co-operative stores (exclusive franchise stores and non-exclusive franchise stores) are not consolidated as these stores are independently managed and they have no right to return their purchased goods.
All significant inter-company balances and transactions have been eliminated in consolidation.
Use of Estimates
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the 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 income and expenses during the reporting period. Actual results could differ from those estimates.
Cash and Cash Equivalents
For purposes of the statements of cash flows, cash and cash equivalents includes cash on hand and cash in time deposits, certificates of deposit and all highly liquid debt instruments with original maturities of three months or less. Deposits held in financial institutions in the PRC are not insured by any government entity or agency. The restricted cash of $0 represents amount deposited by the company against issuance of acceptance bill to its supplier. The Company issues acceptance bills to its suppliers through Chinese banks from time to time. Acceptance bills are in the form of notes payables that are written promises to pay stated sums of money at future dates. Standard practice in China requires Companies to maintain restricted deposits at those banks that issue acceptance bills to suppliers of the Company to ensure sufficient payment on demand.
Trade Accounts Receivable
The Company extends unsecured credit to its customers in the ordinary course of business but mitigates the associated risks by performing credit checks and actively pursuing past due accounts. Trade accounts receivable are recognized and carried at original invoice amount less an allowance for any uncollectible amounts. An allowance for doubtful accounts is established and determined based on management’s regular assessment of known requirements, aging of receivables, payment history, the customer’s current credit worthiness and the economic environment. These factors continuously change, and can have an impact on collections and the Company’s estimation process. These impacts may be material. Management reviews and maintains an allowance for doubtful accounts that reflects the management’s best estimate of potentially uncollectible trade receivables. Certain accounts receivable amounts are charged off against allowances after a designated period of collection efforts. Subsequent cash recoveries are recognized as income in the period when they occur. Allowance for doubtful debts amounted for accounts receivable to $2,198,376 and $2,065,683 as of December 31, 2011 and December 31, 2010, respectively. We do not set a specific date for payments from customers. The Company reviews the balance periodically and decides the collection time based on the market condition, the Company’s cash position, the potential purpose from the customers, the amount of the sales, and other conditions.
Inventories
Inventories are stated at the lower of cost, determined on a weighted average basis, and net realizable value. The cost of the inventory includes that costs of acquiring electronic products sold plus freight in costs incurred acquiring the inventory. The freight costs are allocated to the individual products purchased. Net realizable value is the estimated selling price, in the ordinary course of business, less estimated costs to complete and dispose. Inventories consist of the following:
Property, Plant and Equipment
Property, plant and equipment are carried at cost less accumulated depreciation. Depreciation is computed using the straight-line method over the useful lives of the assets. Major renewals are capitalized and depreciated; maintenance and repairs that do not extend the life of the respective assets are charged to expense as incurred. Upon disposal of assets, the cost and related accumulated depreciation are removed from the accounts and any gain or loss is included in income. Depreciation related to manufacturing is reported in cost of revenues. Depreciation not related to manufacturing is reported in selling, general and administrative expenses. Property, plant and equipment are depreciated over their estimated useful lives as follows:
Furniture and office equipment
5 years
Motor vehicles
10 years
Impairment of Long-Lived and Intangible Assets
Long-lived assets of the Company are reviewed annually to assess whether the carrying value has become impaired according to the guidelines established in FASB Codification (ASC) 360. The Company considers assets to be impaired if the carrying value exceeds the future projected cash flows from related operations. The Company also re-evaluates the periods of depreciation to determine whether subsequent events and circumstances warrant revised estimates of useful lives. As of December 31, 2011, the Company expects these assets to be fully recoverable. No impairment of assets was recorded in the periods reported.
Revenue Recognition - Product Sales
The Company receives revenue from sale of electronic products. The Company's revenue recognition policies are in compliance with ASC 605 (previously Staff Accounting Bulletin 104). The Company recognizes all product sales revenue at the date of shipment to customers, when a formal arrangement exists, the price is fixed or determinable, the delivery is completed, no other significant obligations of the Company exist and collectability is reasonably assured. The Company recognizes product sales revenue from our sales to exclusive franchise stores and non-exclusive franchise stores when the products are delivered to the respective store. Product sales to all co-operative stores are recorded at the gross amount billed to the store as we have determined that we are principal to the transaction because we are the primary obligor in the arrangement.
No return rights are granted to co-operative stores if they are unable to sell their purchased inventories to the end users. Additionally, our product sales from company-owned stores are covered by the respective manufacturers’ return and warranty policies and we receive full reimbursement for any costs associated with returns and warranty payments. As such, we do not estimate deductions or allowance for sales returns.
Our sales are covered by the manufacturers’ return and warranty policies and we receive a full reimbursement for costs associated with returns and warranty payments. Therefore, we do not estimate deductions or allowance for sales returns. The Company’s revenue from sales is presented as gross revenue. Payments received before all of the relevant criteria for revenue recognition are satisfied are recorded as unearned. Revenue amounted to $0 and $1,926,811 as of December 31, 2011 and December 31, 2010, respectively.
Our products delivered to customers would be checked on site by customers and, once the products are accepted by customers, they will sign the acceptance notice. Rewards or incentives given to our retail customers or franchise stores are an adjustment of the selling prices of our products sold to our customers; therefore, the consideration is characterized as a reduction of revenue when recognized in our income statement.
