SECURITIES
AND EXCHANGE COMMISSION
WASHINGTON,
D.C. 20549
FORM
8-K
CURRENT
REPORT
Pursuant
to Section 13 or 15(d) of the
Securities
Exchange Act of 1934
Date of
Report (Date of Earliest event Reported): February 12, 2010
Datone,
Inc.
(Exact
name of registrant as specified in its charter)
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Delaware
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000-53075
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16-1591157
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(State
or other jurisdiction of
incorporation
or organization)
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(Commission
File Number)
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(IRS
Employer Identification No.)
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Qingdao
Hongguan Shoes Co., Ltd.
269 First
Huashan Road
Jimo
City, Qingdao
Shandong,
PRC
Telephone:
86-0532-8659 5999
Check the
appropriate box below if the Form 8-K filing is intended to simultaneously
satisfy the filing obligation of the registrant under any of the following
provisions (see
General Instruction A.2. below):
o
Written communications pursuant to Rule 425 under the Securities Act (17 CFR
230.425)
o
Soliciting material pursuant to Rule 14a-12 under the Exchange Act (17 CFR
240.14a -12)
o
Pre-commencement communications pursuant to Rule 14d-2(b) under the Exchange Act
(17 CFR 240.14d -2(b))
o
Pre-commencement communications pursuant to Rule 13e-4(c) under the Exchange Act
(17 CFR 240.13e -4(c))
This
report contains forward-looking statements. The forward-looking statements are
contained principally in the sections entitled “Description of Business,” “Risk
Factors,” and “Management’s Discussion and Analysis of Financial Condition and
Results of Operations.” These statements involve known and unknown risks,
uncertainties and other factors which may cause our actual results, performance
or achievements to be materially different from any future results, performances
or achievements expressed or implied by the forward-looking statements. In some
cases, you can identify forward-looking statements by terms such as
“anticipates,” “believes,” “could,” “estimates,” “expects,” “intends,” “may,”
“plans,” “potential,” “predicts,” “projects,” “should,” “would” and similar
expressions intended to identify forward-looking statements. Forward-looking
statements reflect our current views with respect to future events and are based
on assumptions and subject to risks and uncertainties. Given these
uncertainties, you should not place undue reliance on these forward-looking
statements. These forward-looking statements include, among other things,
statements relating to:
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Our
ability to source products from manufacturers at the high quality and
competitive pricing as we have
historically;
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the
impact that a downturn or negative changes in the Chinese retail economy
may have on our sales;
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our
ability to obtain additional capital in future years to fund our planned
expansion;
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economic,
political, regulatory, legal and foreign exchange risks associated with
our operations; or
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the
loss of key members of our senior management and our qualified sales
personnel.
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Also,
forward-looking statements represent our estimates and assumptions only as of
the date of this report. You should read this report and the documents that we
reference and filed as exhibits to the report completely and with the
understanding that our actual future results may be materially different from
what we expect. Except as required by law, we assume no obligation to update any
forward-looking statements publicly, or to update the reasons actual results
could differ materially from those anticipated in any forward-looking
statements, even if new information becomes available in the
future.
Use
of Certain Defined Terms
Except
where the context otherwise requires and for the purposes of this report
only:
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the
“Company,” “we,” “us,” and “our” refer to the combined business of Datone,
Inc. and its wholly owned direct and indirect subsidiaries, (i) Glory
Reach International Limited, or “Glory Reach,” a Hong Kong limited
company; and (ii) Qingdao Hongguan Shoes Co., Ltd., a PRC limited company,
or “Qingdao Shoes,” as the case may
be;
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“BVI”
refers to the British Virgin
Islands;
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“Exchange
Act” refers to the Securities Exchange Act of 1934, as
amended;
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“Hong
Kong” refers to the Hong Kong Special Administrative Region of the
People’s Republic of China;
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“PRC,”
“China,” and “Chinese,” refer to the People’s Republic of China (excluding
Hong Kong and Taiwan);
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“Renminbi”
and “RMB” refer to the legal currency of
China;
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“Securities
Act” refers to the Securities Act of 1933, as amended;
and
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“U.S.
dollars,” “dollars” and “$” refer to the legal currency of the United
States.
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ITEM
1.01
ENTRY
INTO A MATERIAL DEFINITIVE AGREEMENT
On
February 12, 2010, we entered into and closed a share purchase and share
exchange agreement, or the Share Exchange Agreement, with Glory Reach
International Limited, a Hong Kong limited company (“Glory Reach”), its
shareholders, Greenwich Holdings LLC, and Qingdao Shoes, pursuant to which we
acquired 100% of the issued and outstanding capital stock of Glory Reach in
exchange for 10,000 shares of our Series A Convertible stock, , which
constituted 97% of our issued and outstanding capital stock on an as-converted
to common stock basis as of and immediately after the consummation of the
transactions contemplated by the Share Exchange Agreement.
The
foregoing description of the terms of the Share Exchange Agreement is qualified
in its entirety by reference to the provisions of the agreement filed as Exhibit
2.1 to this report, which are incorporated by reference herein.
Immediately
following the acquisition of Glory Reach, under an Agreement of Conveyance,
Transfer and Assignment of Assets and Assumption of Obligations (the “Conveyance
Agreement”), we transferred all of our pre-acquisition assets and liabilities to
our wholly-owned subsidiary, DT Communications, Inc. The Conveyance
Agreement is attached as Exhibit 10.5 to this Current Report on 8-K and is
incorporated herein by reference.
On
February 11, 2010, the Company entered into Indemnification Agreements with its
three directors. Pursuant to the Indemnification Agreements, the
Company agreed to indemnify and hold harmless the directors from certain losses
resulting from actions or failures to act in their capacity as directors or
officers or losses resulting from their status as directors or
officers. The indemnifiable losses do not include certain losses
where the directors are adjudged to be liable to the Company. The
indemnification obligations include the right to advancement by the Company of
expenses related to indemnifiable claims.
The terms
of the Indemnification Agreement are filed as exhibit 10.4 to this Current
Report on Form 8-k and are incorporated by reference herein.
ITEM
2.01
COMPLETION
OF ACQUISITION OR DISPOSITION OF ASSETS
On
February 12, 2010, we completed an acquisition of Glory Reach pursuant to the
Share Exchange Agreement. The acquisition was accounted for as a
recapitalization effected by a share exchange, wherein Glory Reach is considered
the acquirer for accounting and financial reporting purposes. The assets and
liabilities of the acquired entity have been brought forward at their book value
and no goodwill has been recognized.
For the
convenience of our stockholders, we are providing below the information that
would be included in a Form 10 if we were to file a Form 10. Please note that
the information provided below relates to the combined enterprises after the
acquisition of Glory Reach except that information relating to the periods prior
to the date of the reverse acquisition only relate to Glory Reach and its
subsidiary Qingdao Shoes unless otherwise specifically
indicated.
3
DESCRIPTION
OF BUSINESS
Business
Overview
We are a
designer and retailer of branded footwear in Northern China. We were
organized to service what we believe is an unmet and increasing demand for high
quality formal and casual footwear throughout the PRC. As
urbanization and individual purchasing power has increased in China, the demand
for leather footwear has also grown.
Our
principal business includes (1) the design or selection of design for men’s and
women’s leather shoe lines (2) sourcing and purchase of the contract
manufactured footwear (3) retail and sales of said footwear under
our proprietary brand, “Hongung”. We operate a number of flagship
stores throughout greater Qingdao. Our products are also brought to
market through our extensive distribution network of authorized independent
distributors as well as through third party retailers selected to operate
exclusive Hongung brand stores on our behalf. Our company
headquarters and main sales office is located in Shandong province in northern
China, in the city of Jimo, less than 25 miles from the major urban center of
Qingdao.
Since
2007, our revenues have increased from $ 8,594,468 in fiscal year 2007 to $
13,904,314 in fiscal year 2008, representing a growth rate of approximately 62%.
Our revenues have increased from $ 9,116,272 in nine months ended of September
30, 2008 to $12,517,751 in the same period during 2009, representing a growth
rate of approximately 37%.
Datone,
Inc. was originally incorporated on August 9, 2000 under the laws of the State
of Delaware. We operated as a wholly-owned subsidiary of USIP.COM,
Inc. On August 24, 2006 USIP decided to spin-off it’s
subsidiary companies one of which was Datone Inc. On February 1, 2008 Datone
filed a Form 10-SB registration statement. On November 13, 2008 , Datone went
effective.
Acquisition
of Glory Reach International, Inc.
On
February 12, we completed a reverse acquisition transaction through a share
exchange with Glory Reach and its shareholders, or the Shareholders, whereby we
acquired 100% of the issued and outstanding capital stock of Glory Reach in
exchange for 10,000 shares of our Series A Convertible Preferred Stock which
constituted 97% of our issued and outstanding capital stock on an as-converted
to common stock basis as of and immediately after the consummation of the
reverse acquisition. As a result of the reverse acquisition, Glory Reach became
our wholly-owned subsidiary and the former shareholders of Glory Reach became
our controlling stockholders. The share exchange transaction with
Glory Reach was treated as a reverse acquisition, with Glory Reach as the
acquirer and Datone, Inc. as the acquired party. Unless the context suggests
otherwise, when we refer in this report to business and financial information
for periods prior to the consummation of the reverse acquisition, we are
referring to the business and financial information of Glory Reach and its
consolidated subsidiaries.
Immediately
following closing of the reverse acquisition of Glory Reach, one Shareholder
transferred 337 of the 874 shares of Series A Convertible Preferred
Stock issued to him under the share exchange to certain persons who
provided services to Glory Reach’s subsidiaries, pursuant to share
allocation agreements that the Shareholder entered into with such service
providers.
4
Upon the
closing of the reverse acquisition, Craig H. Burton, our President and Director,
Joseph J. Passalaqua, our Secretary and Director, and Joseph Meuse, our
Director, submitted a resignation letter pursuant to which they resigned from
all offices that they held effective immediately and from
their position as our directors that will become effective on the
tenth day following the mailing by us of an information statement to our
stockholders that complies with the requirements of Section 14f-1 of the
Exchange Act, which will be mailed out on or about February 22. In
addition, our board of directors on February 12 appointed Tao Wang (Chairman),
Renwei Ma and Lanhai Sun to fill the vacancies created by such resignations,
which appointments will become effective upon the effectiveness of the
resignation of Craig H. Burton, Joseph J. Passalaqua, and Joseph Meuse on the
tenth day following the mailing by us of the Information Statement to our
stockholders. In addition, our executive officers were replaced by
the Qingdao Shoes’ executive officers upon the closing of the reverse
acquisition as indicated in more detail below.
As a
result of our acquisition of Glory Reach, we now own all of the issued and
outstanding capital stock of Glory Reach, which in turn owns all of the
outstanding capital stock of Qingdao Shoes .
Since
there is common control between the Glory Reach and Qingdao Shoes, for
accounting purposes, the acquisitions of Qingdao Shoes has been treated as a
recapitalization with no adjustment to the historical basis of their assets and
liabilities. The restructuring has been accounted for using the “as if” pooling
method of accounting and the operations were consolidated as if the
restructuring had occurred as of the beginning of the earliest period presented
in our consolidated financial statements and the current corporate structure had
been in existence throughout the periods covered by our consolidated financial
statements.
Immediately
following the acquisition of Glory Reach, under an Agreement of Conveyance,
Transfer and Assignment of Assets and Assumption of Obligations (the “Conveyance
Agreement”), we transferred all of our pre-acquisition assets and liabilities to
our wholly-owned subsidiary, DT Communications, Inc. The Conveyance
Agreement is attached as Exhibit 10.5 to this Current Report on 8-K and is
incorporated herein by reference.
Our
Corporate Structure
All of
our business operations are conducted through our Hong Kong and Chinese
subsidiaries. The chart below presents our corporate structure.
5
Our Industry and Principal
Market:
China is
the largest producer of footwear in the world, with at least 25,000 enterprises
employing more than 10 million employees who manufacture more than 10 billion
pairs of shoes per annum. China’s annual production accounts for
nearly 70% of the 14.8 billion pairs of shoes produced worldwide. In
2007, roughly 80% of PRC production capacity was exported while the remaining
20% were consumed domestically. Chinese consumption of footwear in 2005
reached 2.1 billion pairs, representing 16% of global footwear
consumption. In 2008, a deterioration in the global economy resulted in a
collapse of the Chinese textile and footwear and export market and a material
percentage of low margin manufacturers were forced out of
business. Domestic consumption and retail sales within China,
however, remained robust throughout the export downturn and global
financial crisis. As we have strategically avoided the manufacturing
sector, we were able to capitalize on the economic conditions and maintain our
profit margin and seize the opportunity of overcapacity in our sourcing market
and growing consumer demand.
PRC
Domestic Consumption:
GDP
growth in the PRC has been strong and positive over the past ten
years:
Along
with growth in the economy as a whole, Chinese domestic consumption has
increased in lockstep with rapid urbanization and increases in disposable income
over the past 15 years. Per capita urban disposable income has
increased by an annualized rate of 12.9% over the 5 years ending in 2008, and is
anticipated to top $2,000 in 2012. The urban population as a
percentage of the total population increased from 40.6% in 2003 to 45.0% in 2007
and this trend is expected to continue into the future.
These
trends have driven a boom in retail sales in the PRC, which is expected to grow
to well over two trillion dollars by 2011, representing an annualized growth of
11.8% over the prior ten years.
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The
PRC Footwear Market:
The size
of the domestic footwear market in China is 28.5 billion dollars:
Even
given the tremendous growth in the Chinese economy over the past 20 years,
estimates from market research groups expect the Chinese footwear market to grow
by at least 5% annual thorugh 2013 in terms of value. Furthermore, the average
Chinese consumer still purchases far fewer shoes per year per capita than Korea,
Japan or the west. As income levels continue to increase, it is expected that
shoe consumption will approach levels of other nations with similar cultural
consumption characteristics, so we expect our room to grow with the market will
continue for the foreseeable future.
7
Source: *Plastics News and Satra Technology Center
Our
Growth Strategy
We
believe that the market for affordable, high quality footwear in China provides
us with attractive and sustainable growth opportunities.
We intend
to pursue the following strategies to achieve our goal:
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1)
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Continue
our aggressive marketing and advertising campaigns in order to gain brand
awareness.
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2)
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Expand
distributor and third party operator stores in prime locations to maximize
profits.
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3)
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Bring
more self owned stores online to increase higher margin
sales.
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4)
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Continue
to strive for excellence in quality, customer service and design in order
to attract new and retain repeat
customers.
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5)
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Leverage
our growing purchasing power with manufacturers to lower
costs
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Our
Products
Our
products consist of men and women’s footwear. Our designs are on the
whole targeted at consumers seeking business casual and formal leather shoes
appropriate for an office setting. Each year we design or commission
designs for more than 300 unique styles. We do not manufacture our
products, but instead outsource manufacturing to third parties. Our
designs are split roughly evenly between men’s and women’s
products. Designs are made based on collaboration between our sales
department and design department regarding market demand and assessment of
what will designs be fashionable in the upcoming season. As of September
30, 2009, Men’s footwear constituted 60% of revenue and women’s footwear the
remainder. 40% of sales were formal shoes, and the remaining 40% are
attributed to casual footwear.
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Sourcing
and Purchase of Products
We are a
retailer and designer of footwear products, and as such we fully outsource
production of our footwear to third party
manufacturers. Due to excess capacity in the footwear
manufacturing industry in the PRC, we have historically been able to source our
products at competitive prices that allow us to maintain strong margins in
comparison with our competitors. In this way, we avoid what we
perceive to be the risks and lower margins associated with manufacturing
footwear and are able to focus our energies on our brand building and retail
business.
Our
suppliers are selected for their ability to meet our high quality standards,
timely execution of our orders, and competitive pricing. As of
September 30 2009, we had contractual relationships with 48 footwear
manufacturers. None of our suppliers accounted for more than 10% of
the total cost of our goods sold in 2008. Our suppliers are mainly
located in Wenzhou, Chongqing and various towns in Jiangsu.
Our
contracts with suppliers are on an as ordered basis, with payment due at the end
of the month of delivery, and are usually for a term of one
year. Prices are negotiated based on a by design basis by our
sourcing team. All of our suppliers are subject to our strict quality
control standards, and we are entitled to return product without payment if it
is not according to the quality set forth in our agreement.
During
the year ended December 31, 2007, purchases from one vendor accounted for 13.2%
of the total merchandise purchases of the Company. There is no such
concentration for the year ended December 31, 2008.
The
following diagram details our current distribution channels:
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As of
September 30, 2009, we had 11 flagship stores, 11 exclusive third party
managed retail outlets, and 192 outlets managed by distributors.
The
following table details the locations of our sales network:
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Flagship Stores
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Distributors
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3rd Party Operators
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Qingdao
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11
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26
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4
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Shandong
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0
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155
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6
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Xinjiang
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0
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1
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0
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Shanxi
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0
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3
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1
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Tianjiang
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0
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1
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0
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Heilongjiang
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0
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1
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0
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Hebei
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0
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2
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0
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Liaoning
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0
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1
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0
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Henan
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0
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1
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0
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10
Flagship
Stores:
We
directly own or lease and operate all of our flagship stores. All
located in Jimo or greater Qingdao. Each store has an individual
sales team and managers that report to our central office in
Qingdao. All sales staff are compensated on a commission based pay
scale. Locations are selected according to management’s estimation of
market opportunity. Our flagship stores of our stores bear the
Hongung brand name and exclusively retail Hongung footwear.
During
the years ended December 31, 2008 and 2007, the sales generated by the Company’s
flagship stores accounted for 15% and 12% of total sales,
respectively.
Hongung
Outlets in Jimo:
Stores
Managed by Third Party Operators:
In order
to meet consumer demand for our products and efficiently expand of our business,
we also select certain third parties to operate Hongung branded
outlets. We have literature and rules regarding the location, size, store
layout, interior design and product display of their Hongung retail
stores. All potential third party operators require prior approval
before opening new stores. We visit potential locations for new
outlets and consider the suitability of such locations before
approval. Furthermore, all third party operators must personally
operate their stores.
These
operators are chosen based on the following criteria:
-
Management experience in retail operations and our confidence in their ability
to effectively meet our sales targets and high standards of
conduct.
- Good
credit and sufficient capital
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Proposed store location, size and condition
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After
approval, the third party operators must purchase a fixed amount of footwear
stock at wholesale prices and Hongung branded decorations for proper interior
and exterior design. Third party operators then continue to pay
wholesale prices for footwear on an on demand basis. Contracts with
third party operators are typically for a period of two years.
Distributors
We
identify suitable distributors and enter into distributorship agreements,
usually for a term of two years. Distributors purchase wholesale priced shoes
and vend them at sales points throughout China. We require our
distributors to implement, monitor compliance with and enforce our retail store
guidelines. Our distributors are independent third parties that
do not pay us any fee other than the purchase price for the purchase of our
products, nor do we pay them any incentives or fees.
Our
distribution contracts usually contain the following terms:
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Geographic Limitation — distributors
must sell our Hongung branded footwear within a specific authorized
location(s).
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Wholesale price
— distributors pay a discounted wholesale price for our
products.
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Payment and credit terms
— payment and credit terms are on a case by case
basis. The credit period is usually one month, and 25%
percent of our distributors prepay for their
stock.
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Performance— Qingdao Shoes typically
retains the right to end the agreement if a distributor does to meet sales
targets.
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Exclusivity
— the distributorship agreements allow our distributors
to sell our products under the Hongung brand on an exclusive
basis. If there are other brands featured at the distributor’s
outlet, Hongung brand shoes must constitute a certain percentage,
generally a majority, of product on display. Furthermore, the
products must be displayed according to our
standards.
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Training
— training and instructional materials are provided to
all of our distributers regarding product display, decoration, and sales
techniques.
Renewal and Termination — we
can renew contracts at our discretion and can terminate contracts if
contractual conditions including sales targets are not
met.
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We do not
have a return policy with our distributors. In the event a
distributor is unable to sell their stock, we will attempt to help them relocate
it to a nearby Qingdao Shoes outlet.
Purchasing and
Sales Prices
We have
historically organized one sales fair per year in which distributors and third
parties operators can view and select upcoming designs. We also
maintain several showrooms in our head office in Jimo with the current and
future product lines which our sales force visits on a regular
basis.
12
We intend to keep the pricing of our
products at reasonable levels in the foreseeable future in order to stay competitive and maintain product
demand. Our wholesale prices are
generally not more than a 50% discount to the sales price.
The table
below details the various departments and number of employees in
each.