The Company recognizes its revenues net of value-added taxes (“VAT”). Currently, the Company is exempt from VAT by the PRC Government and hence, a fixed annual amount of approximately $1,200 cover value added taxes.
Revenue Recognition - Franchise Fees
Franchise fees, including area development and initial franchise fees, continuing fees, and royalties (collectively referred to as “franchise fees”) received from co-operative stores (exclusive franchise stores and non-exclusive franchise stores) for the purpose of establishing new stores and royalties are charged to franchisees based on a percentage of a franchised store’s sales.
Franchise fees are accrued as unearned franchise revenue when received and are recognized as revenue when the respective franchised store opens, which is generally when we have fulfilled all significant obligations to the franchisee. Continuing fees and royalties are recognized in the period earned.
Currently, in connection with promotional efforts aimed at network growth, the Company has ceased charging franchise fees, continuing fees and royalties to our co-operative stores as the Company. As such, total franchise fees for the years-ended December 31, 2011 and 2010 were 0.
Cost of Goods Sold
Cost of goods sold consists primarily of the costs of the products sold, including freight in charges on those goods.
Selling Expenses
Selling expenses include costs incurred in connection with performing general selling activities, such as sales commissions, freight-out charges, marketing and advertisement costs, shipping and handling costs, and sales salaries.
General and Administrative Expenses
General and administrative expenses include the costs of non-selling related salaries and related employee benefits, professional service fees, rent and depreciation, warehousing costs, office supplies, and bad debts expense.
Shipping and Handling Costs
ASC 605-45-20 ( formely EITF No. 00-10, “ Accounting for Shipping and Handling Fees and Costs ” ) establishes standards for the classification of shipping and handling costs. Shipping and Handling costs include shipping and handling costs related to shipping and handling our products from our warehouses to buyers’ designated locations at our exclusive or non-exclusive franchise stores, and company owned stores. Shipping and handling costs that are billed to customers are classified as revenue, while those costs not billed to customers are classified as selling expenses. Shipping and handling costs billed to customers and included within revenue for the years ended December 31, 2011 and 2010 were $0 because the Company did not charge any shipping and handling expenses from customers. Shipping and handling costs not billed to customers and included within selling expenses for the years ended December 31, 2011 and 2010 were $849,850 and $1,817,653, respectively.
Advertising Costs
The Company expenses advertising costs as incurred. Advertising costs of $654,410 and $570,917 are included in selling, general and administrative expense for the years ended December 31, 2011 and 2010, respectively.
Foreign Currency and Comprehensive Income
The accompanying financial statements are presented in US dollars. The functional currency is the Renminbi (“RMB”) of the PRC. The financial statements are translated into US dollars from RMB at period-end exchange rates for assets and liabilities, and weighted average exchange rates for revenues and expenses. Capital accounts are translated at their historical exchange rates when the capital transactions occurred.
RMB is not freely convertible into the currency of other nations. All such exchange transactions must take place through authorized institutions. There is no guarantee the RMB amounts could have been, or could be, converted into US dollars at rates used in translation. At December 31, 2011 and 2010, the cumulative translation adjustment of $3,347,001 and $1,765,664, respectively, was classified as an item of other comprehensive income in the stockholders’ equity section of the consolidated balance sheet. For the years ended December 31, 2011 and 2010, accumulated other comprehensive gain was $1,581,337 and $1,076,580, respectively.
Income Taxes
The Company accounts for income taxes in accordance with ASC 740 (formerly SFAS 109, “Accounting for Income Taxes.”) Under the asset and liability method as required by ASC 740, deferred income taxes are recognized for the tax consequences of temporary differences by applying enacted statutory tax rates applicable to future years to differences between the financial statement carrying amounts and the tax bases of existing assets and liabilities. Under ASC 740, the effect on deferred income taxes of a change in tax rates is recognized in income in the period that includes the enactment date. A valuation allowance is recognized if it is more likely than not that some portion, or all of, a deferred tax asset will not be realized. As of December 31, 2011 and 2010, the Company did not have any deferred tax assets or liabilities, and as such, no valuation allowances were recorded at December 31, 2011 and 2010.
ASC 740 clarifies the accounting and disclosure for uncertain tax positions and prescribes a recognition threshold and measurement attribute for recognition and measurement of a tax position taken or expected to be taken in a tax return. ASC 740 also provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods, disclosure and transition.
Under ASC 740, evaluation of a tax position is a two-step process. The first step is to determine whether it is more-likely-than-not that a tax position will be sustained upon examination, including the resolution of any related appeals or litigation based on the technical merits of that position. The second step is to measure a tax position that meets the more-likely-than-not threshold to determine the amount of benefit to be recognized in the financial statements. A tax position is measured at the largest amount of benefit that is greater than 50 percent likely of being realized upon ultimate settlement. Tax positions that previously failed to meet the more-likely-than-not recognition threshold should be recognized in the first subsequent period in which the threshold is met. Previously recognized tax positions that no longer meet the more-likely-than-not criteria should be de-recognized in the first subsequent financial reporting period in which the threshold is no longer met.
The Company’s operations are subject to income and transaction taxes in the United States and the PRC jurisdictions. Significant estimates and judgments are required in determining the Company’s worldwide provision for income taxes. Some of these estimates are based on interpretations of existing tax laws or regulations, and as a result the ultimate amount of tax liability may be uncertain. However, the Company does not anticipate any events that would lead to changes to these uncertainties.
Restrictions on Transfer of Assets Out of the PRC
Dividend payments by the Company are limited by certain statutory regulations in the PRC. No dividends may be paid by the Company without first receiving prior approval from the Foreign Currency Exchange Management Bureau. However, no such restrictions exist with respect to loans and advances.
Financial Instruments
ASC 825 (formerly SFAS 107, “Disclosures about Fair Value of Financial Instruments”) defines financial instruments and requires disclosure of the fair value of those instruments. ASC 820 (formerly SFAS 157, “Fair Value Measurements”), adopted July 1, 2008, defines fair value, establishes a three-level valuation hierarchy for disclosures of fair value measurement and enhances disclosure requirements for fair value measures. The carrying amounts reported in the balance sheets for current receivables and payables, including short-term loans, qualify as financial instruments and are a reasonable estimate of fair value because of the short period of time between the origination of such instruments, their expected realization and, if applicable, the stated rate of interest is equivalent to rates currently available. The three levels are defined as follows:
·
Level 1: inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets.
·
Level 2: inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the assets or liability, either directly or indirectly, for substantially the full term of the financial instruments.
·
Level 3: inputs to the valuation methodology are unobservable and significant to the fair value.
The Company did not identify any assets or liabilities that are required to be presented on the balance sheet at fair value in accordance with ASC 820.
Stock-Based Compensation
The Company records stock-based compensation expense pursuant to ASC 718 (formerly SFAS 123R, “Share Based Payment.”) The Company uses the Black-Scholes option pricing model which requires the input of highly complex and subjective variables including the expected life of options granted and the Company’s expected stock price volatility over a period equal to or greater than the expected life of the options. Because changes in the subjective assumptions can materially affect the estimated value of the Company’s employee stock options, it is management’s opinion that the Black-Scholes option pricing model may not provide an accurate measure of the fair value of the Company’s employee stock options. Although the fair value of employee stock options is determined in accordance with ASC 718 using an option pricing model, that value may not be indicative of the fair value observed in a willing buyer/willing seller market transaction.
Stock-based compensation expense is recognized based on awards expected to vest, and there were no estimated forfeitures as the Company has a short history of issuing options. ASC 718 (formerly SFAS 123R) requires forfeitures to be estimated at the time of grant and revised in subsequent periods, if necessary, if actual forfeitures differ from those estimates.
There was no stock based compensation for the years ended December 31, 2011 and 2010.
Statement of Cash Flows
In accordance with ASC 230 (formerly SFAS No. 95 “Statement of Cash Flows”) cash flows from the Company's operations is calculated based upon the local currencies. As a result, amounts related to assets and liabilities reported on the statement of cash flows may not necessarily agree with changes in the corresponding balances on the balance sheet.
Segment Reporting
ASC 280 (formerly SFAS No. 131, “Disclosure about Segments of an Enterprise and Related Information”) requires use of the management approach model for segment reporting. The Company uses the management approach model for segment reporting, which is based on the way a company's management organizes segments within the company for making operating decisions and assessing performance. Reportable segments are based on products and services, geography, legal structure, management structure, or any other manner in which management disaggregates a company. The Company has determined that its operations consist of three reportable business segments as all revenue is derived from customers in the People’s Republic of China (PRC) and all of the Company’s assets are located in PRC.
Recent Accounting Pronouncements
The Company has reviewed all recently issued, but not yet effective, accounting pronouncements and does not believe the future adoption of any such pronouncements may be expected to cause a material impact on its financial condition or the results of its operations.
In December 2011, the FASB issued guidance on offsetting (netting) assets and liabilities. Entities are required to disclose both gross information and net information about both instruments and transactions eligible for offset in the statement of financial position and instruments and transactions subject to an agreement similar to a master netting arrangement. The new guidance is effective for annual periods beginning after January 1, 2013.
In September 2011, the FASB issued guidance on testing goodwill for impairment. The new guidance provides an entity the option to first perform a qualitative assessment to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If an entity determines that this is the case, it is required to perform the currently prescribed two-step goodwill impairment test to identify potential goodwill impairment and measure the amount of goodwill impairment loss to be recognized for that reporting unit (if any). If an entity determines that the fair value of a reporting unit is less than its carrying amount, the two-step goodwill impairment test is not required. The new guidance will be effective for us beginning July 1, 2012.
In June 2011, the FASB issued guidance on presentation of comprehensive income. The new guidance eliminates the current option to report other comprehensive income and its components in the statement of changes in equity. Instead, an entity will be required to present either a continuous statement of net income and other comprehensive income or in two separate but consecutive statements. The new guidance will be effective for us beginning July 1, 2012 and will have financial statement presentation changes only.