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Management
and Sales
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9 | |||
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Design
& Purchasing
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3 | |||
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Accounting
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5 | |||
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Warehouse
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8 | |||
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Administration
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7 | |||
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Sales
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30 | |||
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Total
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62 |
We
believe we are in material compliance with all applicable labor and safety laws
and regulations in the PRC, including the PRC Labor Contract Law , the
PRC Unemployment Insurance Law, the PRC Provisional Insurance Measures for
Maternity of Employees, PRC Interim Provisions on Registration of Social
Insurance, PRC Interim Regulation on the Collection and Payment of Social
Insurance Premiums and other related regulations, rules and provisions issued by
the relevant governmental authorities for our operations in the
PRC. According to the PRC Labor Contract Law, we are required to
enter into labor contracts with our employees and to pay them no less than local
minimum wage.
Intellectual
Property Rights
Our
products are sold under the Hongung brand name, which is a registered trademark
in the PRC.
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Trademarks
(Mandarin)
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Trademarks
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Cetificate
#
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Valid
Term
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|||
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Hongung
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3483788
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March
14, 2005 to March 13,
2015
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Our
principal executive offices are in Jimo, China.
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Certificate
No.
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Jin
Guo Yong (2007) 534
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User
of the Land
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Wang
Tao
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Location
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West
#1 Huashan Road., Jimo City, Shandong Province
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Usage
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Industrial
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Area
(sqm)
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14,225
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Form
of Acquisition
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By
means of transfer
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Expiration
Date
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12/28/2052
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13
The
Company leases one of its stores from Mr. Tao Wang under a four-year operating
lease expiring August 2011. For the years ended December 31, 2008 and 2007, rent
expense of $17,298 and $15,800, respectively, was included in total rent expense
for the respective years. The Company leases one of its warehouse
buildings to Weidong Liang, brother-in-law of Mr. Tao Wang, for three years
starting May 2008. Per the agreement, the lessee shall pay equal amount of
advertising expense on behalf of the lessor as the lease payment. For the year
ended December 31, 2008, the Company recorded other income of $57,660 from
leasing the aforementioned building and advertising expense of
$57,660.
Our
Advertising and Marketing Efforts
Our sales
and marketing department is responsible for the organization of sales fairs,
selection, review, execution and management of contracts with third parties and
distributers, and operation of our own retail
outlets. We utilize television, print media, radio, the internet
and outdoor billboard displays to build brand awareness. Popular television
star Ren Quan is currently the face of Qingdao Shoes’ advertising
campaign. In 2006, we entered into a contract with Ren Quan and
purchased the rights to use his image for our marketing purposes, and he is
often featured in our television commercials and our various
advertisements. We are contractually obligated to maintain
confidentiality as to the terms at which we acquired his rights.
Competition
The
retail and in particular the footwear retail industry are highly
competitive in the PRC. Our competitors are a number of international and
domestic enterprises with shoe sales operations in our target market, including
but not limited to Jinhou Footwear Company, Liangda Leather Company, Haining
Leather Footwear Company, Fude Leather Shoe Company. We expect competition
to further intensify due to the entry of new footwear retailers in the PRC and
as a result we may be subject to competitive pricing pressures in the
future. Quality, cutting edge style, brand awareness, customer
service, highly motivated sales force and affordable footwear prices are vital
cornerstones to success in our industry. We believe that we are highly
competitive in all these areas.
Design Team
Our
design team consists of three full time designers that are engaged in creating
new fashionable designs for upcoming seasons. They are also engaged
in the review, selection and alteration of designs proposed by contract
manufacturers. On average, our design team is responsible for the
selection or creation 300 models of footwear per year.
Regulation
Because
our principal operating subsidiary, Qingdao Shoes, is located in the PRC, our
business is regulated by the national and local laws of the PRC. We believe our
conduct of business complies with existing PRC laws, rules and
regulations.
General
Regulation of Businesses
We
believe we are in material compliance with all applicable labor and safety laws
and regulations in the PRC, including the PRC Labor Contract Law, the PRC
Production Safety Law, the PRC Regulation for Insurance for Labor Injury, the
PRC Unemployment Insurance Law, the PRC Provisional Insurance Measures for
Maternity of Employees, PRC Interim Provisions on Registration of Social
Insurance, PRC Interim Regulation on the Collection and Payment of Social
Insurance Premiums and other related regulations, rules and provisions issued by
the relevant governmental authorities from time to time, for our operations in
the PRC.
According
to the PRC Labor Contract Law, we are required to enter into labor contracts
with our employees. We are required to pay no less than local minimum wages to
our employees. We are also required to provide employees with labor safety and
sanitation conditions meeting PRC government laws and regulations and carry out
regular health examinations of our employees engaged in hazardous
occupations.
14
Foreign
Currency Exchange
The
principal regulation governing foreign currency exchange in China is the Foreign
Currency Administration Rules (1996), as amended (2008). Under these Rules, RMB
is freely convertible for current account items, such as trade and
service-related foreign exchange transactions, but not for capital account
items, such as direct investment, loan or investment in securities outside China
unless the prior approval of, and/or registration with, the State Administration
of Foreign Exchange of the People’s Republic of China, or SAFE, or its local
counterparts (as the case may be) is obtained.
Regulation
of Income Taxes
On March
16, 2007, the National People’s Congress of China passed a new Enterprise Income
Tax Law, or the New EIT Law, and its implementing rules, both of which became
effective on January 1, 2008. Before the implementation of the New EIT Law, FIEs
established in the PRC, unless granted preferential tax treatments by the PRC
government, were generally subject to an earned income tax, or EIT, rate of
33.0%, which included a 30.0% state income tax and a 3.0% local income tax. The
New EIT Law and its implementing rules impose a unified EIT rate of 25.0% on all
domestic-invested enterprises and FIEs, unless they qualify under certain
limited exceptions.
In
addition to the changes to the current tax structure, under the New EIT Law, an
enterprise established outside of China with “de facto management bodies” within
China is considered a resident enterprise and will normally be subject to an EIT
of 25% on its global income. The implementing rules define the term “de facto
management bodies” as “an establishment that exercises, in substance, overall
management and control over the production, business, personnel, accounting,
etc., of a Chinese enterprise.” If the PRC tax authorities subsequently
determine that we should be classified as a resident enterprise, then our
organization’s global income will be subject to PRC income tax of 25%. For
detailed discussion of PRC tax issues related to resident enterprise status, see
“Risk Factors – Risks Related to Our Business – Under the New EIT Law, we may be
classified as a ‘resident enterprise’ of China. Such classification will likely
result in unfavorable tax consequences to us and our non-PRC
stockholders.”
Our
future effective income tax rate depends on various factors, such as tax
legislation, the geographic composition of our pre-tax income and non-tax
deductible expenses incurred. Our management carefully monitors these legal
developments and will timely adjust our effective income tax rate when
necessary.
Dividend
Distribution
Under
applicable PRC regulations, FIEs in China may pay dividends only out of their
accumulated profits, if any, determined in accordance with PRC accounting
standards and regulations. In addition, a FIE in China is required to set aside
at least 10.0% of its after-tax profit based on PRC accounting standards each
year to its general reserves until the accumulative amount of such reserves
reach 50.0% of its registered capital. These reserves are not distributable as
cash dividends. The board of directors of a FIE has the discretion to allocate a
portion of its after-tax profits to staff welfare and bonus funds, which may not
be distributed to equity owners except in the event of
liquidation.
15
The New
EIT Law and its implementing rules generally provide that a 10% withholding tax
applies to China-sourced income derived by non-resident enterprises for PRC
enterprise income tax purposes unless the jurisdiction of incorporation of such
enterprises’ shareholder has a tax treaty with China that provides for a
different withholding arrangement. Qingdao Shoes is considered an FIE and is
directly held by our subsidiary Glory Reach in Hong Kong. According to a 2006
tax treaty between the Mainland and Hong Kong, dividends payable by an FIE in
China to the company in Hong Kong who directly holds at least 25% of the equity
interests in the FIE will be subject to a no more than 5% withholding tax. We
expect that such 5% withholding tax will apply to dividends paid to Glory Reach
by Qingdao Shoes, but this treatment will depend on our status as a non-resident
enterprise.
Our
operations are not subject to any environmental regulations.
Insurance
Insurance
companies in China offer limited business insurance products. While business
interruption insurance is available to a limited extent in China, we have
determined that the risks of interruption, cost of such insurance and the
difficulties associated with acquiring such insurance on commercially reasonable
terms make it impractical for us to have such insurance. As a result, we could
face liability from the interruption of our business as summarized under “Risk
Factors – Risks Related to Our Business – We do not carry business interruption
insurance so we could incur unrecoverable losses if our business is
interrupted.”
16
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 report, 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. You
should read the section entitled “Special Note Regarding Forward-Looking
Statements” above for a discussion of what types of statements are
forward-looking statements, as well as the significance of such statements in
the context of this report.
We
have a short operating history.
We have
only been in retail business since 2003. We may not succeed in
implementing our business plan successfully because of competition from domestic
and foreign market entrants, failure of the market to accept our products, or
other reasons. Therefore, you should not place undue reliance on our past
performance as they may not be indicative of our future results.
We face risks
related to general domestic and global economic conditions and to the current
credit crisis.
Our
current operating cash flows provide us with stable funding capacity. However,
the current uncertainty arising out of domestic and global economic conditions,
including the recent disruption in credit markets, poses a risk to the PRC
economy, and may impact our ability to manage normal relationships with our
customers, suppliers and creditors. If the current situation deteriorates
significantly, our business could be materially negatively impacted, as demand
for our products and services may decrease from a slow-down in the general
economy, or supplier or customer disruptions may result from tighter credit
markets.
Our
business is subject to the health of the PRC economy and our growth may be
inhibited by the inability of potential customers to fund purchases of our
products and services.
Our
products are dependent on the disposable income of PRC citizens, which could be
adversely affected by an economic downturn.
In order to grow
at the pace expected by management, we will require additional capital to
support our long-term growth strategies. If we are unable to obtain additional
capital in future years, we may be unable to proceed with our plans and we may
be forced to curtail our operations.
We will
require additional working capital to support our long-term growth strategies,
which includes identifying suitable points of market entry for expansion growing
the number of points of sale for our products, so as to enhance our product
offerings and benefit from economies of scale. Our working capital requirements
and the cash flow provided by future operating activities, if any, may vary
greatly from quarter to quarter, depending on the volume of business during the
period. We may not be able to obtain adequate levels of additional financing,
whether through equity financing, debt financing or other sources. Additional
financings could result in significant dilution to our earnings per share or the
issuance of securities with rights superior to our current outstanding
securities. In addition, we may grant registration rights to investors
purchasing our equity or debt securities in the future. If we are unable to
raise additional financing, we may be unable to implement our long-term growth
strategies, develop or enhance our products and services, take advantage of
future opportunities or respond to competitive pressures on a timely
basis.
17
As we do
not have any manufacturing capabilities, we are at risk should our suppliers
fail to provide us products at the high quality our customers
expect.
If
we are unable to attract and retain senior management and qualified technical
and sales personnel, our operations, financial condition and prospects will be
materially adversely affected.
Our
future success depends in part on the contributions of our management team and
key technical and sales personnel and our ability to attract and retain
qualified new personnel. In particular, our success depends on the continuing
employment of our Chief Executive Officer, Mr. Tao Wang, our Chief Operating
Officer, Shi Wenmao; and our Chief Financial Officer, Ms. Fang Sui. There is
significant competition in our industry for qualified managerial, technical and
sales personnel and we cannot assure you that we will be able to retain our key
senior managerial, technical and sales personnel or that we will be able to
attract, integrate and retain other such personnel that we may require in the
future. If we are unable to attract and retain key personnel in the future, our
business, operations, financial condition, results of operations and prospects
could be materially adversely affected.
We are
subject to risk inherent to our business, including equipment failure, theft,
natural disasters, industrial accidents, labor disturbances, business
interruptions, property damage, product liability, personal injury and death. We
do not carry any business interruption insurance or third-party liability
insurance or other insurance to cover risks associated with our business. As a
result, if we suffer losses, damages or liabilities, including those caused by
natural disasters or other events beyond our control and we are unable to make a
claim again a third party, we will be required to bear all such losses from our
own funds, which could have a material adverse effect on our business, financial
condition and results of operations.
Our
quarterly operating results are likely to fluctuate, which may affect our stock
price.
Our
quarterly revenues, expenses, operating results and gross profit margins vary
from quarter to quarter. As a result, our operating results may fall below the
expectations of securities analysts and investors in some quarters, which could
result in a decrease in the market price of our common stock. The reasons our
quarterly results may fluctuate include:
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variations
in profit margins attributable to product
mix;
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changes
in the general competitive and economic
conditions;
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delays
in, or uneven timing in the delivery of, customer orders;
and
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the
introduction of new products by us or our
competitors.
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Period to
period comparisons of our results should not be relied on as indications of
future performance.
Our
limited ability to protect our intellectual property, and the possibility that
our technology could inadvertently infringe technology owned by others, may
adversely affect our ability to compete.
We rely
on a combination of trade secret laws and confidentiality procedures to protect
the patents, copyrights and technological know-how that comprise our
intellectual property. We protect our technological know-how pursuant to
non-disclosure and non-competition provisions contained in our employment
agreements, and agreements with them to keep confidential all information
relating to our customers, methods, business and trade secrets during and after
their employment with us. Our employees are also required to acknowledge and
recognize that all inventions, trade secrets, works of authorship, developments
and other processes made by them during their employment are our
property. We have been granted the use of brand name
Hongung.
18
A
successful challenge to the ownership of our intellectual property could
materially damage our business prospects. Our competitors may assert that our
technologies or products infringe on their patents or proprietary rights. We may
be required to obtain from others licenses that may not be available on
commercially reasonable terms, if at all. Problems with intellectual property
rights could increase the cost of our products or delay or preclude our new
product development and commercialization. If infringement claims against us are
deemed valid, we may not be able to obtain appropriate licenses on acceptable
terms or at all. Litigation could be costly and time-consuming but may be
necessary to protect our technology license positions or to defend against
infringement claims.
Our
business may be subject to seasonal and cyclical fluctuations in
sales.
We may
experience seasonal fluctuations in our revenue in the PRC. Moreover,
our revenues are usually higher in the fourth and first quarters due seasonal
purchases.
RISKS
RELATED TO DOING BUSINESS IN CHINA
Changes in
China's political or economic situation could harm us and our operating
results.
Economic
reforms adopted by the Chinese government have had a positive effect on the
economic development of the country, but the government could change these
economic reforms or any of the legal systems at any time. This could either
benefit or damage our operations and profitability. Some of the things that
could have this effect are:
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Level
of government involvement in the
economy;
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Control
of foreign exchange;
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Methods
of allocating resources;
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Balance
of payments position;
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International
trade restrictions; and
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International
conflict.
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The
Chinese economy differs from the economies of most countries belonging to the
Organization for Economic Cooperation and Development, or OECD, in many ways.
For example, state-owned enterprises still constitute a large portion of the
Chinese economy and weak corporate governance and a lack of flexible currency
exchange policy still prevail in China. As a result of these differences, we may
not develop in the same way or at the same rate as might be expected if the
Chinese economy was similar to those of the OECD member countries.
We
conduct substantially all of our business through our operating subsidiaries in
the PRC and Hong Kong. Our principal operating subsidiary, Qingdao Shoes, is
subject to laws and regulations applicable to foreign investments in China and,
in particular, laws applicable to foreign-invested enterprises. The PRC legal
system is based on written statutes, and prior court decisions may be cited for
reference but have limited precedential value. Since 1979, a series of new PRC
laws and regulations have significantly enhanced the protections afforded to
various forms of foreign investments in China. However, since the PRC legal
system continues to evolve rapidly, the interpretations of many laws,
regulations and rules are not always uniform and enforcement of these laws,
regulations and rules involve uncertainties, which may limit legal protections
available to you and us. In addition, any litigation in China may be protracted
and result in substantial costs and diversion of resources and management
attention. In addition, all of our executive officers and all of our directors
are residents of China and not of the United States, and substantially all the
assets of these persons are located outside the United States. As a result, it
could be difficult for investors to affect service of process in the United
States or to enforce a judgment obtained in the United States against our
Chinese operations and subsidiaries.
19
You may have
difficulty enforcing judgments against us.
We are a
Delaware holding company, but Glory Reach is a Hong Kong company, and our
principal operating subsidiary, Qingdao Shoes is located in the PRC. Most of our
assets are located outside the United States and most of our current operations
are conducted in the PRC. In addition, most of our directors and officers are
nationals and residents of countries other than the United States. A substantial
portion of the assets of these persons is located outside the United States. As
a result, it may be difficult for you to effect service of process within the
United States upon these persons. It may also be difficult for you to enforce in
U.S. courts judgments predicated on the civil liability provisions of the U.S.
federal securities laws against us and our officers and directors, most of whom
are not residents in the United States and the substantial majority of whose
assets are located outside the United States. In addition, there is uncertainty
as to whether the courts of the PRC would recognize or enforce judgments of U.S.
courts. The recognition and enforcement of foreign judgments are provided for
under the PRC Civil Procedures Law. Courts in China may recognize and enforce
foreign judgments in accordance with the requirements of the PRC Civil
Procedures Law based on treaties between China and the country where the
judgment is made or on reciprocity between jurisdictions. China does not have
any treaties or other arrangements that provide for the reciprocal recognition
and enforcement of foreign judgments with the United States. In addition,
according to the PRC Civil Procedures Law, courts in the PRC will not enforce a
foreign judgment against us or our directors and officers if they decide that
the judgment violates basic principles of PRC law or national sovereignty,
security or the public interest. So it is uncertain whether a PRC court would
enforce a judgment rendered by a court in the United States.
The PRC
government exerts substantial influence over the manner in which we must conduct
our business activities.
The PRC
government has exercised and continues to exercise substantial control over
virtually every sector of the Chinese economy through regulation and state
ownership. Our ability to operate in China may be harmed by changes in its laws
and regulations, including those relating to taxation, import and export
tariffs, environmental regulations, land use rights, property and other matters.
We believe that our operations in China are in material compliance with all
applicable legal and regulatory requirements. However, the central or local
governments of the jurisdictions in which we operate may impose new, stricter
regulations or interpretations of existing regulations that would require
additional expenditures and efforts on our part to ensure our compliance with
such regulations or interpretations.
Accordingly,
government actions in the future, including any decision not to continue to
support recent economic reforms and to return to a more centrally planned
economy or regional or local variations in the implementation of economic
policies, could have a significant effect on economic conditions in China or
particular regions thereof and could require us to divest ourselves of any
interest we then hold in Chinese properties or joint ventures.
Future inflation
in China may inhibit our ability to conduct business in
China.
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, and thereby harm the market for
our products and our company.
20
Restrictions on currency exchange may limit our ability to receive
and use our revenues effectively.
The
majority of our revenues will be settled in RMB and U.S. dollars, and any future
restrictions on currency exchanges may limit our ability to use revenue
generated in RMB to fund any future business activities outside China or to make
dividend or other payments in U.S. dollars. Although the Chinese government
introduced regulations in 1996 to allow greater convertibility of the RMB for
current account transactions, significant restrictions still remain, including
primarily the restriction 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. In addition,
conversion of RMB for capital account items, including direct investment and
loans, is subject to governmental approval in China, and companies are required
to open and maintain separate foreign exchange accounts for capital account
items. We cannot be certain that the Chinese regulatory authorities will not
impose more stringent restrictions on the convertibility of the
RMB.
Fluctuations in
exchange rates could adversely affect our business and the value of our
securities.
The value
of our common stock will be indirectly affected by the foreign exchange rate
between U.S. dollars and RMB and between those currencies and other currencies
in which our sales may be denominated. Appreciation or depreciation in the value
of the RMB relative to the U.S. dollar would affect our financial results
reported in U.S. dollar terms without giving effect to any underlying change in
our business or results of operations. Fluctuations in the exchange rate will
also affect the relative value of any dividend we issue that will be exchanged
into U.S. dollars as well as earnings from, and the value of, any U.S.
dollar-denominated investments we make in the future.
Since
July 2005, the RMB is no longer pegged to the U.S. dollar. Although the People’s
Bank of China regularly intervenes in the foreign exchange market to prevent
significant short-term fluctuations in the exchange rate, the RMB may appreciate
or depreciate significantly in value against the U.S. dollar in the medium to
long term. Moreover, it is possible that in the future PRC authorities may lift
restrictions on fluctuations in the RMB exchange rate and lessen intervention in
the foreign exchange market.
Very
limited hedging transactions are available in China to reduce our exposure to
exchange rate fluctuations. To date, we have not entered into any hedging
transactions. While we may enter into hedging transactions in the future, the
availability and effectiveness of these transactions may be limited, and we may
not be able to successfully hedge our exposure at all. In addition, our foreign
currency exchange losses may be magnified by PRC exchange control regulations
that restrict our ability to convert RMB into foreign currencies.