In May 2011, the FASB issued guidance to amend the accounting and disclosure requirements on fair value measurements. The new guidance limits the highest-and-best-use measure to nonfinancial assets, permits certain financial assets and liabilities with offsetting positions in market or counterparty credit risks to be measured at a net basis, and provides guidance on the applicability of premiums and discounts. Additionally, the new guidance expands the disclosures on Level 3 inputs by requiring quantitative disclosure of the unobservable inputs and assumptions, as well as description of the valuation processes and the sensitivity of the fair value to changes in unobservable inputs. The new guidance will be effective for us beginning January 1, 2012. Other than requiring additional disclosures, we do not anticipate material impacts on our financial statements upon adoption.
3.
Basic and Diluted Earnings Per Share
Basic and Diluted Earnings Per Share
Basic earnings per share excludes dilution and is computed by dividing income available to common stockholders by the weighted average common shares outstanding during the period. Diluted earnings per share takes into account the potential dilution that could occur if securities or other contracts to issue common stock were exercised and converted into common stock. Under this method, options and warrants are assumed to be exercised at the beginning of the period (or at the time of issuance, if later), and as if funds obtained thereby were used to purchase common stock at the average market price during the period. At December 31, 2011 and 2010, the Company had 1,903,526 and 497,303 warrants outstanding that were anti-dilutive.
The following is a reconciliation of the basic and diluted earnings per share:
4.
Property and Equipment
Property and equipment consisted of the following:
Depreciation expense included in selling, general and administrative expenses for the years ended December 31, 2011 and 2010 was $11,467 and $10,409, respectively.
5.
Other Receivables
Other receivables consisted of the following:
As of December 31, 2011, loans receivable included the followings:
·
The loan receivable from Shanghai Pengbai Electronic Co., Ltd. (“Pengbai”) is secured by assets of Pengbai, interest free, with original payments due in four equal installments from October 2013 to October 2017 of approximately $9.8 million in total. As of December 31, 2011, the balance was approximately $3 million and fully reserved .
·
The loan receivable from Anhui JuNeng Investment Security Co,.Ltd. (“Anhui Juneng”) is guaranteed by an unrelated party, bearing interest at 9% and is due on December 31, 2011. The loan from Anhui JuNeng has been received in full by December 31, 2011.
An allowance for loans receivable is recorded when circumstances indicate that collection of all or a portion of a specific balance is unrecoverable. The Company provides for allowances on other accounts receivable on a specific identification basis. Certain other loans receivable amounts are charged off against the allowance after a sufficient period of collection efforts. Subsequent cash recoveries are recognized as other income in the period when they occur. The Company determined that no allowance was necessary as of December 31, 2011 and 2010.
6.
Due From Related Parties
Due from related parties amounted $0 and $63,866 as of December 31, 2011 and 2010, respectively. Related party receivables are mainly travel expenses to CEO, interest free, unsecured, due on demand.
7.
Advances
The current advances to suppliers amounted to $6,722,052 and $993,941 as of December 31, 2011 and 2010, respectively.
Long term advances related to constructionamounted to $13,464,311 and $0 as of December 31, 2011 and 2010, respectively.
8.
Intangible Assets
Intangible assets amounted to $15,711,584 and $21,459,193 as of December 31, 2011 and December 31, 2010, respectively. Intangible assets consisted of the following:
The Chinese government owns all land in the PRC. However, the government grants "land use rights" for terms ranging from 20 to 50 years. The Company is amortizing the cost of land use rights over the usage terms. Intangible assets are reviewed at least annually and more often if circumstances dictate, to determine whether their carrying value has become impaired. The Company considers assets to be impaired if the carrying value exceeds the future projected cash flows from related operations. The Company also re-evaluates the periods of amortization to determine whether subsequent events and circumstances warrant revised estimates of useful lives. As of December 31, 2011, the Company determined that there had been no impairment.
Approximately $15,740,000 was paid to an unrelated party - Pingqiao Industrial Park in Luan city, Anhui Province, China - for acquiring land use rights. The Company intends to construct a factory, research and development center and a commercial center on this land.
Approximately $6,296,000 was paid to Youbang Pharmaceuticals Co., Ltd., an unrelated party for acquiring land use rights as of December 31, 2010. The Company intended to build a warehouse and distribution center on this land. Then $1,574,000 of this $6,296,000 was returned to the Company during the year ended December 31, 2011. As of December 31, 2011, the balance of $4,722,000 is booked in other receivable and the company expects to receive such receivables by December 2012. The agreement was canceled due to the seller’s failure to provide land use right certificate.
As of December 31, 2011, the Company leased a land use right of 503 Chinese acres of land with a twenty years term for the company’s agricultural and forestry business with a cost of approximately $189,000, and the Company leased another 5,006 Chinese acres of land located in Yumin Village, Sun Gang County, Jin An District with a thirty years term with a cost of approximately $961, 000, as Guoying agricultural and forestry land to grow oil-tea camellia plants.
Amortization expenses amounted $1,161,901 and $0 for the years ended December 31, 2011 and 2010, respectively. The Company does not have amortization expenses for the year ended December 31, 2010 because in 2010 the land use right are advances for land use right for the year ended December 31, 2010.
9.
Accounts Payable and Accrued Expenses
Accounts payable and accrued expenses consisted of the following:
10.
Other Payable
Other payable amounted to 4,806,278 and $75,194 as of December 31, 2011 and 2010, respectively. As of December 31, 2011, other payable include a deposit of $1,403,730 from customers to join the Franchise store network, but those stores have withdrawn in 2011.
11.
Stockholders’ Equity
On December 26, 2008, the shareholders of Guoying entered into a share transfer agreement with CEH Delaware to transfer 40% of their shares of Guoying Electronic Group Co, Ltd. to CEH Delaware for a consideration of RMB 400,000 (approximately $60,000). The shareholders of Guoying also entered into another share transfer agreement with CEH Delaware in February 2010 to transfer the rest of their shares (60%) to CEH Delaware for a consideration of RMB 600,000 (together with the previously paid RMB 400,000, referred to as “Purchase Price”), Guoying Shareholders contributed the Purchase Price to Guoying for working capital and general corporate purpose and as a result of the 2008 and 2010 Share Transfers, Guoying became a wholly foreign-owned subsidiary (“WFOE”) of CEH Delaware.
The Company entered into a Share Exchange Agreement, dated as of July 9, 2010 (the “Share Exchange Agreement”) with CEH Delaware and certain stockholders and warrant holders of CEH Delaware (the “CEH Delaware Stockholders”). Pursuant to the Share Exchange Agreement, on July 15, 2010, 10 CEH Delaware Stockholders transferred 100% of the outstanding shares of common stock and preferred stock and 100% of the warrants to purchase common stock of CEH Delaware held by them, in exchange for an aggregate of 13,785,902 newly issued shares of the Company’s Common Stock (including 13,665,902 shares of common stock issued pursuant to the Share Exchange Agreement dated July 22, 2010, and 120,000 shares of common stock issued to consultants related to their professional services) and warrants to purchase an aggregate of 1,628,570 shares of our Common Stock. The shares of the Company’s common stock acquired by the CEH Delaware Stockholders in such transactions constitute approximately 82.2% of the Company’s issued and outstanding Common Stock giving effect to the share and warrant exchange and the sale of the Company’s Common Stock pursuant to the Subscription Agreement, but not including any outstanding purchase warrants to purchase shares of the Company’s common stock, including the warrants issued pursuant to the Subscription Agreement. In connection with the closing of the Share Exchange Agreement, CEH Delaware purchased from the former principal stockholder of Buyonate an aggregate of 4 million shares of our common stock and then agreed to the cancellation of such shares.
The Share Exchange resulted in (i) a change in our control with a shareholder of CEH Delaware owning approximately 82.2%of issued and outstanding shares of the Company’s common stock, including the shares of common stock sold to PIPE investors pursuant to the Subscription Agreement, (ii) CEH Delaware becoming our wholly-owned subsidiary, and (iii) appointment of Mr. Hailong Liuas as the Company’s sole director, Chief Executive Officer, Chief Financial Officer, Secretary and Treasurer.
The exchange of shares pursuant to the July 10, 2010 Share Exchange was accounted for as a reverse acquisition at historical cost since the controlling stockholder and beneficial owner of CEH Delaware obtained control of the Company and the management of CEH Delaware became the management of the Company. Mr, Liu, who maintained control of Guoying prior to the mergers and subsequently, obtained control of CEH Delaware pursuant to 2008 and 2010 Share Transfers, effectively obtained control of the Company upon completion of Share Exchange subject to the Voting Trust Agreement and Call Option Agreement.
Shares issued for cash
There were no stock issuances during the year ended December 31, 2011.
Warrants
On July 9, 2010, in connection with the Share Exchange Agreement between the Company and CEH Delaware, the Company issued 314,285 series A warrants to CEH Delaware shareholders. The series A warrants carry an exercise price of $2.19 and a 3-year term. The Company also issued 314,285 series B warrants to CEH Delaware shareholders. The series B warrants carry an exercise price of $2.63 and a 3-year term. The Warrants contain standard adjustment provisions upon stock dividend, stock split, stock combination, recapitalization, and a change of control transaction.
On July 9, 2010, in connection with the Share Subscription, the Company issued 499,403 series C warrants with an exercise price of $3.70 and a 3-year term to investors. The Warrants contain standard adjustment provisions upon stock dividend, stock split, stock combination, recapitalization, and a change of control transaction.
On July 9, 2010, in connection with the Share Purchase Agreement, the Company issued 499,403 series D warrants with an exercise price of $4.75 and a 3-year term to a professional who held warrants with CEH Delaware. The Warrants contain standard adjustment provisions upon stock dividend, stock split, stock combination, recapitalization, and a change of control transaction.
On July 9, 2010, in connection with the Share Exchange Agreement between the Company and CEH Delaware, the Company issued 1,000,000 series E warrants with an exercise price of $0.25. The Warrants contain standard adjustment provisions upon stock dividend, stock split, stock combination, recapitalization, and a change of control transaction.
On July 13, 2010, in connection with the Share Subscription Agreement, the Company issued to Hunter Wise, a placement agent series F warrants to purchase 31,429 shares of Common Stock exercisable for a period of five years at an exercise price of $1.75 per share and series F warrants to purchase 94,329 shares of Common Stock exercisable for a period of five years at an exercise price of $2.64 per share. In connection with the subscription, the Company issued to American Capital Partners, a placement agent series F warrants to purchase 104,592 shares of Common Stock exercisable for a period of five years at an exercise price $2.64 per share.