Restrictions
under PRC law on our PRC subsidiary’s ability to make dividends and other
distributions could materially and adversely affect our ability to grow, make
investments or acquisitions that could benefit our business, pay dividends to
you, and otherwise fund and conduct our businesses.
Substantially
all of our revenues are earned by Qingdao Shoes, our PRC subsidiary. PRC
regulations restrict the ability of our PRC subsidiary to make dividends and
other payments to its offshore parent company. PRC legal restrictions permit
payments of dividend by our PRC subsidiary only out of its accumulated after-tax
profits, if any, determined in accordance with PRC accounting standards and
regulations. Our PRC subsidiary is also required under PRC laws and regulations
to allocate at least 10% of our annual after-tax profits determined in
accordance with PRC GAAP to a statutory general reserve fund until the amounts
in said fund reaches 50% of our registered capital. Allocations to these
statutory reserve funds can only be used for specific purposes and are not
transferable to us in the form of loans, advances or cash dividends. Any
limitations on the ability of our PRC subsidiary to transfer funds to us could
materially and adversely limit our ability to grow, make investments or
acquisitions that could be beneficial to our business, pay dividends and
otherwise fund and conduct our business.
21
In
October 2005, SAFE, issued the Notice on Relevant Issues in the Foreign Exchange
Control over Financing and Return Investment Through Special Purpose Companies
by Residents Inside China, generally referred to as Circular 75, which required
PRC residents to register with the competent local SAFE branch before
establishing or acquiring control over an offshore special purpose company, or
SPV, for the purpose of engaging in an equity financing outside of China on the
strength of domestic PRC assets originally held by those residents. Internal
implementing guidelines issued by SAFE, which became public in June 2007 (known
as Notice 106), expanded the reach of Circular 75 by (1) purporting to cover the
establishment or acquisition of control by PRC residents of offshore entities
which merely acquire “control” over domestic companies or assets, even in the
absence of legal ownership; (2) adding requirements relating to the source of
the PRC resident’s funds used to establish or acquire the offshore entity;
covering the use of existing offshore entities for offshore financings; (3)
purporting to cover situations in which an offshore SPV establishes a new
subsidiary in China or acquires an unrelated company or unrelated assets in
China; and (4) making the domestic affiliate of the SPV responsible for the
accuracy of certain documents which must be filed in connection with any such
registration, notably, the business plan which describes the overseas financing
and the use of proceeds. Amendments to registrations made under Circular 75 are
required in connection with any increase or decrease of capital, transfer of
shares, mergers and acquisitions, equity investment or creation of any security
interest in any assets located in China to guarantee offshore obligations, and
Notice 106 makes the offshore SPV jointly responsible for these filings. In the
case of an SPV which was established, and which acquired a related domestic
company or assets, before the implementation date of Circular 75, a retroactive
SAFE registration was required to have been completed before March 31, 2006;
this date was subsequently extended indefinitely by Notice 106, which also
required that the registrant establish that all foreign exchange transactions
undertaken by the SPV and its affiliates were in compliance with applicable laws
and regulations. Failure to comply with the requirements of Circular 75, as
applied by SAFE in accordance with Notice 106, may result in fines and other
penalties under PRC laws for evasion of applicable foreign exchange
restrictions. Any such failure could also result in the SPV’s affiliates being
impeded or prevented from distributing their profits and the proceeds from any
reduction in capital, share transfer or liquidation to the SPV, or from engaging
in other transfers of funds into or out of China.
We have
advised our shareholders who are PRC residents, as defined in Circular 75, to
register with the relevant branch of SAFE, as currently required, in connection
with their equity interests in us and our acquisitions of equity interests in
our PRC subsidiaries. However, we cannot provide any assurances that their
existing registrations have fully complied with, and they have made all
necessary amendments to their registration to fully comply with, all applicable
registrations or approvals required by Circular 75. Moreover, because of
uncertainty over how Circular 75 will be interpreted and implemented, and how or
whether SAFE will apply it to us, we cannot predict how it will affect our
business operations or future strategies. For example, our present and
prospective PRC subsidiaries’ ability to conduct foreign exchange activities,
such as the remittance of dividends and foreign currency-denominated borrowings,
may be subject to compliance with Circular 75 by our PRC resident beneficial
holders. In addition, such PRC residents may not always be able to complete the
necessary registration procedures required by Circular 75. We also have little
control over either our present or prospective direct or indirect shareholders
or the outcome of such registration procedures. A failure by our PRC resident
beneficial holders or future PRC resident shareholders to comply with Circular
75, if SAFE requires it, could subject these PRC resident beneficial holders to
fines or legal sanctions, restrict our overseas or cross-border investment
activities, limit our subsidiaries’ ability to make distributions or pay
dividends or affect our ownership structure, which could adversely affect our
business and prospects.
Our
business and financial performance may be materially adversely affected if the
PRC regulatory authorities determine that our acquisition of Qingdao Shoes
constitutes a Round-trip Investment without MOFCOM approval.
On August
8, 2006, six PRC regulatory agencies promulgated the Regulation on Mergers and
Acquisitions of Domestic Companies by Foreign Investors, or the 2006 M&A
Rule, which became effective on September 8, 2006. According to the 2006 M&A
Rule, when a PRC business that is owned by PRC individual(s) is sold to a
non-PRC entity that is established or controlled, directly or indirectly, by
those same PRC individual(s) it must be approved by the Ministry of Commerce, or
MOFCOM, and any indirect arrangement or series of arrangements which achieves
the same end result without the approval of MOFCOM is a violation of PRC
law.
22
After
Wang Tao exercises this option, the Founder, will, through his ownership of
BVICo, be our controlling stockholder. His acquisition of our equity interest,
or the Acquisition, is required to be registered with the competent
administration of industry and commerce authorities, or AIC, in Beijing. The
Founder will also be required to make filings with the SAFE to register the
Company and its non-PRC subsidiaries to qualify them as SPVs, pursuant to
Circular 75 and Circular 106.
The PRC
regulatory authorities may take the view that the Acquisition and the Share
Exchange Agreement are part of an overall series of arrangements which
constitute a Round-trip Investment, because at the end of these transactions,
the Founder will become majority owner and effective controlling party of a
foreign entity that acquired ownership of our Chinese subsidiaries. The PRC
regulatory authorities may also take the view that the registration of the
Acquisition with the relevant AIC in Beijing and the filings with the SAFE may
not be evidence that the Acquisition has been properly approved because the
relevant parties did not fully disclose to the AIC, SAFE or MOFCOM the overall
restructuring arrangements, the existence of the Share Exchange Agreement and
its link with the Acquisition. If the PRC regulatory authorities take the view
that the Acquisition constitutes a Round-trip Investment under the 2006 M&A
Rules, we cannot assure you we may be able to obtain the approval required from
MOFCOM.
If the
PRC regulatory authorities take the view that the Acquisition constitutes a
Round-trip Investment without MOFCOM approval, they could invalidate our
acquisition and ownership of our Chinese subsidiaries. Additionally, the PRC
regulatory authorities may take the view that the Acquisition constitutes a
transaction which requires the prior approval of the China Securities Regulatory
Commission, or CSRC, before MOFCOM approval is obtained. We believe that if this
takes place, we may be able to find a way to re-establish control of our Chinese
subsidiaries’ business operations through a series of contractual arrangements
rather than an outright purchase of our Chinese subsidiaries. But we cannot
assure you that such contractual arrangements will be protected by PRC law or
that the registrant can receive as complete or effective economic benefit and
overall control of our Chinese subsidiaries’ business than if the Company had
direct ownership of our Chinese subsidiaries. In addition, we cannot assure you
that such contractual arrangements can be successfully effected under PRC law.
If we cannot obtain MOFCOM or CSRC approval if required by the PRC regulatory
authorities to do so, and if we cannot put in place or enforce relevant
contractual arrangements as an alternative and equivalent means of control of
our Chinese subsidiaries, our business and financial performance will be
materially adversely affected.
If
we make equity compensation grants to persons who are PRC citizens, they may be
required to register with the State Administration of Foreign Exchange of the
PRC, or SAFE. We may also face regulatory uncertainties that could restrict our
ability to adopt an equity compensation plan for our directors and employees and
other parties under PRC law.
On April
6, 2007, SAFE issued the “Operating Procedures for Administration of Domestic
Individuals Participating in the Employee Stock Ownership Plan or Stock Option
Plan of An Overseas Listed Company, also know as “Circular 78.” It is not clear
whether Circular 78 covers all forms of equity compensation plans or only those
which provide for the granting of stock options. For any plans which are so
covered and are adopted by a non-PRC listed company after April 6, 2007,
Circular 78 requires all participants who are PRC citizens to register with and
obtain approvals from SAFE prior to their participation in the plan. In
addition, Circular 78 also requires PRC citizens to register with SAFE and make
the necessary applications and filings if they participated in an overseas
listed company’s covered equity compensation plan prior to April 6, 2007. We
intend to adopt an equity compensation plan in the future and make option grants
to our officers and directors, most of who are PRC citizens. Circular 78 may
require our officers and directors who receive option grants and are PRC
citizens to register with SAFE. We believe that the registration and approval
requirements contemplated in Circular 78 will be burdensome and time consuming.
If it is determined that any of our equity compensation plans are subject to
Circular 78, failure to comply with such provisions may subject us and
participants of our equity incentive plan who are PRC citizens to fines and
legal sanctions and prevent us from being able to grant equity compensation to
our PRC employees. In that case, our ability to compensate our employees and
directors through equity compensation would be hindered and our business
operations may be adversely affected. "
Under the New EIT Law, we may be
classified as a “resident enterprise” of China. Such classification will likely
result in unfavorable tax consequences to us and our non-PRC
shareholders.
Under the
New EIT Law effective on January 1, 2008, an enterprise established outside
China with “de facto management bodies” within China is considered a “resident
enterprise,” meaning that it can be treated in a manner similar to a Chinese
enterprise for enterprise income tax purposes. The implementing rules of the New
EIT Law define de facto management as “substantial and overall management and
control over the production and operations, personnel, accounting, and
properties” of the enterprise.
23
On April
22, 2009, the State Administration of Taxation issued the Notice Concerning
Relevant Issues Regarding Cognizance of Chinese Investment Controlled
Enterprises Incorporated Offshore as Resident Enterprises pursuant to Criteria
of de facto Management Bodies, or the Notice, further interpreting the
application of the New EIT Law and its implementation non-Chinese enterprise or
group controlled offshore entities. Pursuant to the Notice, an enterprise
incorporated in an offshore jurisdiction and controlled by a Chinese enterprise
or group will be classified as a “non-domestically incorporated resident
enterprise” if (i) its senior management in charge of daily operations reside or
perform their duties mainly in China; (ii) its financial or personnel decisions
are made or approved by bodies or persons in China; (iii) its substantial assets
and properties, accounting books, corporate chops, board and shareholder minutes
are kept in China; and (iv) at least half of its directors with voting rights or
senior management often resident in China. A resident enterprise would be
subject to an enterprise income tax rate of 25% on its worldwide income and must
pay a withholding tax at a rate of 10% when paying dividends to its non-PRC
shareholders. However, it remains unclear as to whether the Notice is applicable
to an offshore enterprise incorporated by a Chinese natural person. Nor are
detailed measures on imposition of tax from non-domestically incorporated
resident enterprises are available. Therefore, it is unclear how tax authorities
will determine tax residency based on the facts of each case.
If we
were treated as a “resident enterprise” by PRC tax authorities, we would be
subject to taxation in both the U.S. and China, and our PRC tax may not be
creditable against our U.S. tax.
We may be exposed
to liabilities under the Foreign Corrupt Practices Act and Chinese
anti-corruption laws, and any determination that we violated these laws could
have a material adverse effect on our business.
We are
subject to the Foreign Corrupt Practice Act, or FCPA, and other laws that
prohibit improper payments or offers of payments to foreign governments and
their officials and political parties by U.S. persons and issuers as defined by
the statute, for the purpose of obtaining or retaining business. We have
operations, agreements with third parties and we make most of our sales in
China. PRC also strictly prohibits bribery of government officials. Our
activities in China create the risk of unauthorized payments or offers of
payments by the employees, consultants, sales agents or distributors of our
Company, even though they may not always be 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 to be
less than effective, 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 or Chinese anti-corruption laws may result
in severe criminal or civil sanctions, and we may be subject to other
liabilities, which could negatively affect our business, operating results and
financial condition. In addition, the U.S. government may seek to hold our
Company liable for successor liability FCPA violations committed by companies in
which we invest or that we acquire.
24
RISKS
RELATED TO THE MARKET FOR OUR STOCK GENERALLY
Our common stock
is quoted on the OTC Bulletin Board, which may have an unfavorable impact on our
stock price and liquidity.
Our
common stock is quoted on the OTC Bulletin Board. The OTC Bulletin Board is a
significantly more limited market than established trading markets such as the
New York Stock Exchange or NASDAQ. The quotation of our shares on the OTC
Bulletin Board may result in a less liquid market available for existing and
potential shareholders to trade shares of our common stock, could depress the
trading price of our common stock and could have a long-term adverse impact on
our ability to raise capital in the future. We plan to list our common stock as
soon as practicable. However, we cannot assure you that we will be able to meet
the initial listing standards of any stock exchange, or that we will be able to
maintain any such listing.
We may be subject
to penny stock regulations and restrictions and you may have difficulty selling
shares of our common stock.
The SEC
has adopted regulations which generally define so-called “penny stocks” to be an
equity security that has a market price less than $5.00 per share or an exercise
price of less than $5.00 per share, subject to certain exemptions. Our common
stock is a “penny stock” and is subject to Rule 15g-9 under the Exchange Act, or
the Penny Stock Rule. This rule imposes additional sales practice requirements
on broker-dealers that sell such securities to persons other than established
customers and “accredited investors” (generally, individuals with a net worth in
excess of $1,000,000 or annual incomes exceeding $200,000, or $300,000 together
with their spouses). For transactions covered by Rule 15g-9, a broker-dealer
must make a special suitability determination for the purchaser and have
received the purchaser's written consent to the transaction prior to sale. As a
result, this rule may affect the ability of broker-dealers to sell our
securities and may affect the ability of purchasers to sell any of our
securities in the secondary market, thus possibly making it more difficult for
us to raise additional capital.
There can
be no assurance that our common stock will qualify for exemption from the Penny
Stock Rule. In any event, even if our common stock were exempt from the Penny
Stock Rule, we would remain subject to Section 15(b)(6) of the Exchange Act,
which gives the SEC the authority to restrict any person from participating in a
distribution of penny stock, if the SEC finds that such a restriction would be
in the public interest.
Provisions
in our Certificate of Incorporation and Bylaws or Delaware law might
discourage, delay or prevent a change of control of us or changes in our
management and, therefore depress the trading price of the common
stock.
Our Certificate
of Incorporation authorizes our board of directors to issue up to 10,000,000
shares of preferred stock. The preferred stock may be issued in one or more
series, the terms of which may be determined at the time of issuance by the
board of directors without further action by stockholders. These terms may
include preferences as to dividends and liquidation, conversion rights,
redemption rights and sinking fund provisions. The issuance of any preferred
stock could diminish the rights of holders of our common stock, and therefore
could reduce the value of such common stock. In addition, specific rights
granted to future holders of preferred stock could be used to restrict our
ability to merge with, or sell assets to, a third party. The ability of our
board of directors to issue preferred stock could make it more difficult, delay,
discourage, prevent or make it more costly to acquire or effect a
change-in-control, which in turn could prevent our stockholders from recognizing
a gain in the event that a favorable offer is extended and could materially and
negatively affect the market price of our common stock.
In
addition, Delaware corporate law and our Certificate of Incorporation and
Bylaws also contain other provisions that could discourage, delay or prevent a
change in control of our Company or changes in its management that our
stockholders may deem advantageous. These provisions:
25
|
|
·
|
deny
holders of our common stock cumulative voting rights in the election of
directors, meaning that stockholders owning a majority of our outstanding
shares of common stock will be able to elect all of our
directors;
|
|
|
·
|
require
any stockholder wishing to properly bring a matter before a meeting of
stockholders to comply with specified procedural and advance notice
requirements; and
|
|
|
·
|
allow
any vacancy on the board of directors, however the vacancy occurs, to be
filled by the directors.
|
We
do not intend to pay dividends for the foreseeable future.
For the
foreseeable future, we intend to retain any earnings to finance the development
and expansion of our business, and we do not anticipate paying any cash
dividends on our common stock. Accordingly, investors must be prepared to rely
on sales of their common stock after price appreciation to earn an investment
return, which may never occur. Investors seeking cash dividends should not
purchase our common stock. Any determination to pay dividends in the future will
be made at the discretion of our board of directors and will depend on our
results of operations, financial condition, contractual restrictions,
restrictions imposed by applicable law and other factors our board deems
relevant.
Our
controlling stockholder holds a significant percentage of our outstanding voting
securities, which could hinder our ability to engage in significant corporate
transactions without his approval.
Swift
Dynamic Ltd., which is run by Mr. Tao Wang, is the beneficial owner of
approximately 63% of our outstanding voting securities. As a result, Swift
Dynamic Ltd., and Mr. Tao Wang possess significant influence,
giving them the ability, among other things, to elect a majority of
our board of directors and to authorize or prevent proposed significant
corporate transactions. Their ownership and control may also have the effect of
delaying or preventing a future change in control, impeding a merger,
consolidation, takeover or other business combination or discourage a potential
acquirer from making a tender offer.
26
OPERATIONS
Overview
We are a
designer and retailer of branded footwear in Northern China. We were
organized to service what we believe is an unmet and increasing demand for high
quality formal and casual footwear throughout the PRC. As
urbanization and individual purchasing power has increased in China, the demand
leather footwear has also grown.
Our
principal business includes (1) the design or selection of design for men’s and
women’s leather shoe lines (2) sourcing and purchase of the contract
manufactured footwear (3) retail and sales of said footwear under our
proprietary brand, “Hongung”. We operate a number of flagship stores
throughout greater Qingdao. Our products are also brought to market
through our extensive distribution network of authorized independent
distributors as well as through third party retailers selected to operate
exclusive Hongung brand stores on our behalf. Our company
headquarters and main sales office is located in Shandong province in northern
China, in the city of Jimo, less than 25 miles from the major urban center of
Qingdao.
Recent
Developments
Acquisition
of Glory Reach
On
February 12, 2010, we completed a reverse acquisition transaction through a
share exchange with Glory Reach and the shareholders of Glory Reach (the
“Shareholders”), whereby we acquired 100% of the issued and outstanding capital
stock of Glory Reach in exchange for 10,000 shares of our Series A Preferred
Stock, which constituted 97% of our issued and outstanding capital stock on an
as-converted to common stock basis as of and immediately after the consummation
of the reverse acquisition. As a result of the reverse acquisition, Glory Reach
became our wholly-owned subsidiary and the Shareholders became our beneficially
controlling stockholders. The share exchange transaction with Glory Reach was
treated as a reverse acquisition, with Glory Reach as the acquirer and Datone,
Inc. as the acquired party. Unless the context suggests otherwise, when we refer
in this report to business and financial information for periods prior to the
consummation of the reverse acquisition, we are referring to the business and
financial information of Glory Reach and its consolidated
subsidiaries.
Immediately
following closing of the reverse acquisition of Glory Reach, one of the
Shareholders transferred 337 of the 874 shares of Series A Convertible
Preferred Stock issued to him under the share exchange to certain persons
who provided services to Glory Reach’s subsidiaries, pursuant to share
allocation agreements that the Shareholder entered into with such service
providers.
Upon the
closing of the reverse acquisition, Craig H. Burton, our President and Director,
Joseph J. Passalaqua, our Secretary and Director, and Joseph Meuse, our
Director, submitted a resignation letter pursuant to which they resigned from
all offices that they held effective immediately and from
their position as our directors that will become effective on the
tenth day following the mailing by us of an information statement to our
stockholders that complies with the requirements of Section 14f-1 of the
Exchange Act, which will be mailed out on or about February 22,
2010. In addition, our board of directors on February 12 appointed
Tao Wang (Chairman), Renwei Ma and Lanhai Sun to fill the vacancies created by
such resignations, which appointments will become effective upon the
effectiveness of the resignation of Craig H. Burton, Joseph J. Passalaqua, and
Joseph Meuse on the tenth day following the mailing by us of the Information
Statement to our stockholders. In addition, our executive officers
were replaced by the Qingdao Shoes’ executive officers upon the closing of the
reverse acquisition as indicated in more detail below.