On July 9, 2010, in connection with share issuance, the Company issued 50,000 series G warrants with an exercise price of $2.64 and a 3-year term to a professional firm. The Warrants contain standard adjustment provisions upon stock dividend, stock split, stock combination, recapitalization, and a change of control transaction.
The fair value of the Series C and Series D warrants that were issued as part of the Company’s July 2010 private placements were $393,592 and $113,680, respectively. The fair value of the Series E and Series F warrants that were issued to the placement agent in July 2010 were $4,119,275 and $435,901, respectively. The fair value of the Series G warrants that were issued to a professional firm in July 2010 was $87,538. The total fair value of the warrant issued was $5,149,986, however, all of these warrants were issued to investors in the private placement, the placement agent or a professional firm that performed services directly related to the private placement. The recording of the value of these warrants had no impact in the financial statements as the entry was to debit and credit additional paid in capital for the value of the warrants of $5,149,986.
Warrants consisted of the following:
Warrants referred to in the preceding paragraphs do not trade in an active securities market, and as such, the Company estimates the fair value of these warrants using the Black-Scholes option pricing model using the following assumptions:
12.
Statutory Reserve Fund
The laws and regulations of the PRC require that before a Sino-foreign cooperative joint venture enterprise distributes profits to its partners, it must first satisfy all tax liabilities, provide for losses in previous years, and make allocations in proportions determined at the discretion of the board of directors, after the statutory reserves. The statutory reserves include the surplus reserve fund, the common welfare fund, and the enterprise fund. These statutory reserves represent restricted retained earnings.
The Company is required to transfer 10% of its net income, as determined in accordance with the PRC’s accounting rules and regulations, to a statutory surplus reserve fund until such reserve balance reaches 50% of the Company’s registered capital.
The transfer to this reserve must be made before distribution of any dividends to shareholders. For the years ended December 31, 2011 and 2010, the Company transferred $1,656,663 and $1,455,369, respectively, to this reserve. The surplus reserve fund is non-distributable other than during liquidation and can be used to fund previous years’ losses, if any, and may be utilized for business expansion or converted into share capital by issuing new shares to existing shareholders in proportion to their shareholding or by increasing the par value of the shares currently held by them, provided that the remaining reserve balance after such issue is not less than 25% of the registered capital.
Enterprise fund
The enterprise fund may be used to acquire fixed assets or to increase the working capital to expand production and operations of the Company. No minimum contribution is required and the Company has not made any contribution to this fund. For the years ended December 31, 2011 and 2010, the Company transferred $0 and $0, respectively, to this reserve.
13.
Employee Welfare Plan
The Company has established its own employee welfare plan in accordance with Chinese law and regulations. The Company makes contributions to an employee welfare plan. The total expense for the above plan was $36,419 and $14,869 for the years ended December 31, 2011 and 2010, respectively.
14.
Other Expense
Other expense for the years ended December 31, 2011 and 2010 are as follows:
Other expense for the year ended December 31, 2010 amounted to $14,259. It was mainly consisted of financial expenses.
Other expense for the year ended December 31, 2010 amounted to $43,602. It was mainly consisted of donation to charities.
15.
Income Tax
The Company is registered in the State of Nevada and has operations in primarily two tax jurisdictions - the People’s Republic of China and the United States. For operation in the US, the Company has incurred net accumulated operating losses for income tax purposes. The Company believes that it is more likely than not that these net accumulated operating losses will not be utilized in the future. Therefore, the Company has provided full valuation allowance for the deferred tax assets arising from the losses at these locations as of December 31, 2011. Accordingly, the Company has no net deferred tax assets.
Our effective tax rates were approximately 0% and 0% for the years ended December 31, 2011 and 2010, respectively. Currently the local government and central government tax benefit will expire on December 31, 2012 and December 31, 2013, respectively. Our effective tax rate was lower than the U.S. federal statutory rate due to the fact that our operations are carried out in foreign jurisdictions, which are subject to lower income tax rates.
The following table reconciles the U.S. statutory rates to the Company’s effective tax rate for the years ended December 31, 2011 and 2010:
The provision for income taxes from continuing operations on income consists of the following for the years ended December 31, 2011 and 2010:
United States of America
As of December 31, 2011, the Company in the United States had approximately $2,369,773 in net operating loss carry forwards available to offset future taxable income. Federal net operating losses can generally be carried forward 20 years. The deferred tax assets for the United States entities at December 31, 2011 consists mainly of net operating loss incurred in 2011 and were fully reserved as the management believes it is more likely than not that these assets will not be realized in the future.
The following table sets forth the significant components of the net deferred tax assets for operation in the US as of December 31, 2011 and December 31, 2010.
People’s Republic of China (PRC)
Under the Income Tax Laws of the PRC, the Company’s subsidiaries are generally subject to an Enterprise Income Tax (EIT) at a standard rate of 25% on income reported in the statutory financial statements after appropriate tax adjustments. The State Tax Bureau of Lu’An City, Anhui province issued an income tax benefit approval to Guoying on September 2, 2007 providing that Guoying is subject to income tax and VAT benefit treatment of reduced rate of RMB 7,500 tax payment per year (including income tax and VAT) valid from October 1, 2007 until December 31, 2010. The State Tax Bureau of Lu’An City, Anhui province issued an income tax benefit approval to Guoying on December 10, 2011 providing that Guoying is subject to income tax and VAT benefit treatment of reduced rate of RMB 7,500 tax payment per year (including income tax and VAT) valid from December 1, 2011 until December 31, 2013. However, according to the approval, Guoying has option to pay more tax per year at its discretion. Therefore, currently, Guoying is charged at a fixed annual amount of reduced tax rate of no less than RMB7, 500 per year that changes every year to cover all types of taxes including income taxes. The income tax expenses for the years ended December 31, 2011 and 2010 are $1,255 and $4,073, respectively. There were no significant book and tax basis differences.