27
Glory
Reach was established in Hong Kong on November 18, 2009 to serve as an
intermediate holding company. Qingdao Shoes was established on May 11, 2003 for
the purpose of engaging in the development and sales of shoe products. On
February 8, 2010, also pursuant to the restructuring plan, Glory Reach, acquired
100% of the equity interests in Qingdao Shoes Company from Mr. Wang Tao, our
Chief Executive Officer, our Chairman, and other minority shareholders, who are
all PRC residents. On February 4, 2010, the local government of the PRC issued
the certificate of approval regarding the change in shareholding of Qingdao
Shoes and its transformation from a PRC domestic company to a wholly-foreign
owned enterprise.
For
accounting purposes, the acquisitions of Glory Reach and Qingdao Shoes have been
treated as a recapitalization of Glory Reach and Qingdao Shoes with no
adjustment to the historical basis of their assets and liabilities. The
restructuring has been accounted for using the “as if” pooling method of
accounting and the operations were consolidated as if the restructuring had
occurred as of the beginning of the earliest period presented in our
consolidated financial statements and the current corporate structure had been
in existence throughout the periods covered by our consolidated financial
statements.
Principal
Factors Affecting Our Financial Performance
Our
operating results are primarily affected by the following factors:
|
|
·
|
Growth in
the Chinese Economy - We operate our facilities in China and derive
almost all of our revenues from sales to customers in China. Economic
conditions in China, therefore, affect virtually all aspects of our
operations, including the demand for our products, the availability and
prices of our raw materials and our other expenses. China has experienced
significant economic growth, achieving a compound annual growth rate of
over 10% in gross domestic product from 1996 through 2008. China is
expected to experience continued growth in all areas of investment and
consumption, even in the face of a global economic recession. However,
China has not been entirely immune to the global economic slowdown and is
experiencing a slowing of its growth rate. Our business model
is also dependent on increasing numbers of middle class urban consumers
driving demand for shoes appropriate for business casual and formal
occasions, as well as urban consumer habits, such as window
shopping. Retail sales grew by 15.5% in 2009. We
anticipate to continue to benefit from these trends due to our presence
throughout rapidly urbanizing and gentrifying neighborhoods in
Shandong.
|
|
|
·
|
Brand
Strength – Continued development of our brand’s strength and
visibility are vital to our goal of taking significant market share on a
PRC wide scale. We believe our advertising campaigns, from
print media to television advertisements and celebrity endorsements have
been instrumental to the rapid success of building the strength of our
brand. Furthermore, our growing expansion in Shandong will be
fueled by our tight management of our brand, customer service, and
decoration. We are on actively involved with all of our
distributers to ensure uniform and superb quality of customer service,
product, and consumer experience at every point of
sale.
|
|
|
·
|
Competitive
Environment – We face an increasing number of both international
and domestic competitors. As we are focused on retail, we
believe our margins to higher and risks lower than other competitors who
are tied to factories with expensive labor and asset costs. As
labor costs continue to rise in China, we are particularly well positioned
to avoid the challenges associated with divesting of factories in China
and/or moving to new production facilities in Southeast
Asia. Our margins are better than industry average precisely
because we have focused developing in the most profitable portion of the
footwear industry’s value chain.
|
United
States and Hong Kong
We are
subject to United States tax at a tax rate of 34%. No provision for income taxes
in the United States has been made as we have no income taxable in the United
States.
28
Glory
Reach is incorporated in Hong Kong and is subject to Hong Kong profits tax of
16.5%.
People’s
Republic of China
Income
Taxes:
The
Company accounts for income taxes in accordance with ASC 740 “Income
Taxes”. ASC 740 requires an asset and liability approach for
financial accounting and reporting for income taxes and allows recognition and
measurement of deferred tax assets based upon the likelihood of realization of
tax benefits in future years. Under the asset and liability approach,
deferred taxes are provided for the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. A valuation
allowance is provided for deferred tax assets if it is more likely than not
these items will either expire before the Company is able to realize their
benefits, or that future deductibility is uncertain. There was no deferred tax
asset or liability for the years ended December 31, 2008 and
2007. The Company is governed by the Income Tax Law of the PRC
concerning the private-run enterprises, which are generally subject to tax at a
statutory rate of 25% and 33% on income reported in the statutory financial
statements after appropriated tax adjustments in 2008 and 2007
respectively.
Value
Added Taxes:
The
Company is subject to value added tax (“VAT”) for selling merchandise. The
applicable VAT rate is 17% for products sold in the PRC. The amount of VAT
liability is determined by applying the applicable tax rate to the invoiced
amount of goods sold (output VAT) less VAT paid on purchases made with the
relevant supporting invoices (input VAT). Under the commercial practice of the
PRC, the Company pays VAT based on tax invoices issued. The tax invoices may be
issued subsequent to the date on which revenue is recognized, and there may be a
considerable delay between the date on which the revenue is recognized and the
date on which the tax invoice is issued. In the event that the PRC tax
authorities dispute the date on which revenue is recognized for tax purposes,
the PRC tax office has the right to assess a penalty based on the amount of the
taxes which are determined to be late or deficient, and will be expensed in the
period if and when a determination is made by the tax authorities that a penalty
is due.
Our
future effective income tax rate depends on various factors, such as tax
legislation, the geographic composition of our pre-tax income and non-tax
deductible expenses incurred. Our management carefully monitors these legal
developments and will punctually adjust our effective income tax rate when
necessary.
Results
of Operations
Comparison of Nine Months
Ended September 30, 2009 and September 30, 2008 (Unaudited)
The
following table sets forth key components of our results of operations during
the nine month periods ended September 30, 2009 and 2008, both in dollars and as
a percentage of our net sales. As the reverse acquisition of Glory Reach was
entered into after September 30, 2009 and during the periods indicated Qingdao
Shoes was the only entity in our combined business that had operations, the
results of operations below refer only to that of Qingdao Shoes.
|
Nine Months
Ended
|
Nine Months
Ended
|
|||||||||||||||
|
September 30,
2009
|
September 30,
2008
|
|||||||||||||||
|
%
of Net
|
%
of Net
|
|||||||||||||||
|
Amount
|
Sales
|
Amount
|
Sales
|
|||||||||||||
|
Net
Sales
|
$ | 12,517,751 | 100 | % | $ | 9,116,272 | 100 | % | ||||||||
|
Cost
of sales
|
7,102,669 | 57 | % | 5,432,591 | 60 | % | ||||||||||
|
Gross
profit
|
5,415,082 | 43 | % | 3,683,681 | 40 | % | ||||||||||
|
Selling,
General and Administrative Expenses
|
686,645 | 5 | % | 557,793 | 6 | % | ||||||||||
|
Operating
Income
|
4,728,437 | 38 | % | 3,125,888 | 34 | % | ||||||||||
|
Other income & interest expense
|
24,879 | 0 | % | -1,657 | 0 | % | ||||||||||
|
Income
Before Income Taxes
|
4,753,316 | 38 | % | 3,124,231 | 34 | % | ||||||||||
|
Income
taxes
|
1,188,329 | 9 | % | 781,058 | 9 | % | ||||||||||
|
Net
income
|
$ | 3,564,987 | 28 | % | $ | 2,343,173 | 26 | % | ||||||||
29
Net Sales.
Our net sales increased to $12,517,751 in the nine months ended September 30,
2009 from $9,116,272 in the same period in 2008, representing a 37.31%increase
year-on-year. This increase was mainly due to the growth in our points of
sales.
Cost of
Sales. Our cost of sales increased $1,670,078 to $7,102,669 in the nine
months ended September 30, 2009 from $5,432,591 in the same period in 2008. The
cost of goods sold per sales ratio changed from 60% to 57%, mainly due to
greater efficiencies our cost control.
Gross Profit and
Gross Margin.
Our gross profit increased $1,731,401 to $5,415,082 in the nine months
ended September 30, 2009 from $3,683,681 in the same period in 2008. Gross
profit as a percentage of net revenue was 43% and 40% for the nine
months ended September 30, 2009 and 2008, respectively. The slight increase in
the gross margin was primarily due changes in our product mix and greater
efficiencies in cost control.
Selling, General
and Administrative Expenses. Our selling, general and administration grew
slightly to $686,645 in the nine months ended September 30, 2009 from $557,793
in the same period in 2008. This increase was mainly due to our rapid growth as
these costs are proportional to sales. As a percentage of revenues,
however, we were able to lower SG&A costs by roughly one percentage
point.
Other
Income. Other income decreased increased to $24,879 in the nine months
ended September 30, 2009 from $-1,657 in the same period in 2008.
Income Before
Income Taxes. Our income before income taxes increased to $4,753,316 in
the nine months ended September 30, 2009 from $3,124,231 in the same period in
2008. This increase was mainly due to the general expansion in our operational
scope.
Income
Taxes. Income tax increased to $1,188,329 in the nine months ended
September 30, 2009 from $781,058 in the same period in 2008. The increase was
due to an increase in income.
Year Ended December 31, 2008
Compared to Year Ended December 31, 2007
The
following table sets forth key components of our results of operations for the
periods indicated, both in dollars and as a percentage of our net sales. As the
reverse acquisition of Glory Reach was entered into after December 31, 2008 and
during the periods indicated Qingdao Shoes were the only entities in our
combined business that had operations, the results of operations below refer
only to that of Qingdao Shoes.
|
Year
Ended
|
Year
Ended
|
|||||||||||||||
|
December 31,
2008
|
December 31,
2007
|
|||||||||||||||
|
%
of Net
|
%
of Net
|
|||||||||||||||
|
Amount
|
Sales
|
Amount
|
Sales
|
|||||||||||||
|
Net
Sales
|
$ | 13,904,314 | 100 | % | $ | 8,594,468 | 100 | % | ||||||||
|
Cost
of sales
|
8,246,592 | 59 | % | 4,996,377 | 58 | % | ||||||||||
|
Gross
profit
|
5,657,722 | 41 | % | 3,598,091 | 42 | % | ||||||||||
|
Selling,
General and Administrative Expenses
|
759,470 | 5 | % | 517,140 | 6 | % | ||||||||||
|
Operating
Income
|
4,842,892, | 35 | % | 3,023,842 | 35 | % | ||||||||||
|
Other income
|
4,704 | 0 | % | (24,796 | ) | 0 | % | |||||||||
|
Income
Before Income Taxes
|
4,847,596 | 35 | % | 2,999,046 | 35 | % | ||||||||||
|
Income
taxes
|
1,211,899 | 9 | % | 989,685 | 12 | % | ||||||||||
|
Net
income
|
$ | 3,635,697 | 26 | % | $ | 2,009,361 | 23 | % | ||||||||
30
Net Sales.
Our sales grew substantially to $13,904,314 in 2008 from $8,594,468 in 2007,
primarily due to an increase in the number of our sales points and volume at
existing stores.
Cost of
Sales. Our cost of sales increased from $4,996,377 in 2007 to $8,246,592
in 2008, due to the expansion of our business in 2008.
Gross Profit and
Gross Margin. Our gross profit increased from $3,598,091 in 2007 to
$5,657,722 in 2008, due to the expansion of our business. Our gross profit
margin was improved stayed roughly the same, a slight decrease to 41% in 2008 to
as opposed to 42% in 2007.
Selling, General
and Administrative Expenses. In 2008, our selling, general and
administration expenses rose to $759,470, from $517,140 in 2007
reflecting increased commissions and cost associated with increased
revenues.
Other
Income. Other income increased to $4,704 in 2008, from -$24,796 in 2007
and represents a negligible percentage of revenues.
Income Before
Income Taxes. Our income before income taxes increased to $4,847,596 in
2008 from $2,999,046 in 2007.
Income
Taxes. Income tax increased to $1,211,899 in 2008 from $989,685 in 2007.
The increase was mainly due to the increase in our income, as our income tax
rate was lowered from 33% to 25% from period to period.
Net
Income. In 2008, we generated a net income of $3,635,697, an increase of
$1,626,336 from $2,009,361 in 2007, representing a growth rate of 81%. Such
increase was mainly due to successful scaling out of our business
model.
Liquidity
And Capital Resources
As of
September 30, 2009, we had cash and cash equivalents of $464,914, primarily
consisting of cash on hand and demand deposits. The following table provides
detailed information about our net cash flow for all financial statement periods
presented in this report. To date, we have financed our operations primarily
through cash flows from operations and equity contributions by our
shareholders.
The
following table sets forth a summary of our cash flows for the periods
indicated:
Cash
Flow
(all
amounts in U.S. dollars)
|
Nine Months
Ended
|
Fiscal Year
Ended
|
|||||||||||||||
|
September
30,
|
December
31,
|
|||||||||||||||
|
2009
|
2008
|
2008
|
2007
|
|||||||||||||
|
Net
cash provided by operating activities
|
$ | 6,591,232 | $ | 4,984,660 | $ | 7,746,685 | $ | 5,005,406 | ||||||||
|
Net
cash provided by (used in) investing activities
|
309,930 | (2,212,812 | ) | (5,823,377 | ) | (4,849,957 | ) | |||||||||
|
Net
cash provided by (used in) financing activities
|
(6,552,342 | ) | (1,874,600 | ) | (1,874,600 | ) | (257,220 | ) | ||||||||
|
Effects
of Exchange Rate Change in Cash
|
-2,440 | 23,772 | 35,218 | 47,022 | ||||||||||||
|
Net
(Decrease) Increase in Cash and Cash Equivalents
|
346,380 | 921,020 | 83,926 | -54,749 | ||||||||||||
|
Cash
and Cash Equivalent at Beginning of the Year
|
118,534 | 34,608 | 34,608 | 89,357 | ||||||||||||
|
Cash
and Cash Equivalent at End of the Year
|
464,914 | 955,628 | 118,534 | 34,608 | ||||||||||||
31
Operating
activities
Net cash
provided by operating activities was $6,591,232 for the nine months ended
September 30, 2009, as compared to $4,984,660 for the same period in 2008. The
increase in net cash provided by operating activities was due to growth in the
scope of our business.
Net cash
provided by operating activities was $7,746,685 for the year ended December 31,
2008, as compared to $5,005,406 for the same period in 2007. The increase in net
cash provided by operating activities was due to growth in the scope of our
business.
Investing
activities
Net cash
provided in investing activities for the nine months ended September 30,
2009 was $309,930, as
compared to $(2,212,812)
net cash used in investing activities during the same period of 2008.
The change in net cash provided by (used
in) investing activities was mainly due to advances to/collections
from related party.
Net cash
used in investing activities for the year ended December 31, 2008 was (5,823,377) as compared to
$(4,849,957) in the same
period of 2007. The increase of net cash used in investing activities was mainly
due to advances to related party.
Financing
activities
Net cash
used in financing activities for the nine months ended September 30, 2009 was
$(6,552,342), as compared
to $(1,874,600) in the
same period of 2008. The significant increase in net cash used in financing
activities was mainly due to distributions to shareholders.
Net cash used in financing activities
for the years ended December 31, 2008 and 2007 was $(1,874,600) and
$(257,220) respectively. The
significant increase in net cash used in financing activities was mainly due to
distributions to shareholders.
We
believe that our cash on hand and cash flow from operations will meet part of
our present cash needs and we will require additional cash resources, to meet
our expected capital expenditure and working capital for the next 12 months. We
may, however, in the future, require additional cash resources due to changed
business conditions, implementation of our strategy to ramp up our marketing
efforts and increase brand awareness, or acquisitions we may decide to pursue.
If our own financial resources are insufficient to satisfy our capital
requirements, we may seek to sell additional equity or debt securities or obtain
additional credit facilities. The sale of additional equity securities could
result in dilution to our stockholders. The incurrence of indebtedness would
result in increased debt service obligations and could require us to agree to
operating and financial covenants that would restrict our operations. Financing
may not be available in amounts or on terms acceptable to us, if at all. Any
failure by us to raise additional funds on terms favorable to us, or at all,
could limit our ability to expand our business operations and could harm our
overall business prospects.
Inflation
Inflation
and changing prices have not had a material effect on our business and we do not
expect that inflation or changing prices will materially affect our business in
the foreseeable future. However, our management will closely monitor the price
change in travel industry and continually maintain effective cost control in
operations.
Off
Balance Sheet Arrangements
We do not
have any off balance sheet arrangements that have or are reasonably likely to
have a current or future effect on our financial condition, changes in financial
condition, revenues or expenses, results of operations, liquidity or capital
expenditures or capital resources that is material to an investor in our
securities.
32
Seasonality
We may
experience seasonal fluctuations in our revenue in some regions in the PRC,
based on the seasonal changes in the weather and the tendency of customers to
make purchases relating to their apparel suitable for the time of
year. Any seasonality may cause significant pressure on us to monitor
the development of materials accurately and to anticipate and satisfy these
requirements. Our revenues are usually higher in the fourth and
first quarters due seasonal purchases.
The
preparation of financial statements in conformity with accounting principles
generally accepted in the United States requires our management to make
assumptions, estimates and judgments that affect the amounts reported, including
the notes thereto, and related disclosures of commitments and contingencies, if
any. We have identified certain accounting policies that are significant to the
preparation of our financial statements. These accounting policies are important
for an understanding of our financial condition and results of operation.
Critical accounting policies are those that are most important to the portrayal
of our financial conditions and results of operations and require management’s
difficult, subjective, or complex judgment, often as a result of the need to
make estimates about the effect of matters that are inherently uncertain and may
change in subsequent periods. Certain accounting estimates are particularly
sensitive because of their significance to financial statements and because of
the possibility that future events affecting the estimate may differ
significantly from management’s current judgments. We believe the following
critical accounting policies involve the most significant estimates and
judgments used in the preparation of our financial statements:
Revenue
Recognition
Retail
sales are recognized at the point of sale to customers, are recorded net of
estimated returns, and exclude value added tax (“VAT”). Wholesales to its
contracted customers are recognized as revenue at the time the product is
shipped and title passes to the customer on an FOB shipping point
basis.
Use
of Estimates
The
preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America (“US GAAP”) requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the dates of the financial statements and the amount of revenues and expenses
during the reporting periods. Management makes these estimates using
the best information available at the time the estimates are
made. However, actual results could differ materially from those
estimates.
Accounts
Receivable
Accounts
receivable consists of unpaid balances due from the whole-sale customers. Such
balances generally are cleared in the subsequent month when the whole-sale
customers place another order. The Company does not provide an allowance for
doubtful accounts because the Company has not experienced any credit losses in
collecting these amounts from whole-sale customers.
The
Company accounts for impairment of property and equipment and amortizable
intangible assets in accordance with ASC 360, “Accounting for Impairment of
Long-Lived Assets and Long-Lived Assets to be Disposed Of”, which requires the
Company to evaluate a long-lived asset for recoverability when there is event or
circumstance that indicate the carrying value of the asset may not be
recoverable. An impairment loss is recognized when the carrying amount of a
long-lived asset or asset group is not recoverable (when carrying amount exceeds
the gross, undiscounted cash flows from use and disposition) and is measured as
the excess of the carrying amount over the asset’s (or asset group’s) fair
value. There was no impairment of long-lived assets for the years ended December
31, 2008 and 2007.
33
Inventories
Merchandise
inventories are stated at the lower of cost or market. Cost is
determined on a weighted average basis and includes all expenditures incurred in
bringing the goods to the point of sale and putting them in a salable
condition. In assessing the ultimate realization of inventories, the
management makes judgments as to future demand requirements compared to current
or committed inventory levels. Our reserve requirements generally
increase as our projected demand requirements; or decrease due to market
conditions and product life cycle changes. The Company estimates the
demand requirements based on market conditions, forecasts prepared by its
customers, sales contracts and orders in hand.
In
addition, the Company estimates net realizable value based on intended use,
current market value and inventory ageing analyses. The Company
writes down inventories for estimated obsolescence or unmarketable inventory
equal to the difference between the cost of inventories and their estimated
market value based upon assumptions about future demand and market
conditions.
Comprehensive
Income
The
Company has adopted the provisions of ASC 220 “Reporting Comprehensive Income”
which establishes standards for the reporting and display of comprehensive
income, its components and accumulated balances in a full set of general purpose
financial statements.
ASC 220
defines comprehensive income is comprised of net income and all changes to the
statements of stockholders' equity, except those due to investments by
stockholders, changes in paid-in capital and distributions to stockholders,
including adjustments to minimum pension liabilities, accumulated foreign
currency translation, and unrealized gains or losses on marketable securities.
The Company’s other comprehensive income arose from the effect of foreign
currency translation adjustments.
Foreign
Currency Translation
The
Company’s functional currency is Chinese currency Renminbi (“RMB”) and its
reporting currency is the U.S. dollar. Transactions denominated in foreign
currencies are translated into U.S. dollar at exchange rate in effect on the
date of the transactions. Exchange gains or losses on transaction are included
in earnings.