16.
Concentration of Credit Risks and Uncertainties and Commitments and Contingencies
Credit Risk
The Company’s practical operations are all carried out in the PRC. Accordingly, the Company’s business, financial condition, and results of operations may be influenced by the political, economic and legal environments in the PRC, and by the general state of the PRC's economy.
The Company’s operations in the PRC are subject to specific considerations and significant risks not typically associated with companies in North America and Western Europe. These include risks associated with, among others, the political, economic and legal environments and foreign currency exchange. The Company’s results may be adversely affected by changes in governmental policies with respect to laws and regulations, anti-inflationary measures, currency conversion and remittance abroad, and rates and methods of taxation, among other things.
Concentration of credit risk exists when changes in economic, industry or geographic factors similarly affect groups of counter parties whose aggregate credit exposure is material in relation to the Company’s total credit exposure.
For the years ended December 31, 2011 and 2010, there is no major customer that individually comprised more than 10% of the Company’s total sales.
There are two major vendor accounting for over 10% of the Company’s total purchases for the year ended December 31, 2011, with Shangdong Huangming Solar Power Sales Co. accounting for 45%, Hefei Ririshun Sales Co. accounting for 10%. The accounts payable balance as of December 31, 2011 for this one vendor was $0. There are three major vendors each accounting for over 10% of the Company’s total purchases for the year ended December 31, 2010, with Shangdong Huangming Solar Power Sales Co. accounting for 43%, Jiangsu Huayang Solar Power Sales Co. accounting for 17%, and Yangzhou Huiyin Ltd. accounting for12%. The accounts payable balance as of December 31, 2010 for these three vendors was $0.
The Company’s exposure to foreign currency exchange rate risk primarily relates to cash and cash equivalents and short-term investments, denominated in the U.S. dollar. Any significant revaluation of RMB may materially and adversely affect the cash flows, revenues, earnings and financial position of the Company.
Contingency
The Company is in litigation with its prior attorney, who commenced an action against the company in the Supreme Court of the State of New York County of New York for approximately $145,308.14 plus accrued interest for legal services provided to China Financial Services, a financial advisory firm, on behalf of the Company. The Company intends to contest this action. According to the litigation time schedule, we do not expect a judgment to be entered as to the outcome of this litigation by December 2012 as possibly the earliest. The Company believes that there are defenses available to the Company. This amount has been accrued as of December 31, 2011 and is included in accrued expenses.
In connection with our private placement in July and August 2010, we entered into a Subscription Agreement with the investors which sets forth the rights of the investors to have the registrable shares registered with the SEC for public resale. Pursuant to the registration rights provisions, we agreed to file the registration statement pursuant to the Subscription Agreement to be declared effective by the Securities and Exchange Commission (the “Commission”) by the date (the “Required Effectiveness Date”) which is not later than the earlier of (x) one hundred eighty (180) calendar days after the final closing date of the Offerings dated July 9, 2010, or (y) ten (10) business days after oral or written notice to the Company or its counsel from the Commission that it may be declared effective. The registration statement has not been declared effective before the Required Effectiveness Date (the “Required Effectiveness Failure”). As liquidated damages (“Liquidated Damages”), the Company shall deliver to the Subscribers, as on a pro-rata basis (determined by dividing each Subscriber’s Issue Price by the aggregate Issue Price delivered to the Company by the Subscribers hereunder)an amount equal to one-half percent (0.5%) of the aggregate Issue Price of the Purchased Securities owned of record by such Subscribers on the first business day after the Non-Registration Event and for each subsequent thirty (30) day period (pro rata for any period less than thirty days) which are subject to non-registration event. The maximum aggregate Liquidated Damages payable to the Subscriber under this Agreement shall be five percent (5%) of the aggregate Issue Price paid by the Subscribers. The registration statement was not declared effective by Required Effectiveness Date, as such an Effectiveness Failure occurred and the Company made an estimate of the probable amount it would pay in damages and accrued $262,500.
The Company entered into a Settlement Agreement dated December 6, 2011, wherein it agreed to pay an aggregate of $262,500 due to the Company’s failure to obtain the effectiveness of an S-1 Registration Statement by the agreed upon date. The $262,500 is to be paid in three installments with the final installment due March 31, 2012. In consideration of such amount the investors waived their right to bring any actions against the Company, CEH Delaware or Guoying for damages due to the Company’s inability to cause the Registration Statement to be effective in a timely manner and any subsequent damages that might have become due under Section 9(d) of their Subscription Agreements. The investors further agreed to waive their rights to declare any future Event of Default under Section 7(o) “Further Registration Statements”, Section 7(r) “Uplisting” and Section 9(d) “Non-Registration Events” of their Subscription Agreements. The Company has made payment of Liquidated Damages in amount of $72,812.50 as of December 31, 2011. The Company will continue to negotiate the penalty payment wth investors and assess the likelihood of payments under this arrangement.
Operating Leases
The Company leases various facilities under operating leases that terminate on various dates.
The Company incurred rent expenses of $143,743 and $55,308 for the years ended December 31, 2011 and 2010 respectively.
The lease expenses for the next five years are estimated to be as follows:
17.
China Electronics Holdings, Inc (Parent Company)
Under PRC regulations, the Company’s operating subsidiary, Guoying, 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”). In addition, Guoying 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 income tax to be contributed to the statutory general reserve is at Guoying’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. Further, Guoying is also required to allocate 5% of the profit after tax, determined in accordance with PRC GAAP, to the statutory public welfare fund which is restricted to be used for capital expenditures for staff welfare facilities owned by the Company. The statutory public welfare fund is not available for distribution to equity owners (except in liquidation) and may not be transferred in the form of loans, advances, or cash dividends. As of December 31, 2011, an aggregate amount of $3,958,981 has been appropriated from retained earnings and set aside for statutory general reserve and public welfare fund, by Guoying.
As of December 31, 2011, the amount of restricted net assets of Guoying, which may not be transferred to the Company in the form of loans, advances or cash dividends by the subsidiaries without the consent of a third party, was approximately 7.43% of the Company’s consolidated net assets as discussed above. In addition, the current foreign exchange control policies applicable in the PRC also restrict the transfer of assets or dividends outside the PRC.
The following presents condensed unaudited unconsolidated financial information of the Parent Company only.
Condensed unaudited Balance Sheet as of December 31, 2011 and 2010
Condensed unaudited Statements of Operations (For the years ended December 31, 2011 and 2010)
Condensed unaudited Statement of Cash Flows (For the year ended December 31, 2011 and 2010)
18.
Restatement Earnings per Share Computation 2010
The Company has restated its earnings per share calculation for the year ended December 31, 2010 to take into account certain computational errors that were made in the prior calculation.
19.
Segment information
ASC 280 requires use of the “management approach” model for segment reporting. The management approach model is based on the way a company’s management organizes segments within the company for making operating decisions and assessing performance. Reportable segments are based on products and services, geography, legal structure, management structure, or any other manner in which management disaggregates a company.
During 2011 and 2010, the Company was organized into three main business segments: (1) Exclusive franchise stores, (2) Non-exclusive franchise stores, and (3) Company owned stores. The following table presents a summary of operating information and certain year-end balance sheet information as of December 31, 2011 and 2010, respectively.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
CHINA ELECTRONICS HOLDINGS, INC.
By:
/s/ Hailong Liu
Name: Hailong Liu
Title: Chairman, Chief Executive Officer and
President (principal executive officer) &
Chief Financial Officer
(principal financial officer and
principal accounting officer)
Date: April 16, 2012
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons, on behalf of the Registrant, and in the capacities and on the dates indicated.
Signature
Title
Date
/s/
Chairman, Chief Executive Officer and President &
Chief Financial Officer
April 16, 2012
Hailong Liu
/s/
Vice President and Director
April 16, 2012
Haibo Liu
EXHIBIT INDEX
Number
Description
2.1
Share Exchange Agreement by and among China Electronics Holdings, Inc. (formerly, Buyonate, Inc.), China Electronic Holdings, Inc. and the CEH Stockholders dated as of July 9, 2010. Incorporated by reference to Exhibit 2.1 to our Current Report on Form 8-K filed with the Commission on July 22, 2010 (the “July 2010 8-K”).
3.1
Articles of Incorporation of the Company. Incorporated by reference to Exhibit 3.1 to our Registration Statement on Form S-1 (File No. 333-152535) filed on July 25, 2008 (the “2008 S-1”).
3.2
By-laws of the Company. Incorporated by reference to Exhibit 3.2 to the 2008 S-1.
4.1
Subscription Agreement between among China Electronics Holdings, Inc. (formerly, Buyonate, Inc.) and certain investors, dated as of July 9, 2010. Incorporated by reference to Exhibit 4.1 to the July 2010 8-K.
4.2
Form of Warrant of China Electronics Holdings, Inc. (formerly, Buyonate, Inc.) issued on July 15, 2010. Incorporated by reference to Exhibit 4.2 to the July 2010 8-K.
4.3
Chairman Lock-up Agreement between China Electronics Holdings, Inc. (formerly, Buyonate, Inc.) and Hailong Liu, dated July 9, 2010. Incorporated by reference to Exhibit 4.3 to the July 2010 8-K.
4.4
Specimen of Common Stock certificate. Incorporated by reference to Exhibit 4.4 to our Registration Statement on Form S-1 (File No. 333-169968) filed on October 15, 2010.
10.1
Call Option Agreement between Sherry Li and Hailong Liu, dated as July 9, 2010. Incorporated by reference to Exhibit 10.1 to the July 2010 8-K.
10.2
Voting Trust Agreement between Sherry Li and Hailong Liu, dated as July 9, 2010 Incorporated by reference to Exhibit 10.2 to the July 2010 8-K.
31.1
Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer.*
31.2
Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer.*
32.1
Section 1350 Certification, Chief Executive Officer and Chief Financial Officer.*
________________
*
filed herewith