The
financial statements of the Company are translated into United States dollars in
accordance with the provisions of ASC 830 “Foreign Currency Matters”, using the
year-end rates of exchange for assets and liabilities, and average rates of
exchange for the period for revenues, costs, and expenses and historical rates
for the equity. Translation adjustments resulting from the process of
translating the local currency financial statements into U.S. dollars are
included in determining comprehensive income. At December 31, 2008 and 2007, the
cumulative translation adjustment of $437,665 and $205,618 were classified as an
item of accumulated other comprehensive income in the shareholders’ equity
section of the balance sheet respectively. For the years ended December 31, 2008
and 2007, other comprehensive income was $232,047 and $141,675,
respectively.
Recent
Accounting Pronouncements
Fair Value Measurements and
Disclosures (Included in ASC 820, previously FSP No. 157-4, “Determining Whether
a Market is Not Active and a Transaction Is Not
Distressed”). FSP No. 157-4 clarifies when markets are
illiquid or that market pricing may not actually reflect the “real” value of an
asset. If a market is determined to be inactive and market price is
reflective of a distressed price then an alternative method of pricing can be
used, such as a present value technique to estimate fair value. FSP
No. 157-4 identifies factors to be considered when determining whether or not a
market is inactive. FSP No. 157-4 would be effective for interim and
annual periods ending after June 15, 2009, with early adoption permitted for
periods ending after March 15, 2009 and shall be applied
prospectively. The adoption of this standard had no material effect
on the Company's financial statements.
34
Interim Disclosures about Fair Value
of Financial Instruments (Included in ASC 825 “Financial Instruments”,
previously FSP SFAS No. 107-1). This guidance requires that
the fair value disclosures required for all financial instruments within the
scope of SFAS No. 107, “Disclosures about Fair Value of Financial Instruments”,
be included in interim financial statements. This guidance also
requires entities to disclose the method and significant assumptions used to
estimate the fair value of financial instruments on an interim and annual basis
and to highlight any changes from prior periods. FSP 107-1 was
effective for interim periods ending after September 15, 2009. The
adoption of FSP 107-1 had no material impact on the Company’s financial
statements.
Consolidation of Variable Interest
Entities – Amended (To be included in ASC 810 “Consolidation”, previously SFAS
167 “Amendments to FASB Interpretation No. 46(R)”). SFAS 167 amends FASB
Interpretation No. 46 (revised December 2003), “Consolidation of Variable
Interest Entities,” to require an enterprise to perform an analysis to determine
the primary beneficiary of a variable interest entity; to require ongoing
reassessments of whether an enterprise is the primary beneficiary of a variable
interest entity and to eliminate the quantitative approach previously required
for determining the primary beneficiary of a variable interest
entity. SFAS 167 also requires enhanced disclosures that will provide
users of financial statements with more transparent information about an
enterprise’s involvement in a variable interest entity. SFAS 167 is
effective for the first annual reporting period beginning after November 15,
2009 and will be effective for us as of January 1, 2010. The
management is in the process of evaluating the impact of adopting this standard
on the Company’s financial statements.
FASB Accounting Standards
Codification (Accounting Standards Update “ASU” 2009-1). In June 2009,
the Financial Accounting Standard Board (“FASB”) approved its Accounting
Standards Codification (“Codification”) as the single source of authoritative
United States accounting and reporting standards applicable for all
non-governmental entities, with the exception of the SEC and its
staff. The Codification is effective for interim or annual financial
periods ending after September 15, 2009 and impacts our financial statements as
all future references to authoritative accounting literature will be referenced
in accordance with the Codification. There have been no changes to
the content of our financial statements or disclosures as a result of
implementing the Codification.
As a
result of our implementation of the Codification during the quarter ended
September 30, 2009, previous references to new accounting standards and
literature are no longer applicable. In the current quarter financial
statements, we will provide reference to both new and old guidance to assist in
understanding the impacts of recently adopted accounting literature,
particularly for guidance adopted since the beginning of the current fiscal year
but prior to the Codification.
In August
2009, the FASB issued Accounting Standards Update No. 2009-05 (“ASC Update
2009-05”), an update to ASC 820, Fair Value Measurements and
Disclosures. This update provides amendments to reduce potential
ambiguity in financial reporting when measuring the fair value of
liabilities. Among other provisions, this update provides
clarification that in circumstances in which a quoted price in an active market
for the identical liability is not available, a reporting entity is required to
measure fair value using one or more of the valuation techniques described in
ASC Update 2009-05. ASC Update 2009-05 will become effective for the
Company’s annual financial statements for the year ended December 31, 2009. The
management is in the process of evaluating the impact of adopting this standard
on the Company’s financial statements.
In
October 2009, the FASB issued Accounting Standards Update, 2009-13, Revenue
Recognition (Topic 605) “Multiple Deliverable Revenue Arrangements - A Consensus
of the FASB Emerging Issues Task Force”. This update provides
application guidance on whether multiple deliverables exist, how the
deliverables should be separated and how the consideration should be allocated
to one or more units of accounting. This update establishes a selling
price hierarchy for determining the selling price of a
deliverable. The selling price used for each deliverable will be
based on vendor-specific objective evidence, if available, third-party evidence
if vendor-specific objective evidence is not available, or estimated selling
price if neither vendor-specific or third-party evidence is
available. The Company will be required to apply this guidance
prospectively for revenue arrangements entered into or materially modified after
January 1, 2011; however, earlier application is permitted. The
management is in the process of evaluating the impact of adopting this standard
on the Company’s financial statements.
35
SECURITY OWNERSHIP OF CERTAIN
BENEFICIAL OWNERS AND MANAGEMENT
The
following table sets forth information regarding beneficial ownership of our
common stock as of February 12, 2010 (i) by each person who is known by us to
beneficially own more than 5% of our common stock; (ii) by each of our officers
and directors; and (iii) by all of our officers and directors as a group. Unless
otherwise specified, the address of each of the persons set forth below is in
care of the Company, 269 First Huashan Road, Jimo City, Qingdao, Shandong,
China. Except as
indicated in the footnotes to this table and subject to applicable community
property laws, the persons named in the table to our knowledge have sole voting
and investment power with respect to all shares of securities shown as
beneficially owned by them. The information in this table is as of February 12,
2010 based upon (i) 8,100,000 shares of common stock outstanding and (ii)
10,000,000 shares of Series A convertible Preferred Stock
outstanding.
|
Name and Address of
Beneficial Owner
|
Office, If Any
|
Title of Class
|
Amount and
Nature of
Beneficial
Ownership
|
Percent of
Combined
Voting
Power of
Common
Stock and
Series A
Preferred
Stock
(1)
|
||||||||
|
Officers and
Directors
|
||||||||||||
|
Tao
Wang
|
Chief
Executive Officer
|
Series
A Convertible Preferred Stock
|
6,495 | (2) | 63.0 | % | ||||||
|
Joseph
Meuse
|
Director
|
Series
A Convertible Preferred Stock
|
873 | 8.5 | ||||||||
|
360
Main Street
PO
Box 393
Washington,
Virginia 22747
|
||||||||||||
|
Craig
Burton
|
Director
|
Common
Stock
|
115,000 | * | ||||||||
|
Joseph
J. Passalaqua
|
Director
|
Common
Stock
|
120,000 | * | ||||||||
|
All
officers and directors as a
group
(2 persons named above)
|
Series
A Convertible Preferred Stock
Common
Stock
|
7,368
235,000
|
71.6
|
|||||||||
|
5% Security
Holders
|
||||||||||||
|
Swift
Dynamic Limited
P.O.
Box 957,
Offshore
Incorporations Centre,
Road
Town,
British
Virgin Islands
|
Series
A Convertible Preferred Stock
|
6,495 | (2) | 63.0 | ||||||||
|
Greenwich
Holdings, LLC (3)
106
Glenwood Drive
Liverpool
NY 13090
|
Common
Stock
|
6,792,781 | (3) | 2.5 | ||||||||
|
William
Luckman
360
Main Street
PO
Box 393
Washington,
Virginia 22747
|
Series
A Convertible Preferred Stock
|
874 | 8.5 | |||||||||
* Less
than 1%
(1)
Common Stock shares have one vote per share. Shares of Series A
Convertible Preferred Stock will automatically convert into shares of common
stock on the basis of one share of Series A Preferred Stock for 970 shares of
common stock upon the effectiveness of a planned 1-for-27 reverse split of our
outstanding common stock, which we expect to become effective in or about March
2010. Holders of Series A Preferred Stock vote with the holders of
common stock on all matters on an as-converted to common stock based on an
assumed post 1-for-27 reverse split basis.
(2) Based
on 6,495 shares of Series A Convertible Preferred held by Swift Dynamic Limited,
a British Virgin Islands limited company. Tao Wang serves as Chief
Executive Officer and Director of Swift Dynamic Limited.
(3) Based
on 6,792,781 shares of Common Stock held by Greenwich Holdings,
LLC. Greenwich Holdings, LLC is a New York limited liability company
that is owned by Joseph C. Passalaqua, a resident of Liverpool, New
York.
36
Changes
in Control
The
Company does not have any change of control or retirement arrangements with its
executive officers.
DIRECTORS
AND EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS
Directors
and Executive Officers
The
following sets forth information about our directors and executive officers as
of the date of this report:
|
NAME
|
AGE
|
POSITION
|
||
|
Tao
Wang
|
39
|
Chief
Executive Officer
|
||
|
Renwei
Ma
|
43
|
General
Counsel
|
||
|
Fang
Sui
|
28
|
Chief
Financial Officer, Controller
|
||
|
Wenmao
Shi
|
39
|
Chief
Operating Officer
|
||
|
Zhengdian
Xing
|
33
|
Vice
President, Sales
|
||
|
Xianfu
Qiao
|
47
|
Sourcing
and Design Manager
|
||
|
Craig
H. Burton
|
46
|
Director
|
||
|
Joseph
J. Passalaqua
|
36
|
Director
|
||
|
Joseph
Meuse
|
39
|
Director
|
Tao Wang Mr. Wang has been the
company’s CEO and founder since March 10, 2003. Before
founding Hongung, Mr. Wang was engaged in variety of capacities involving
branding, strategic marketing and sales of footwear since 1992. Mr. Wang
has over 18 years experience in shoe industry.
Renwei Ma Mr. Ma is the company
legal representative since the founding of the Hongung in March 2003. Prior
becoming Hongung’s legal representative, he was self-employed, as well worked in
the shoe industry. He obtained a bachelor degree in Marketing.
Fang Sui Ms. Sui joined
Hongung in March 2003. She is responsible for the company’s financial
information. She holds a bachelor’s degree, and she is a
registered accountant.
Wenmao Shi Mr. Mao has been with
the Company in the sales department since inception in March
2003. Prior joining Hongung, Mr. Mao was a director of sales at
Qingdao Double Star Group. Mr. Mao has over 18 years of sales experience, and
obtained a bachelor degree in 1992, majoring in Economics.
Zhengdian Xing Mr. Xing is a Sales
Manager and has been with the Company since March , 2003. Prior
joining Hongung, Mr. Mao was previously an entrepreneur in
the footwear industry since 1998. Mr. Xing has over 10 years of
sales experience, and obtained a bachelor degree in 1998, majoring in Sales and
Marketing.
37
Xianfu Qiao, Mr. Qiao has been
the Company’s Development Manager since March , 2003. Prior
joining Hongung, Mr. Mao was self-employed, he has worked in the shoe industry
in a variety of capacities since 1986. Mr. Qiao has over 20 years of industry
experience.
Craig Burton, Mr. Burton has
served as President and director of Datone, Inc. since August, 2000. On February
12, 2010 Mr. Burton resigned as President of Datone. Mr. Burton
attended the University of South Carolina-Coastal and was a licensed real estate
agent in the State of New York. He began working in marketing for a long
distance carrier in 1996 and in 1999, Mr. Burton became Director of Marketing
for Datone Communications, Inc., an owner of payphones and distributor of
prepaid calling cards. Datone was acquired by USIP in January, 2000. Mr. Burton
served as President and a director of USIP.Com from January 2000-2006.
Additionally, Mr. Burton was secretary and director of NB Telecom,Inc. from
December 2005-2008.
Joseph J. Passalaqua, Mr.
Passalaqua has served as our secretary and director since August 2000. On
February 12, 2010 Mr. Passalaqua resigned as Secretary of
Datone. Since 1999, Mr. Passalaqua has worked as a trainer at Sports
Karate and fitness training company located in Cicero, New York. Mr. Passalaqua
is a high school graduate.
Joseph Meuse, Mr. Meuse has
served as a director of Datone since January 25, 2010. Mr. Meuse has
been involved with corporate restructuring since 1995. He is the
Managing Member of Belmont Partners, LLC and was previously a Managing Partner
of Castle Capital Partners. Additionally, Mr. Meuse maintains a position as a
Board Member of numerous public companies. Mr. Meuse attended the
College of William and Mary.
Family
Relationships
There is
no family relationship among any of our officers or directors.
Involvement
in Certain Legal Proceedings
To the
best of our knowledge, none of our directors or executive officers has been
convicted in a criminal proceeding, excluding traffic violations or similar
misdemeanors, or has been a party to any judicial or administrative proceeding
during the past five years that resulted in a judgment, decree or final order
enjoining the person from future violations of, or prohibiting activities
subject to, federal or state securities laws, or a finding of any violation of
federal or state securities laws. Except as set forth in our discussion below in
“Certain Relationships and Related Transactions, and Director Independence –
Transactions with Related Persons,” none of our directors, director nominees or
executive officers has been involved in any transactions with us or any of our
directors, executive officers, affiliates or associates which are required to be
disclosed pursuant to the rules and regulations of the SEC.
38
EXECUTIVE
COMPENSATION
Summary
Compensation Table — Fiscal Years Ended December 31, 2008 and 2007
The
following table sets forth information concerning all cash and non-cash
compensation awarded to, earned by or paid to the named persons for services
rendered in all capacities during the noted periods. No other executive officer
received total annual salary and bonus compensation in excess of
$100,000.
|
Name and Principal Position
|
Year
|
Salary ($)
|
Bonus ($)
|
Total ($)
|
|||||||
|
Tao
Wang, Chief Executive Officer
|
2008
|
8,088 | 3,676 | 11,764 | |||||||
|
2009
|
8,088 | 3,676 | 11,764 | ||||||||
|
Craig
Burton, former President
|
2008
|
40,040 | 0 | 40,040 | |||||||
|
2009
|
40,040 | 0 | 40,040 | ||||||||
|
(1)
|
On
February 12, 2010, we acquired Glory Reach in a reverse acquisition
transaction that was structured as a share exchange and in connection with
that transaction, Mr. Tao Wang became our Chief Executive Officer. Prior
to the effective date of the reverse acquisition, Mr. Craig Burton served
as Chief Executive Officer of
Datone.
|
Summary of Employment Agreements and
Material Terms
Prior to
our reverse acquisition of Glory Reach, our operating subsidiaries were private
limited companies organized under the laws of the PRC, and in accordance with
PRC regulations, the salary and bonus of our executives was determined by our
shareholders.
Other
than the salary and necessary social benefits required by the government, we
currently do not provide other benefits to the officers at this time. Our
executive officers are not entitled to severance payments upon the termination
of their employment agreements or following a change in control.
We have
not provided retirement benefits (other than a state pension scheme in which all
of our employees in China participate) or severance or change of control
benefits to our named executive officers.
Outstanding Equity Awards at Fiscal
Year End
For the
year ended December 31, 2009, no director or executive officer has received
compensation from us pursuant to any compensatory or benefit plan. There is no
plan or understanding, express or implied, to pay any compensation to any
director or executive officer pursuant to any compensatory or benefit plan,
although we anticipate that we will compensate our officers and directors for
services to us with stock or options to purchase stock, in lieu of
cash.
Compensation of
Directors
No member
of our board of directors received any compensation for his services as a
director during the year ended December 31, 2009 and currently no compensation
arrangements are in place for the compensation of directors.
39
Transactions
With Related Persons
The
following includes a summary of transactions since the beginning of the 2007
year, or any currently proposed transaction, in which we were or are to be a
participant and the amount involved exceeded or exceeds the lesser of $120,000
or one percent of the average of our total assets at year end for the last two
completed fiscal years, and in which any related person had or will have a
direct or indirect material interest (other than compensation described under
“Executive Compensation”). We believe the terms obtained or consideration that
we paid or received, as applicable, in connection with the transactions
described below were comparable to terms available or the amounts that would be
paid or received, as applicable, in arm’s-length transactions.
Mr. Tao
Wang entered into the contract with the Company to assume fiscal
responsibilities for all tax liabilities recorded and potential penalties
relating to all tax liabilities before December 31, 2009. As of
December 31, 2008 and 2007, the assumed amount was $3,799,872 and $2,620,236,
respectively, which mainly included VAT tax payable and income tax payable. As
of September 30, 2009 the assumed amount was $3,464,650. According to PRC tax
law, late or deficient tax payment could subject to significant tax penalty. On
December 25, 2009, the local tax authority in Jimo City issued a “Tax Review
Report”, stating that the tax authority reviewed the Company’s income tax, VAT
tax, stamp tax and invoices for the period between June 2006 and November 2009
and noted that the Company had paid off all its tax liability by December 21,
2009.
The
Company leases one of its stores from Mr. Tao Wang under a four-year operating
lease expiring August 2011. For the years ended December 31, 2008 and 2007,
related party rent expense of $17,298 and $15,800, respectively, was included in
total rent expense of the year.
The
Company leases one of its warehouse buildings to Weidong, Liang, brother-in-law
of Mr. Tao Wang, for three years starting May 2008. Per the agreement, the
lessee shall pay equal amount of advertising expense on behalf of the lessor as
the lease payment. For the year ended December 31, 2008, the Company recorded
other income of $57,660 from leasing the aforementioned building and advertising
expense of $57,660.
Prior to
the acquisitions of Datone the Company loaned Mr. Tao Wang amounts of $222,108
and $4,373,588 at September 30, 2009 and December 31, 2008, respectively. As of
the date of this filing, all balances loaned by the Company to Mr. Tao Wang have
been repaid and no loans to Mr. Tao Wang are outstanding.
Insider
Transactions Policies and Procedures
The
Company does not currently have an insider transaction policy.
Director
Independence
We
currently do not have any independent directors, as the term “independent” is
defined by the rules of the Nasdaq Stock Market.
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 legal proceedings or claims that we believe will have a material adverse
affect on our business, financial condition or operating results.
MARKET
PRICE AND DIVIDENDS ON OUR COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
Market
Information
Our
common stock is quoted under the symbol “DATI” on the Electronic Bulletin Board
maintained by the Financial Industry Regulatory Authority, however there is not
currently an active trading market for our common stock, and no information is
available for the prices of our common stock, as reported by www.otcbb.com. The
CUSIP number for our common stock is 23816A103.
40
Holders
As of
February 9, 2010 there were approximately 256 stockholders of record of our
common stock. This number does not include shares held by brokerage clearing
houses, depositories or others in unregistered form.
Dividends
We have
in the past distributed earnings to shareholders. Any future
decisions regarding dividends will be made by our board of directors. We
currently intend to retain and use any future earnings for the development and
expansion of our business and do not anticipate paying any cash dividends in the
foreseeable future. Our board of directors has complete discretion on whether to
pay dividends. Even if our board of directors decides to pay dividends, the
form, frequency and amount will depend upon our future operations and earnings,
capital requirements and surplus, general financial condition, contractual
restrictions and other factors that the board of directors may deem
relevant.
Substantially
all of our revenues are earned by Qingdao Shoes, our PRC subsidiary. PRC
regulations restrict the ability of our PRC subsidiary to make dividends and
other payments to its offshore parent company. PRC legal restrictions permit
payments of dividend by our PRC subsidiary only out of its accumulated after-tax
profits, if any, determined in accordance with PRC accounting standards and
regulations. Our PRC subsidiary is also required under PRC laws and regulations
to allocate at least 10% of our annual after-tax profits determined in
accordance with PRC GAAP to a statutory general reserve fund until the amounts
in said fund reaches 50% of our registered capital. Allocations to these
statutory reserve funds can only be used for specific purposes and are not
transferable to us in the form of loans, advances or cash dividends. Any
limitations on the ability of our PRC subsidiary to transfer funds to us could
materially and adversely limit our ability to grow, make investments or
acquisitions that could be beneficial to our business, pay dividends and
otherwise fund and conduct our business.
Securities
Authorized for Issuance Under Equity Compensation Plans
We do not
have in effect any compensation plans under which our equity securities are
authorized for issuance and we do not have any outstanding stock
options.
RECENT
SALES OF UNREGISTERED SECURITIES
Reference
is made to the disclosure set forth under Item 3.02 of this report, which
disclosure is incorporated by reference into this section.
DESCRIPTION
OF SECURITIES
Common
Stock
We are
authorized to issue up to 100,000,000 shares of common stock, par value $0.0001
per share. We plan to amend our Certificate of Incorporation to, among other
things, effect a 1-for-27 stock reverse split of our outstanding shares of
common stock (the “Reverse Split”), which we expect to become effective in or
about March 2010. Each outstanding share of common stock entitles the
holder thereof to one vote per share on all matters. Our bylaws provide that any
vacancy occurring in the board of directors may be filled by the affirmative
vote of a majority of the remaining directors though less than a quorum of the
board of directors. Shareholders do not have preemptive rights to purchase
shares in any future issuance of our common stock.
The
holders of shares of our common stock are entitled to dividends out of funds
legally available when and as declared by our board of directors. Our board of
directors has never declared a dividend and does not anticipate declaring a
dividend in the foreseeable future. Should we decide in the future to pay
dividends, as a holding company, our ability to do so and meet other obligations
depends upon the receipt of dividends or other payments from our operating
subsidiary and other holdings and investments. In addition, our operating
subsidiary in the PRC, from time to time, may be subject to restrictions on
their ability to make distributions to us, including as a result of restrictive
covenants in loan agreements, restrictions on the conversion of local currency
into U.S. dollars or other hard currency and other regulatory restrictions. In
the event of our liquidation, dissolution or winding up, holders of our common
stock are entitled to receive, ratably, the net assets available to shareholders
after payment of all creditors.
41
As
February 12, 2010, we had a total of 8,100,000 shares of common stock
outstanding.
Preferred
Stock
We are
authorized to issue up to 10,000,000 shares of preferred stock, par value
$0.0001 per share, in one or more classes or series within a class as may be
determined by our board of directors, who may establish, from time to time, the
number of shares to be included in each class or series, may fix the
designation, powers, preferences and rights of the shares of each such class or
series and any qualifications, limitations or restrictions thereof. Any
preferred stock so issued by the board of directors may rank senior to the
common stock with respect to the payment of dividends or amounts upon
liquidation, dissolution or winding up of us, or both. Moreover, while providing
desirable flexibility in connection with possible acquisitions and other
corporate purposes, under certain circumstances, the issuance of preferred stock
or the existence of the unissued preferred stock might tend to discourage or
render more difficult a merger or other change of control.
Series A Convertible
Preferred Stock
In
accordance with our Certificate of Incorporation, our Board of Directors
unanimously approved the filing of a Certificate of Designation designating and
authorizing the issuance of up to 10,000 shares of our Series A Convertible
Preferred Stock (“Series A Preferred Stock”). The Certificate of
Designation was filed on February 11, 2010.
Shares of
Series A Preferred Stock will automatically convert into shares of common stock
on the basis of one share of Series A Preferred Stock for 970 shares of common
stock immediately subsequent to the effectiveness of a planned 1-for-27
reverse split of our outstanding common stock, which we expect to become
effective in or about March 2010. Upon the reverse split the 10,000
outstanding shares of Series A Preferred Stock will automatically convert into
9,700,000 shares of common stock, which will constitute 97% of the outstanding
common stock of Datone subsequent to the Reverse Split.
Holders
of Series A Preferred Stock vote with the holders of common stock on all matters
on an as-converted to common stock basis, based on an assumed post 1-for-27
reverse split (to retroactively take into account the Reverse
Split). For example, assuming 100 shares of Series A Preferred Stock
are issued and outstanding on the record date for any stockholder vote, such
shares, voting in aggregate, would vote a total of 2,619,000 voting
shares.
The
holders of our Series A Preferred Stock are entitled to vote on all matters
together with all other classes of stock. Holders of Series A
Preferred Stock have protective class voting veto rights on certain matters,
such as increasing the authorized shares of Series A Preferred Stock and
modifying the rights of Series A Preferred Stock.
Following
the effectiveness of the Reverse Split and conversion of Series A Preferred
Stock into common stock, there will be approximately 10,000,000 shares of our
common stock issued and outstanding.
42
Anti-takeover Effects of
Our Certificate of Incorporation and By-laws
Our Certificate
of Incorporation and Bylaws contain certain provisions that may have
anti-takeover effects, making it more difficult for or preventing a third party
from acquiring control of the Company or changing its board of directors and
management. According to our Bylaws and Articles of Incorporation, neither the
holders of the Company’s common stock nor the holders of the Company’s preferred
stock have cumulative voting rights in the election of our directors. The
combination of the present ownership by a few stockholders of a significant
portion of the Company’s issued and outstanding common stock and lack of
cumulative voting makes it more difficult for other stockholders to replace the
Company’s board of directors or for a third party to obtain control of the
Company by replacing its board of directors.
Anti-takeover
Effects of Delaware Law
Delaware
Anti-Takeover Statute.
We are
subject to the provisions of Section 203 of the Delaware General Corporation Law
regulating corporate takeovers. In general, Section 203 prohibits a publicly
held Delaware corporation from engaging, under certain circumstances, in a
business combination with an interested stockholder for a period of three years
following the date the person became an interested stockholder
unless:
|
|
·
|
prior
to the date of the transaction, our board of directors approved either the
business combination or the transaction which resulted in the stockholder
becoming an interested stockholder;
|
|
|
·
|
upon
completion of the transaction that resulted in the stockholder becoming an
interested stockholder, the interested stockholder owned at least 85% of
the voting stock of the corporation outstanding at the time the
transaction commenced, calculated as provided under Section 203;
or
|
|
|
·
|
at
or subsequent to the date of the transaction, the business combination is
approved by our board of directors and authorized at an annual or special
meeting of stockholders, and not by written consent, by the affirmative
vote of at least two-thirds of the outstanding voting stock which is not
owned by the interested
stockholder.
|
Generally,
a business combination includes a merger, asset or stock sale, or other
transaction resulting in a financial benefit to the interested stockholder. An
interested stockholder is a person who, together with affiliates and associates,
owns or, within three years prior to the determination of interested stockholder
status, did own 15% or more of a corporation’s outstanding voting stock. We
expect the existence of this provision to have an anti-takeover effect with
respect to transactions our board of directors does not approve in advance. We
also anticipate that Section 203 may also discourage attempts that might result
in a premium over the market price for the shares of common stock held by
stockholders.
The
provisions of Delaware law and the provisions of our amended and restated
certificate of incorporation could have the effect of discouraging others from
attempting hostile takeovers and, as a consequence, they might also inhibit
temporary fluctuations in the market price of our common stock that often result
from actual or rumored hostile takeover attempts. These provisions might also
have the effect of preventing changes in our management. It is possible that
these provisions could make it more difficult to accomplish transactions that
stockholders might otherwise deem to be in their best interests.
Transfer
Agent And Registrar
Our
independent stock transfer agent is Fidelity Transfer Company. Their mailing
address is 8915 South 700 East. Suite 102, Sandy, UT 84070 and their phone
number is 801-562-1300.
43
INDEMNIFICATION
OF DIRECTORS AND OFFICERS
Section
145 of the Delaware General Corporation Law authorizes a corporation’s board of
directors to grant, and authorizes a court to award, indemnity to officers,
directors and other corporate agents.
As
permitted by Section 102(b)(7) of the Delaware General Corporation Law, the
Company’s certificate of incorporation includes provisions that eliminate the
personal liability of its directors for monetary damages for breach of their
fiduciary duty as directors. To the extent Section 102(b)(7) is interpreted, or
the Delaware General Corporation Law is amended, to allow similar protections
for officers of a corporation, such provisions of the Company’s certificate of
incorporation shall also extend to those persons. In
addition, we have entered into Indemnification Agreements with our Directors,
which provide for similar rights.
In
addition, as permitted by Section 145 of the Delaware General Corporation Law,
the bylaws, certificate of incorporation and Indemnification Agreements of the
Company provide that:
|
|
·
|
The
Company shall indemnify its directors and officers for serving the Company
in those capacities or for serving other business enterprises at the
Company’s request, to the fullest extent permitted by Delaware law.
Delaware law provides that a corporation may indemnify such person if such
person acted in good faith and in a manner such person reasonably believed
to be in or not opposed to the best interests of the Company and, with
respect to any criminal proceeding, had no reasonable cause to believe
such person’s conduct was unlawful.
|
|
|
·
|
The
Company may, in its discretion, indemnify employees and agents in those
circumstances where indemnification is permitted by applicable
law.
|
|
|
·
|
The
Company is required to advance expenses, as incurred, to its directors and
officers in connection with defending a proceeding, except that such
director or officer shall undertake to repay such advances if it is
ultimately determined that such person is not entitled to
indemnification.
|
|
|
·
|
The
Company will not be obligated pursuant to the bylaws to indemnify a person
with respect to proceedings initiated by that person, except with respect
to proceedings authorized by the Company’s board of directors or brought
to enforce a right to
indemnification.
|
|
|
·
|
The
rights conferred in the bylaws are not exclusive, and the Company is
authorized to enter into indemnification agreements with its directors,
officers, employees and agents and to obtain insurance to indemnify such
persons.
|
|
|
·
|
The
Company may not retroactively amend the bylaw provisions to reduce its
indemnification obligations to directors, officers, employees and
agents.
|
These
indemnification provisions may be sufficiently broad to permit indemnification
of the Company’s officers and directors for liabilities (including reimbursement
of expenses incurred) arising under the Securities Act of 1933. The
Company may at the discretion of the board of directors purchase and maintain
insurance on behalf of any person who holds or who has held any position
identified in the paragraph above against any and all liability incurred by such
person in any such position or arising out of his status as such.
44
At the
present time, there is no pending litigation or proceeding involving a director,
officer, employee or other agent of ours in which indemnification would be
required or permitted. We are not aware of any threatened litigation or
proceeding, which may result in a claim for such indemnification.
ITEM
3.02
UNREGISTERED
SALES OF EQUITY SECURITIES
On
February 12, 2010, we issued 10,000 shares of our Series A Convertible Preferred
stock (“Series A Preferred Stock”) to the shareholders of Glory Reach. The total
consideration for the 10,000 shares of our Series A Convertible Preferred stock
was 10,000 ordinary shares of Glory Reach, which is all the issued and
outstanding capital stock of Glory Reach. The number of our shares issued to the
shareholders of Glory Reach was determined based on an arms-length
negotiation. The issuance of our shares to these shareholders was
made in reliance on the exemption provided by Section 4(2) of the Securities Act
for the offer and sale of securities not involving a public offering and
Regulation D promulgated thereunder.
On
February 10, 2010, we issued 3,136,768 shares of common stock to our landlord to
extinguish approximately $47,052 of debt owed to Callaway Properties, our pre
reverse acquisition landlord. Callaway Properties’ sole shareholder
is Mary Passalaqua, wife of the Company’s director and
former secretary Joseph Passalaqua.
We issued
securities in reliance upon Rule 506 of Regulation D of the Securities Act.
These shareholders who received the securities in such instances made
representations that (a) the shareholder is acquiring the securities for his,
her or its own account for investment and not for the account of any other
person and not with a view to or for distribution, assignment or resale in
connection with any distribution within the meaning of the Securities Act, (b)
the shareholder agrees not to sell or otherwise transfer the purchased shares
unless they are registered under the Securities Act and any applicable state
securities laws, or an exemption or exemptions from such registration are
available, (c) the shareholder has knowledge and experience in financial and
business matters such that he, she or it is capable of evaluating the merits and
risks of an investment in us, (d) the shareholder had access to all of our
documents, records, and books pertaining to the investment and was provided the
opportunity ask questions and receive answers regarding the terms and conditions
of the offering and to obtain any additional information which we possessed or
were able to acquire without unreasonable effort and expense, and (e) the
shareholder has no need for the liquidity in its investment in us and could
afford the complete loss of such investment. Management made the determination
that the investors in instances where we relied on Regulation D are accredited
investors (as defined in Regulation D) based upon management’s inquiry into
their sophistication and net worth. In addition, there was no general
solicitation or advertising for securities issued in reliance upon Regulation
D.
ITEM
5.01
CHANGES
IN CONTROL OF REGISTRANT
Reference
is made to the disclosure set forth under Item 2.01 of this report, which
disclosure is incorporated herein by reference.
45
As a
result of the closing of the reverse acquisition with Glory Reach, the former
shareholders of Glory Reach now owns 0% of the total outstanding shares of our
common stock, 100% of our Series A Convertible Preferred stock, and 97% of total
voting power of all our outstanding voting securities.
ITEM
5.02.
DEPARTURE
OF DIRECTORS OR CERTAIN OFFICERS; ELECTION OF DIRECTORS; APPOINTMENT OF CERTAIN
OFFICERS; COMPENSATORY ARRANGEMENTS OF CERTAIN OFFICERS
Upon the
closing of the reverse acquisition, Craig H. Burton, our President and Director,
Joseph J. Passalaqua, our Secretary and Director, and Joseph Meuse, our
Director, submitted a resignation letter pursuant to which they resigned from
all offices that they held effective immediately and from
their position as our directors that will become effective on the
tenth day following the mailing by us of an information statement to our
stockholders that complies with the requirements of Section 14f-1 of the
Exchange Act, which will be mailed out on or about February 22,
2010. In addition, our board of directors on February 12 appointed
Tao Wang (Chairman), Renwei Ma and Lanhai Sun to fill the vacancies created by
such increase, which appointments will become effective upon the effectiveness
of the resignation of Craig H. Burton, Joseph J. Passalaqua, and Joseph Meuse on
the tenth day following the mailing by us of the information statement to our
stockholders. In addition, our executive officers were replaced by
the Qingdao Shoes’ executive officers upon the closing of the reverse
acquisition as indicated in more detail in the disclosure under Item 2.01 of
this report.
ITEM
5.03.
AMENDMENTS
TO ARTICLES OF INCORPORATION OR BYLAWS; CHANGE IN FISCAL YEAR
Series A Convertible
Preferred Stock
In
accordance with our Certificate of Incorporation, our Board of Directors
unanimously approved the filing of a Certificate of Designation designating and
authorizing the issuance of up to 10,000 shares of our Series A Convertible
Preferred Stock (“Series A Preferred Stock”). The Certificate of
Designation was filed on February 11, 2010.
Shares of
Series A Preferred Stock will automatically convert into shares of common stock
on the basis of one share of Series A Preferred Stock for 970 shares of common
stock upon the effectiveness of a planned 1-for-27 reverse split (the “Reverse
Split”) of our outstanding common stock, which we expect to become effective in
or about March 2010. Upon the reverse split the 10,000 outstanding
shares of Series A Preferred Stock will automatically convert into 9,700,000
shares of common stock, which will constitute 97% of the outstanding common
stock of Datone subsequent to the Reverse Split.
Holders
of Series A Preferred Stock vote with the holders of common stock on all matters
on an as-converted to common stock basis, based on an assumed post 1-for-27
reverse split (to retroactively take into account the Reverse
Split). For example, assuming 100 shares of Series A Preferred Stock
are issued and outstanding on the record date for any stockholder vote, such
shares, voting in aggregate, would vote a total of 2,619,000 voting
shares.
46
The
holders of our Series A Preferred Stock are entitled to vote on all matters
together with all other classes of stock. Holders of Series A
Preferred Stock have protective class voting veto rights on certain matters,
such as increasing the authorized shares of Series A Preferred Stock and
modifying the rights of Series A Preferred Stock.
The
Certificate of Designation is filed as Exhibit 3.3 to this Current Report on
Form 8-k and is incorporated herein by reference.
ITEM
9.01
FINANCIAL
STATEMENTS AND EXHIBITS
(a)
Financial
Statements of Business Acquired
Filed
herewith are the following:
1. Audited
consolidated financial statements of Glory Reach and subsidiaries for the fiscal
years ended December 31, 2008 and 2007.
2. Unaudited
consolidated financial statements of Glory Reach and subsidiaries for the nine
months ended September 30, 2009 and 2008.
(b)
Pro
Forma Financial Information
Filed
herewith is the unaudited pro forma condensed consolidated financial information
of Glory Reach and its subsidiaries for the requisite periods.
(d)
Exhibits
|
Exhibit
No.
|
Description
|
|
|
2.1
|
Share
Exchange Agreement, dated February 12, 2010, among the Datone, Glory Reach
International Limited, Qingdao Shoes, the shareholders of Glory Reach
International Limited, and Greenwich Holdings LLC.
|
|
|
*3.1
|
Amended
and Restated Certificate of Incorporation.
|
|
|
*3.2
|
Bylaws
|
|
|
3.3
|
Certificate
of Designation of Series A Voting Convertible Preferred Stock, as filed
with the Delaware Secretary of State on February 11,
2010.
|
|
|
10.1
|
Form
of Distributer Contract (translated)
|
|
|
10.2
|
Form
of Purchase Contract (translated)
|
|
|
10.3
|
Asset
Transfer Agreement between Qingdao Shoes and Tao Wang
(translated)
|
|
| 10.4 | Form of Director Indemnification Agreement | |
| 10.5 | Agreement of Conveyance, Transfer and Assignment of Assets and Assumption of Obligations | |
|
21
|
Subsidiaries
of the Company
|
|
|
*
|
Filed
as an exhibit to the Company's registration statement on Form 10-SB, as
filed with the Securities and Exchange Commission on February 1, 2008, and
incorporated herein by this
reference
|
47
SIGNATURES
Pursuant
to the requirements of the Securities Exchange Act of 1934, the registrant has
duly caused this report to be signed on its behalf by the undersigned hereunto
duly authorized.
Date:
February 12, 2010
|
Datone, Inc.
|
||
|
(Registrant)
|
||
|
/s/Tao Wang
|
||
|
*Signature
|
||
|
Chief Executive Officer
|
||
|
Title
|
48
REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the
Board of Directors and Shareholders of
Glory
Reach International Limited
Qingdao
City, Shandong Province, PRC
We have
audited the accompanying consolidated balance sheets of Glory Reach
International Limited (the “Company”) as of December 31, 2008 and 2007, and the
related statements of operations, shareholders’ equity and cash flows for the
years then ended. 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 audit.
We
conducted our audit in accordance with 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. The Company is not
required to have, nor were we engaged to perform, an audit of its internal
control over financial reporting. Our audit included consideration of
internal control over financial reporting as a basis for designing audit
procedures that are appropriate in the circumstances, but not for the purpose of
expressing an opinion on the effectiveness of the Company’s internal control
over financial reporting. Accordingly, we express no such
opinion. An audit also 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 audit provides a reasonable basis for our opinion.
In our
opinion, the consolidated financial statements of the Company referred to above
present fairly, in all material respects, the financial position of the Company
as of December 31, 2008 and 2007 and the results of its operations and its cash
flows for the years then ended in conformity with accounting principles
generally accepted in the United States of America.
/s/
MALONEBAILEY, LLP
www.malonebailey.com
Houston,
Texas
February 12, 2010
49
GLORY
REACH INTERNATIONAL LIMITED
CONSOLIDATED
BALANCE SHEETS
AS
OF DECEMBER 31, 2008 AND 2007
|
2008
|
2007
|
|||||||
|
ASSETS
|
||||||||
|
Current
assets
|
||||||||
|
Cash
|
$ | 118,534 | $ | 34,608 | ||||
|
Accounts
receivable
|
3,534 | 4,263 | ||||||
|
Inventories
|
189,535 | 407,688 | ||||||
|
Prepaid
expenses
|
58,490 | 64,407 | ||||||
|
Due
from related party
|
4,373,588 | 2,231,755 | ||||||
|
Total
current assets
|
4,743,681 | 2,742,721 | ||||||
|
Property,
plant and equipment, net
|
602,831 | 576,049 | ||||||
|
Intangible
assets
|
213,008 | 203,594 | ||||||
|
Total
Assets
|
$ | 5,559,520 | $ | 3,522,364 | ||||
|
LIABILITIES AND SHAREHOLDERS'
EQUITY
|
||||||||
|
Current
liabilities
|
||||||||
|
Accounts
payable
|
$ | 546 | $ | 2,872 | ||||
|
Taxes
payable
|
2,114 | 1,856 | ||||||
|
Short-term
loans
|
704,160 | 658,080 | ||||||
|
Total
current liabilities
|
706,820 | 662,808 | ||||||
|
Shareholders'
Equity
|
||||||||
|
Common
shares, authorized, issued and outstanding; 10,000 and 10,000 shares
respectively, par value $0.129 per share
|
1,290 | 1,290 | ||||||
|
Additional
paid-in capital
|
319,190 | 319,190 | ||||||
|
Accumulated
other comprehensive income
|
437,665 | 205,618 | ||||||
|
Retained
earnings
|
4,094,555 | 2,333,458 | ||||||
|
Total
shareholders' equity
|
4,852,700 | 2,859,556 | ||||||
|
Total
Liabilities and Shareholders' Equity
|
$ | 5,559,520 | $ | 3,522,364 | ||||
The
accompanying notes are an integral part of these financial
statements.
50
GLORY
REACH INTERNATIONAL LIMITED
CONSOLIDATED
STATEMENTS OF OPERATIONS
FOR
THE YEARS ENDED DECEMBER 31, 2008 AND 2007
|
2008
|
2007
|
|||||||
|
Net
sales
|
$ | 13,904,314 | $ | 8,594,468 | ||||
|
Cost
of sales
|
8,246,592 | 4,996,377 | ||||||
|
Gross
profit
|
5,657,722 | 3,598,091 | ||||||
|
Operating
expenses:
|
||||||||
|
Selling,
general and administrative expenses
|
759,470 | 517,140 | ||||||
|
Depreciation
and amortization expense
|
55,360 | 57,109 | ||||||
|
Profit
from operations
|
4,842,892 | 3,023,842 | ||||||
|
Other
income (expenses):
|
||||||||
|
Other
income
|
57,660 | - | ||||||
|
Interest
income
|
8,949 | 10,351 | ||||||
|
Interest
expense
|
(61,905 | ) | (35,147 | ) | ||||
|
Income
before income taxes
|
4,847,596 | 2,999,046 | ||||||
|
Income
taxes
|
1,211,899 | 989,685 | ||||||
|
Net
income
|
$ | 3,635,697 | $ | 2,009,361 | ||||
|
Net
income per share - basis and diluted
|
$ | 364 | $ | 201 | ||||
|
Weighted
average shares outstanding
|
10,000 | 10,000 | ||||||
|
Comprehensive
income
|
||||||||
|
Net
income
|
$ | 3,635,697 | $ | 2,009,361 | ||||
|
Other
comprehensive income
|
||||||||
|
Foreign
currency translation
|
232,047 | 141,675 | ||||||
|
Comprehensive
income
|
$ | 3,867,744 | $ | 2,151,036 | ||||
The
accompanying notes are an integral part of these financial
statements.
51
GLORY
REACH INTERNATIONAL LIMITED
STATEMENTS
OF CASH FLOWS
FOR
THE YEARS ENDED DECEMBER 31, 2008 AND 2007
|
2008
|
2007
|
|||||||
|
CASH
FLOWS FROM OPERATING ACTIVITIES:
|
||||||||
|
Net
income
|
$ | 3,635,697 | $ | 2,009,361 | ||||
|
Adjustments
to reconcile net income to net cash
|
||||||||
|
provided
by operating activities:
|
||||||||
|
Depreciation
and amortization
|
55,360 | 57,109 | ||||||
|
Changes
in operating assets and liabilities:
|
||||||||
|
Accounts
receivable
|
1,028 | (4,263 | ) | |||||
|
Inventories
|
246,700 | 379,647 | ||||||
|
Prepaid
expenses
|
10,427 | (46,858 | ) | |||||
|
Accounts
payable
|
(2,527 | ) | 2,872 | |||||
|
Accrued
liability
|
- | (13,765 | ) | |||||
|
Taxes
payable
|
3,800,000 | 2,621,303 | ||||||
|
Net
cash provided by operating activities
|
7,746,685 | 5,005,406 | ||||||
|
CASH
FLOWS FROM INVESTING ACTIVITIES:
|
||||||||
|
Advance
to related party
|
(5,785,433 | ) | (4,825,046 | ) | ||||
|
Purchase
of property and equipment
|
(37,944 | ) | (24,911 | ) | ||||
|
Net
cash used in investing activities
|
(5,823,377 | ) | (4,849,957 | ) | ||||
|
CASH
FLOWS FROM FINANCING ACTIVITIES:
|
||||||||
|
Proceeds
from short-term loans
|
850,860 | 932,280 | ||||||
|
Repayments
on short-term loans
|
(850,860 | ) | (411,300 | ) | ||||
|
Distribution
to shareholders
|
(1,874,600 | ) | (778,200 | ) | ||||
|
Net
cash used in financing activities
|
(1,874,600 | ) | (257,220 | ) | ||||
|
Effect
of exchange rate changes on cash
|
35,218 | 47,022 | ||||||
|
Net
increase (decrease) in cash
|
$ | 83,926 | $ | (54,749 | ) | |||
|
Cash,
beginning of year
|
34,608 | 89,357 | ||||||
|
Cash,
end of year
|
$ | 118,534 | $ | 34,608 | ||||
|
SUPPLEMENTAL
DISCLOSURE INFORMATION:
|
||||||||
|
Interest
paid
|
$ | 61,905 | $ | 35,147 | ||||
|
Income
taxes paid
|
$ | 2,539 | $ | 1,428 | ||||
|
NON-CASH
FINANCING AND INVESTING ACTIVITIES:
|
||||||||
|
Transfer
of taxes payable to due from related party
|
3,799,872 | 2,620,236 | ||||||
The
accompanying notes are an integral part of these financial
statements.
52
GLORY
REACH INTERNATIONAL LIMITED
CONSOLIDATED
STATEMENT OF SHAREHOLDERS' EQUITY
FOR
THE YEARS ENDED DECEMBER 31, 2008 AND 2007
|
Common
Stock
|
Additional
Paid-in
Capital
|
Accumulated Other
Comprehensive
Income
|
Retained
Earnings
|
Total
Shareholders'
Equity
|
||||||||||||||||
|
Balance,
December 31, 2006
|
$ | 1,290 | $ | 319,190 | $ | 63,943 | $ | 1,102,297 | $ | 1,486,720 | ||||||||||
|
Distribution
to shareholders
|
- | - | - | (778,200 | ) | (778,200 | ) | |||||||||||||
|
Net
income
|
- | - | - | 2,009,361 | 2,009,361 | |||||||||||||||
|
Foreign
currency translation gain
|
- | - | 141,675 | - | 141,675 | |||||||||||||||
|
Balance,
December 31, 2007
|
$ | 1,290 | $ | 319,190 | $ | 205,618 | $ | 2,333,458 | $ | 2,859,556 | ||||||||||
|
Distribution
to shareholders
|
- | - | - | (1,874,600 | ) | (1,874,600 | ) | |||||||||||||
|
Net
income
|
- | - | - | 3,635,697 | 3,635,697 | |||||||||||||||
|
Foreign
currency translation gain
|
- | - | 232,047 | - | 232,047 | |||||||||||||||
|
Balance,
December 31, 2008
|
$ | 1,290 | $ | 319,190 | $ | 437,665 | $ | 4,094,555 | $ | 4,852,700 | ||||||||||
The
accompanying notes are an integral part of these financial
statements
53
NOTES
TO FINANCIAL STATEMENTS
NOTE
1 - ORGANIZATION AND BUSINESS OPERATIONS
Qingdao
Hongguan Shoes Co., Ltd. (”Qingdao Shoes”) was incorporated on March 11, 2003 in
Jimo County, Qingdao City, Shandong Province, People’s Republic of China (the
“PRC”) with registered capital of $320,480. Mr. Tao Wang owned
80% of Qingdao Shoes and the remaining 20% was owned by Mr. Renwei
Ma. Qingdao Shoes is the owner of the brand name “Honguan” and
principally engaged in the wholesale and retail sales of fashion footwear
primarily in the northeast region of China.
Glory
Reach International Limited (the “Company”) was established in Hong Kong on
November 18, 2009 to serve as an intermediate holding company. Mr. Tao Wang, the
controlling interest holder of Qingdao Shoes also controls the Company. On
February 8, 2010, also pursuant to the restructuring plan, the Company acquired
100% of the equity interests in Qingdao Shoes,
Since the
Company and Qingdao Shoes are under common control, for accounting purposes, the
acquisitions of Hongguan has been treated as a recapitalization with no
adjustment to the historical basis of their assets and liabilities. The
restructuring has been accounted for using the “as if” pooling method of
accounting and the operations were consolidated as if the restructuring had
occurred as of the beginning of the earliest period presented in our
consolidated financial statements and the current corporate structure had been
in existence throughout the periods covered by our consolidated financial
statements.
NOTE
2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of
Presentation
The
consolidated financial statements reflect the financial position, results of
operations and cash flows of the Company and all of its wholly owned and
majority owned subsidiaries as of December 31, 2008 and 2007, and for the year
ended December 31, 2008 and 2007. All intercompany items are eliminated during
consolidation.
Use of
Estimates
The
preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America (“US GAAP”) requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the dates of the financial statements and the amount of revenues and expenses
during the reporting periods. Management makes these estimates using
the best information available at the time the estimates are
made. However, actual results could differ materially from those
estimates.
Risks and
Uncertainties
The
Company is subject to substantial risks from, among other things, intense
competition associated with the industry in general, other risks associated with
financing, liquidity requirements, rapidly changing customer requirements,
limited operating history, foreign currency exchange rates and the volatility of
public markets.
Concentration of Credit
Risk
Financial
instruments that potentially subject the Company to significant concentrations
of credit risk consist principally of cash and trade receivables. As
of December 31, 2008 and 2007, substantially all of the Company’s cash were held
by major financial institutions located in the PRC, which management believes
are of high credit quality. With respect to trade receivables, the
Company rarely extends credit to its customers. The Company generally
does not require collateral for trade receivables and has not experienced any
credit losses in collecting the trade receivables.
54
The
Company operates principally in the PRC and grants credit to its customers in
this geographic region. Although the PRC is economically stable, it is
always possible that unanticipated events in foreign countries could disrupt the
Company’s operations.
Comprehensive
Income
The
Company has adopted the provisions of ASC 220 “Reporting Comprehensive Income”
which establishes standards for the reporting and display of comprehensive
income, its components and accumulated balances in a full set of general purpose
financial statements.
ASC 220
defines comprehensive income is comprised of net income and all changes to the
statements of stockholders' equity, except those due to investments by
stockholders, changes in paid-in capital and distributions to stockholders,
including adjustments to minimum pension liabilities, accumulated foreign
currency translation, and unrealized gains or losses on marketable securities.
The Company’s other comprehensive income arose from the effect of foreign
currency translation adjustments.
Foreign Currency
Translation
The
Company’s functional currency is Chinese currency Renminbi (“RMB”) and its
reporting currency is the U.S. dollar. Transactions denominated in foreign
currencies are translated into U.S. dollar at exchange rate in effect on the
date of the transactions. Exchange gains or losses on transaction are included
in earnings.
The
financial statements of the Company are translated into United States dollars in
accordance with the provisions of ASC 830 “Foreign Currency Matters”, using the
year-end rates of exchange for assets and liabilities, and average rates of
exchange for the period for revenues, costs, and expenses and historical rates
for the equity. Translation adjustments resulting from the process of
translating the local currency financial statements into U.S. dollars are
included in determining comprehensive income. At December 31, 2008 and 2007, the
cumulative translation adjustment of $437,665 and $205,618 were classified as an
item of accumulated other comprehensive income in the shareholders’ equity
section of the balance sheet respectively. For the years ended December 31, 2008
and 2007, other comprehensive income was $232,047 and $141,675,
respectively.
Accounts
Receivable
Accounts
receivable consists of unpaid balances due from the whole-sale customers. Such
balances generally are cleared in the subsequent month when the whole-sale
customers place another order. The Company does not provide an allowance for
doubtful accounts because the Company has not experienced any credit losses in
collecting these amounts from whole-sale customers.
Inventories
Merchandise
inventories are stated at the lower of cost or market. Cost is
determined on a weighted average basis and includes all expenditures incurred in
bringing the goods to the point of sale and putting them in a salable
condition. In assessing the ultimate realization of inventories, the
management makes judgments as to future demand requirements compared to current
or committed inventory levels. Our reserve requirements generally
increase as our projected demand requirements; or decrease due to market
conditions and product life cycle changes. The Company estimates the
demand requirements based on market conditions, forecasts prepared by its
customers, sales contracts and orders in hand.
In
addition, the Company estimates net realizable value based on intended use,
current market value and inventory ageing analyses. The Company
writes down inventories for estimated obsolescence or unmarketable inventory
equal to the difference between the cost of inventories and their estimated
market value based upon assumptions about future demand and market
conditions.
55
Property, Plant and
Equipment
Property,
plant and equipment are recorded at cost. Gains or losses on
disposals are reflected as gain or loss in the year of
disposal. Major renewals and betterments are charged to the property
accounts while replacements, maintenance and repairs, which do not improve or
extend the lives of the respective assets, are expensed in the current
period.
Depreciation
for financial reporting purposes is provided using the straight-line method over
the estimated useful lives of assets as set out below.
|
Estimated Useful Life
|
|
|
Plant
and building
|
20 years
|
|
Office
furniture and equipment
|
5 years
|
|
Transportation
equipment
|
5 years
|
Land Use
Rights
Land use
right is stated at cost less accumulated amortization. Amortization
is provided using the straight-line method over the designated terms of the
lease of 50 years obtained from the relevant PRC land authority.
Impairment of Long-Lived
Assets
The
Company accounts for impairment of property and equipment and amortizable
intangible assets in accordance with ASC 360, “Accounting for Impairment of
Long-Lived Assets and Long-Lived Assets to be Disposed Of”, which requires the
Company to evaluate a long-lived asset for recoverability when there is event or
circumstance that indicate the carrying value of the asset may not be
recoverable. An impairment loss is recognized when the carrying amount of a
long-lived asset or asset group is not recoverable (when carrying amount exceeds
the gross, undiscounted cash flows from use and disposition) and is measured as
the excess of the carrying amount over the asset’s (or asset group’s) fair
value. There was no impairment of long-lived assets for the years ended December
31, 2008 and 2007.
Revenue
Recognition
Retail
sales are recognized at the point of sale to customers, are recorded net of
estimated returns, and exclude value added tax (“VAT”). Whole-sales to its
contracted customers are recognized as revenue at the time the product is
shipped and title passes to the customer on an FOB shipping point
basis.
Cost of
Sales
Cost of
sales includes the cost of merchandise, buying costs, and occupancy
costs.
Advertising
Expense
The
Company expenses cost of advertising, including the cost of TV commercials,
outdoor bulletin boards, promotional materials, and in-store displays as
advertising expense, when incurred. Advertising expenses included in selling,
general and administrative expenses were $57,660 and $3,660 for the years ended
December 31, 2008 and 2007, respectively.
Income
Taxes
The
Company accounts for income taxes in accordance with ASC 740 “Income
Taxes”. ASC 740 requires an asset and liability approach for
financial accounting and reporting for income taxes and allows recognition and
measurement of deferred tax assets based upon the likelihood of realization of
tax benefits in future years. Under the asset and liability approach,
deferred taxes are provided for the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. A valuation
allowance is provided for deferred tax assets if it is more likely than not
these items will either expire before the Company is able to realize their
benefits, or that future deductibility is uncertain. There was no deferred tax
asset or liability for the years ended December 31, 2008 and
2007.
56
Value Added
Taxes
The
Company is subject to value added tax (“VAT”) for selling merchandise. The
applicable VAT rate is 17% for products sold in the PRC. The amount of VAT
liability is determined by applying the applicable tax rate to the invoiced
amount of goods sold (output VAT) less VAT paid on purchases made with the
relevant supporting invoices (input VAT). Under the commercial practice of the
PRC, the Company pays VAT based on tax invoices issued. The tax invoices may be
issued subsequent to the date on which revenue is recognized, and there may be a
considerable delay between the date on which the revenue is recognized and the
date on which the tax invoice is issued. In the event that the PRC tax
authorities dispute the date on which revenue is recognized for tax purposes,
the PRC tax office has the right to assess a penalty based on the amount of the
taxes which are determined to be late or deficient, and will be expensed in the
period if and when a determination is made by the tax authorities that a penalty
is due.
VAT on
sales and VAT on purchases amounted to $2,405,548 and $81,464, respectively, for
the year ended December 31, 2008. VAT on sales and VAT on purchases amounted to
$1,520,969 and $80,546, respectively, for the year ended December 31, 2007.
Sales and purchases are recorded net of VAT collected and paid as the Company
acts as an agent for the government.
Fair Value of Financial
Instruments
ASC 820
“Fair Value Measurements and Disclosures”, adopted January 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 qualify as financial instruments. Management concluded the carrying
values are a reasonable estimate of fair value because of the short period of
time between the origination of such instruments and their expected realization
and if applicable, their stated interest rate approximates current rates
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.
It is
management’s opinion that as of December 31, 2008 and 2007, the estimated fair
values of the financial instruments were not materially different from their
carrying values as presented on the balance sheet. This is attributed
to the short maturities of the instruments and that interest rates on the
borrowings approximate those that would have been available for loans of similar
remaining maturity and risk profile at respective balance sheet
dates. The carrying amounts of short-term loans approximate their
fair values because the applicable interest rates approximate current market
rates.
Recent Accounting
Pronouncements
In
September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements" (Now ASC
820). SFAS No. 157 defines fair value, establishes a framework for measuring
fair value in generally accepted accounting principles, and expands disclosures
about fair value measurements. The provisions of SFAS No. 157 are effective for
fiscal years beginning after November 15, 2007. In February 2008, the FASB
deferred the implementation of SFAS No. 157 for certain non-financial assets and
liabilities for fiscal years beginning after November 15, 2008. We adopted the
provisions of SFAS No. 157 for financial assets and liabilities on January 1,
2008 and elected to defer adoption for non-financial assets and liabilities. The
adoption of SFAS No. 157 for financial assets did not have a material impact on
our financial statements. We do not believe the adoption of SFAS No. 157 for
certain non-financial assets and liabilities will have a material impact on our
financial position, results of operations or cash flows.
57
In April
2008, the FASB issued Staff Position FSP FAS 142-3, "Determination of the Useful
Life of Intangible Assets" ("FSP FAS 142-3"). The FSP amends the
factors considered in developing renewal or extension assumptions for
determining the useful life of a recognized intangible asset under SFAS No. 142
(Now ASC 350-20), "Goodwill and Other Intangible Assets." The FSP's intent is to
improve the consistency between the useful life of a recognized intangible asset
under ASC 350-20 and the period of expected cash flows used to measure the fair
value of the asset under other accounting principles generally accepted in the
U.S. Companies must adopt the FSP for fiscal years and interim periods beginning
after December 15, 2008. Early adoption is prohibited. Companies must
apply the guidance for determining the useful life of a recognized intangible
asset prospectively to intangible assets acquired after the effective
date. Companies must also apply certain disclosure requirements
prospectively to all intangible assets recognized as of, and subsequent to, the
effective date. We adopted this standard effectively January 1, 2009
and do not expect it to have an impact on our financial position, results of
operations or cash flows.
In May
2009, the FASB issued SFAS No. 165, “Subsequent Events” (Now ASC 855), which
provides guidance to establish general standards of accounting for and
disclosures of events that occur after the balance sheet date but before
financial statements are issued or are available to be issued. ASC
855 also requires entities to disclose the date through which subsequent events
were evaluated as well as the rationale for why that date was
selected. This disclosure should alert all users of financial
statements that an entity has not evaluated subsequent events after that date in
the set of financial statements being presented. ASC 855 is effective for
interim and annual periods ending after June 15, 2009. We do not
expect the adoption of ASC 855 will have a material impact on our financial
position, results of operations or cash flows.
In June
2009, the Financial Accounting Standards Board (“FASB”) issued new standards
setting forth a single source of authoritative GAAP for all non-governmental
entities (“Codification”). The Codification, which commenced July 1, 2009,
changes the referencing and organization of accounting guidance. The Codification is effective for interim and annual
periods ending after September 15, 2009. The Codification does not change GAAP
and only affects how specific references to GAAP literature are disclosed in the
notes to our financial position, results of operations or cash
flows.
The
Company does not expect the adoption of any other recently issued accounting
pronouncements to have a significant impact on the Company’s results of
operations, financial position or cash flows.
NOTE
3 – INVENTORY
As of
December 31, 2008 and 2007, inventory consists of the following:
|
December 31, 2008
|
December 31, 2007
|
|||||||
|
Finished
goods
|
$ | 189,535 | $ | 407,668 | ||||
|
Total
inventory
|
$ | 189,535 | $ | 407,668 | ||||
NOTE
4 - PREPAID EXPENSES
As of
December 31, 2008 and 2007, the prepaid expenses consisted of the
following:
|
December 31, 2008
|
December 31, 2007
|
|||||||
|
Retail
store rental prepayment
|
$ | 18,778 | $ | 17,549 | ||||
|
Prepaid
to suppliers
|
39,712 | 41,121 | ||||||
|
Prepaid
miscellaneous office expenses
|
- | 5,737 | ||||||
|
Total
prepaid expenses
|
$ | 58,490 | $ | 64,407 | ||||
58
As of
December 31, 2008 and 2007, property, plant and equipment consisted of the following:
|
December 31, 2007
|
||||||||
|
Plant
and building
|
$ | 731,918 | $ | 660,989 | ||||
|
Office
furniture and equipment
|
12,304 | 11,410 | ||||||
|
Transportation
equipment
|
148,314 | 126,269 | ||||||
|
Total
at cost
|
892,536 | 798,668 | ||||||
| (289,705 | ) | (222,619 | ) | |||||
|
Total
property, plant and equipment, net
|
$ | 602,831 | $ | 576,049 | ||||
Depreciation
for the years ended December 31, 2008 and 2007 was $50,603 and $52,764
respectively.
NOTE
6 - INTANGIBLE ASSETS
The Company obtained the right from the
relevant PRC land authority for fifty years to use the land on which the
office premises and warehouse
of the Company are situated. As of December 31, 2008 and 2007, intangible assets
consisted of the following:
|
|
December 31, 2008
|
December 31, 2007
|
||||||
|
Cost
of land use rights
|
$ | 242,055 | $ | 226,215 | ||||
|
Less:
Accumulated amortization
|
(29,047 | ) | (22,621 | ) | ||||
| $ | 213,008 | $ | 203,594 | |||||
Amortization
expense for the years ended December 31, 2008 and 2007 was $4,757 and $4,345
respectively. Amortization expense for the next five years and
thereafter at December 31, 2008 is as
follows:
|
2009
|
$ | 4,757 | ||
|
2010
|
4,757 | |||
|
2011
|
4,757 | |||
|
2012
|
4,757 | |||
|
2013
|
4,757 | |||
|
Thereafter
|
189,223 | |||
|
Total
|
$ | 213,008 |
59
NOTE
7 - SHORT TERM LOANS
Short-term
loans are due to two financial institutions which are normally due within one
year. As of December 31, 2008 and December 31, 2007, the Company’s
short term loans consisted of the following:
|
December 31, 2008
|
December 31, 2007
|
|||||||
|
Jimo
Rural Cooperative Bank of Qingdao (JMRB), 24-month bank loan due in
November 2008, bears interest at 9.64% average, secured by third
parties
|
$ | - | $ | 137,100 | ||||
|
JMRB,
12-month bank loan due in January 2008, bears interest at 9.64% average,
secured by third parties
|
- | 137,100 | ||||||
|
Bank
of Qingdao Jimo Branch (BOQ), 12-month bank loan due in August 2008, bears
interest at 7.94% average, pledged by Company's building and land use
right
|
- | 383,880 | ||||||
|
JMRB,
two 12-month bank loans both due in November 2009, bear interest at 10.85%
average, secured by third parties
|
293,400 | - | ||||||
|
BOQ,
12-month bank loan due in September 2009, bears interest at 8.25% average,
pledged by Company's building and land use right
|
410,760 | - | ||||||
|
Total
short-term loans
|
$ | 704,160 | $ | 658,080 | ||||
The above
indebtedness to JMRB at December 31, 2008 and 2007 has been guaranteed by two
unrelated companies.
NOTE
8 - RELATED PARTY BALANCES AND TRANSCATIONS
Due from related
party
Due from
related party at December 31, 2008 and 2007 are receivables from Mr. Tao Wang,
the CEO and major shareholder of the Company in the amount of $4,373,588 and
$2,231,755, respectively. Theses borrowings bear no interest and are
repayable on demand.
On
December 31, 2009, in accordance with the related party policy and procedures,
the Company entered into an agreement with Mr. Tao Wang to settle all
outstanding balance of due from related parties. As a result, at the
end of December 31, 2009, the related party balance represented the outstanding
balance of due to Mr. Tao Wang in amount of $104,511, which was partially
settled In January 2010.
Related party
transactions
Mr. Tao
Wang entered into the contract with the Company to assume fiscal
responsibilities for all tax liabilities recorded and potential penalties
relating to all tax liabilities before December 31, 2009. As of
December 31, 2008 and 2007, the assumed amount was $3,799,872 and $2,620,236,
respectively, which mainly included VAT tax payable and income tax payable.
According to PRC tax law, late or deficient tax payment could subject to
significant tax penalty. On December 25, 2009, the local tax authority in Jimo
City issued a “Tax Review Report”, stating that the tax authority reviewed the
Company’s income tax, VAT tax, stamp tax and invoices for the period between
June 2006 and November 2009 and noted that the Company had paid off all its tax
liability by December 21, 2009.
The
Company leases one of its stores from Mr. Tao Wang under a four-year operating
lease expiring August 2011. For the years ended December 31, 2008 and 2007,
related party rent expense of $17,298 and $15,800, respectively, was included in
total rent expense of the year.
The
Company leases one of its warehouse buildings to Weidong, Liang, brother-in-law
of Mr. Tao Wang, for three years starting May 2008. Per the agreement, the
lessee shall pay equal amount of advertising expense on behalf of the lessor as
the lease payment. For the year ended December 31, 2008, the Company recorded
other income of $57,660 from leasing the aforementioned building and advertising
expense of $57,660.
60
NOTE
9 – OPERATING LEASES
The
Company leases store spaces under noncancelable operating leases expiring at
various dates through 2013. Rent expense was $88,652 and $68,337 for the years
ended December 31, 2008 and 2007, respectively.
Future
minimum lease payments at December 31, 2008 are as follows:
|
Year:
|
||||
|
2009
|
$ | 88,652 | ||
|
2010
|
60,543 | |||
|
2011
|
49,876 | |||
|
2012
|
8,649 | |||
|
2013
|
4,325 | |||
| $ | 212,045 | |||
NOTE
10 - INCOME TAX
The
Company is governed by the Income Tax Law of the PRC concerning the private-run
enterprises, which are generally subject to tax at a statutory rate of 25% and
33% on income reported in the statutory financial statements after appropriated
tax adjustments in 2008 and 2007 respectively.
|
2008
|
2007
|
|||||||
|
Income
before income taxes
|
$ | 4,847,596 | $ | 2,999,046 | ||||
|
Income
taxes (25% in 2008 and 33% in 2007)
|
$ | 1,211,899 | $ | 989,685 | ||||
There is
no significant temporary difference between book and tax income.
See Note
8 – Related Party Transactions for the transfer of tax liabilities to the
majority shareholder. On December 25, 2009, the local tax authority in Jimo City
issued a “Tax Review Report”, stating that the tax authority reviewed the
Company’s income tax, VAT tax, stamp tax and invoices for the period between
June 2006 and November 2009 and noted that the Company had paid off all its tax
liability by December 21, 2009.
The
following table reconciles the U.S. statutory corporate income rates to the
Company’s effective tax rate for the years ended December 31, 2008 and
2007:
|
2008
|
2007
|
|||||||
|
US
statutory rates
|
34.0 | % | 34.0 | % | ||||
|
Tax
rate difference
|
(9.0 | )% | (1.0 | )% | ||||
|
Tax
per financial statements
|
25.0 | % | 33.0 | % | ||||
NOTE
11 – SHAREHOLDERS’ EQUITY
During
year 2007, the Company distributed $778,200 to its two owners.
During
year 2008, the Company distributed $1,874,600 to its two
owners.
61
NOTE
12 – COMMITMENTS AND CONTINGECIES
Social insurance for
employees
According
to the prevailing laws and regulations of the PRC, the Company is required to
cover its employees with medical, retirement and unemployment insurance
programs. Management believes that due to the transient nature of its
employees, the Company does not need to provide all employees with such social
insurances, and has paid the social insurances for the Company’s employees who
have completed three months’ continuous employment with the
Company.
In the
event that any current or former employee files a complaint with the PRC
government, the Company may be subject to making up the social insurances as
well as administrative fines. As the Company believes that these fines
would not be material, no provision has been made in this regard.
Guarantees
At
December 31, 2008, we had two outstanding guarantees provided to two unrelated
companies for the amount of $176,040 and $73,350, respectively. The two
unrelated companies also provided guarantees to us for a bank loan amounted
$293,400 (Note 7).
Tax
liabilities
The tax
authority of the PRC Government conducts periodic and ad hoc tax filing reviews
on business enterprises operating in the PRC after those enterprises had
completed their relevant tax filings, hence the Company’s tax filings may not be
finalized. It is therefore uncertain as to whether the PRC tax authority
may take different views about the Company’s tax filings which may lead to
additional tax liabilities.
Mr. Tao
Wang entered into a contract with the Company to assume fiscal responsibilities
for all tax liabilities recorded and potential penalties relating to all the tax
liabilities before December 31, 2009. As of December 31, 2008 and
2007, the assumed amount was $3,799,872 and $2,620,236, respectively, which
mainly included VAT tax payable and income tax payable. According to PRC tax
law, late or deficient tax payment could subject to tax penalty. On December 25,
2009, the local tax authority in Jimo City issued a “Tax Review Report”, stating
that the tax authority reviewed the Company’s income tax, VAT tax, stamp tax and
invoices for the period between June 2006 and November 2009 and noted that the
Company had paid off all its tax liability by December 21, 2009.
NOTE
13 - OPERATING RISKS
(a)
Country
risk
The
Company has significant investments in the PRC. The operating results of the
Company may be adversely affected by changes in the political and social
conditions in the PRC and by changes in Chinese government policies with respect
to laws and regulations, anti-inflationary measures, currency conversion and
remittance abroad, and rates and methods of taxation, among other things. The
Company can give no assurance that those changes in political and other
conditions will not result in a material adverse effect upon the Company’s
business and financial condition.
(b)
Exchange
risk
The
Company cannot guarantee the Renminbi, US dollar exchange rate will remain
steady, therefore the Company could post the same profit for two comparable
periods and post higher or lower profit depending on exchange rate of Renminbi
and US dollars. The exchange rate could fluctuate depending on
changes in the political and economic environments without
notice.
62
(c)
Interest
risk
The
Company is exposed to interest rate risk arising from short-term variable rate
borrowings from time to time. The Company’s future interest expense will
fluctuate in line with any change in borrowing rates. The Company
does not have any derivative financial instruments as of December 31, 2008 and
2007 and believes its exposure to interest rate risk is not
material.
NOTE
14 – CONCENTRATION
During
the years ended December 31, 2008 and 2007, the sales generated by the Company’s
owned stores accounted for 15% and 12% of total sales,
respectively.
During
the year ended December 31, 2007, purchases from one vendor accounted for 13.2%
of the total merchandise purchases of the Company. There is no such
concentration for the year ended December 31, 2008.
NOTE
15 - SUBSEQUENT EVENTS
In
February, 2010, the Company completed a reverse acquisition transaction through
a share exchange with Datone, Inc. (“Datone”), whereby Datone acquired 100% of
the issued and outstanding capital stock of the Company in exchange for 10,000
shares of the Series A Convertible Preferred Stock of Datone. As a result of the
reverse acquisition, the Company became Datone’s wholly-owned subsidiary and the
former shareholders of the Company became controlling stockholders of
Datone. The share exchange transaction with Datone was treated as a
reverse acquisition, with the Company as the accounting acquirer and Datone as
the acquired party.
During
the nine months ended September 30, 2009, the Company distributed $6,860,412 to
its two owners.
During
the nine months ended September 30, 2009, the Company transferred $3,464,650 tax
liability to Mr. Tao Wang, CEO and majority shareholders of the
Company.
During
the nine months ended September 30, 2009, Mr. Tao Wang repaid $686,829 to the
Company.
The
Company obtained a 60-day loan from JMRB on October 23, 2009, with principal
amount of $440,100 bearing interest at 9.72% per annum and the loan has been
paid off on December 20, 2009.
The
Company obtained a short term loan from JMRB on November 11, 2009, with
principle amount of $146,259 bearing interest of 9.72% per annum and matures on
November 8, 2010.
The
Company obtained a short term loan from JMRB on November 18, 2009, with
principle amount of $146,259 bearing interest of 8% per annum and matures on
November 17, 2010.
The
Company obtained a long term loan from JMRB on December 16, 2009, with principle
amount of $248,640 bearing interest of 8% per annum and matures on December 10,
2011.
The
Company obtained a long term loan from JMRB on January 20, 2010, with principle
amount of $438,776 bearing interest of 9.72% per annum and matures on December
14, 2010.
The
Company entered into the agreements to settle all outstanding balance of due
from the officer, Mr. Tao Wang in accordance with the relevant related party
policy and procedures on December 31, 2009, which resulted in amounted to
$104,511 outstanding balance of due to Mr. Tao Wang as of December 31,
2009.
The
Company has evaluated all subsequent events through February 12, 2010, the date
of this filing.
63
GLORY
REACH INTERNATIONAL LIMITED
CONSOLIDATED
BALANCE SHEETS
AS
OF SEPTEMBER 30, 2009 AND DECEMBER 31, 2008
(UNAUDITED)
|
September 30,
|
December 31,
|
|||||||
|
2009
|
2008
|
|||||||
|
ASSETS
|
||||||||
|
Current
assets
|
||||||||
|
Cash
|
$ | 464,914 | $ | 118,534 | ||||
|
Accounts
receivable
|
72,554 | 3,534 | ||||||
|
Inventories
|
598,575 | 189,535 | ||||||
|
Prepaid
expenses
|
96,451 | 58,490 | ||||||
|
Due
from related party
|
222,108 | 4,373,588 | ||||||
|
Total
current assets
|
1,454,602 | 4,743,681 | ||||||
|
Property,
plant and equipment, net
|
939,363 | 602,831 | ||||||
|
Intangible
assets
|
209,378 | 213,008 | ||||||
|
Total
Assets
|
$ | 2,603,343 | $ | 5,559,520 | ||||
|
LIABILITIES AND SHAREHOLDERS'
EQUITY
|
||||||||
|
Current
liabilities
|
||||||||
|
Accounts
payable
|
$ | 27,065 | $ | 546 | ||||
|
Taxes
payable
|
9,247 | 2,114 | ||||||
|
Short-term
loans
|
1,012,230 | 704,160 | ||||||
|
Total
current liabilities
|
1,048,542 | 706,820 | ||||||
|
Shareholders'
Equity
|
||||||||
|
Common
shares, authorized, issued and outstanding; 10,000 and 10,000 shares
respectively, par value $0.129 per share
|
1,290 | 1,290 | ||||||
|
Additional
paid-in capital
|
319,190 | 319,190 | ||||||
|
Accumulated
other comprehensive income
|
435,191 | 437,665 | ||||||
|
Retained
earnings
|
799,130 | 4,094,555 | ||||||
|
Total
Shareholders' Equity
|
1,554,801 | 4,852,700 | ||||||
|
Total
Liabilities and Shareholders' Equity
|
$ | 2,603,343 | $ | 5,559,520 | ||||
The
accompanying notes are an integral part of these financial
statements.
64
GLORY
REACH INTERNATIONAL LIMITED
CONSOLIDATED
STATEMENTS OF OPERATIONS
FOR
THE NINE MONTHS PERIOD ENDED SEPTEMBER 30, 2009 AND 2008
(UNAUDITED)
|
Nine Months Ended
|
||||||||
|
September 30,
|
September 30,
|
|||||||
|
2009
|
2008
|
|||||||
|
Net
sales
|
$ | 12,517,751 | $ | 9,116,272 | ||||
|
Cost
of sales
|
7,102,669 | 5,432,591 | ||||||
|
Gross
profit
|
5,415,082 | 3,683,681 | ||||||
|
Operating
expenses:
|
||||||||
|
Selling,
general and administrative expenses
|
642,681 | 515,586 | ||||||
|
Depreciation
and amortization expense
|
43,964 | 42,207 | ||||||
|
Profit
from operations
|
4,728,437 | 3,125,888 | ||||||
|
Other
income (expenses):
|
||||||||
|
Other
income
|
65,966 | 35,843 | ||||||
|
Interest
expense
|
(41,087 | ) | (37,500 | ) | ||||
|
Income
before income taxes
|
4,753,316 | 3,124,231 | ||||||
|
Income
taxes
|
1,188,329 | 781,058 | ||||||
|
Net
income
|
$ | 3,564,987 | $ | 2,343,173 | ||||
|
Net
income per share - basis and diluted
|
$ | 356 | $ | 234 | ||||
|
Weighted
average shares outstanding
|
10,000 | 10,000 | ||||||
|
Comprehensive
income
|
||||||||
|
Net
income
|
$ | 3,564,987 | $ | 2,343,173 | ||||
|
Other
comprehensive income
|
||||||||
|
Foreign
currency translation
|
(2,473 | ) | 212,476 | |||||
|
Comprehensive
income
|
$ | 3,562,514 | $ | 2,555,649 | ||||
The
accompanying notes are an integral part of these financial
statements.
65
GLORY
REACH INTERNATIONAL LIMITED
CONSOLIDATED
STATEMENTS OF CASH FLOWS
FOR
THE NINE MONTHS PERIOD ENDED SEPTEMBER 30, 2009 AND 2008
(UNAUDITED)
|
Nine Months Ended
|
||||||||
|
September 30,
|
September 30,
|
|||||||
|
2009
|
2008
|
|||||||
|
CASH
FLOWS FROM OPERATING ACTIVITIES:
|
||||||||
|
Net
income
|
$ | 3,564,987 | $ | 2,343,173 | ||||
|
Adjustments
to reconcile net income to net cash provided by operating
activities:
|
||||||||
|
Depreciation
and amortization
|
43,964 | 42,207 | ||||||
|
Changes
in operating assets and liabilities:
|
||||||||
|
Accounts
receivable
|
(69,020 | ) | (66,874 | ) | ||||
|
Inventories
|
(409,040 | ) | 105,754 | |||||
|
Prepaid
expenses
|
(37,961 | ) | 53,231 | |||||
|
Accounts
payable
|
26,519 | 33,280 | ||||||
|
Taxes
payable
|
3,471,783 | 2,473,889 | ||||||
|
Net
cash provided by operating activities
|
6,591,232 | 4,984,660 | ||||||
|
CASH
FLOWS FROM INVESTING ACTIVITIES:
|
||||||||
|
Advance
to related party
|
- | (2,175,067 | ) | |||||
|
Collection
from related party
|
686,829 | - | ||||||
|
Purchase
of property and equipment
|
(376,899 | ) | (37,745 | ) | ||||
|
Net
cash provided by (used) in investing activities
|
309,930 | (2,212,812 | ) | |||||
|
CASH
FLOWS FROM FINANCING ACTIVITIES:
|
||||||||
|
Proceeds
from short-term loans
|
718,830 | 555,940 | ||||||
|
Repayments
on short-term loans
|
(410,760 | ) | (555,940 | ) | ||||
|
Distribution
to shareholders
|
(6,860,412 | ) | (1,874,600 | ) | ||||
|
Net
cash used in financing activities
|
(6,552,342 | ) | (1,874,600 | ) | ||||
|
Effect
of exchange rate changes on cash
|
(2,440 | ) | 23,772 | |||||
|
Net
increase in cash
|
$ | 346,380 | $ | 921,020 | ||||
|
Cash,
beginning of period
|
118,534 | 34,608 | ||||||
|
Cash,
end of period
|
$ | 464,914 | $ | 955,628 | ||||
|
SUPPLEMENTAL
DISCLOSURE INFORMATION:
|
||||||||
|
Interest
paid
|
$ | 41,087 | $ | 37,500 | ||||
|
Income
tax paid
|
$ | 3,760 | $ | 2,525 | ||||
|
NON-CASH
FINANCING AND INVESTING ACTIVITIES:
|
||||||||
|
Transfer
of taxes payable to due from related party
|
3,464,650 | - | ||||||
The
accompanying notes are an integral part of these financial
statements.
66
GLORY
REACH INTERNATIONAL LIMITED
NOTES
TO FINANCIAL STATEMENTS
(UNAUDITED)
NOTE
1 - ORGANIZATION AND BUSINESS OPERATIONS
Qingdao
Hongguan Shoes Co., Ltd. (”Qingdao Shoes”) was incorporated on March 11, 2003 in
Jimo County, Qingdao City, Shandong Province, People’s Republic of China (the
“PRC”) with registered capital of $320,480. Mr. Tao Wang owned 80% of
Qingdao Shoes and the remaining 20% was owned by Mr. Renwei
Ma. Qingdao Shoes is the owner of the brand name “Honguan” and
principally engaged in the wholesale and retail sales of fashion footwear
primarily in the northeast region of China.
Glory
Reach International Limited (the “Company”) was established in Hong Kong on
November 18, 2009 to serve as an intermediate holding company. Mr.
Tao Wang, the controlling interest holder of Qingdao Shoes also controls the
Company. On February 8, 2010, also pursuant to the restructuring plan, the
Company acquired 100% of the equity interests in Qingdao Shoes.
Since the
common control between the Company and Qingdao Shoes, for accounting purposes,
the acquisitions of Hongguan has been treated as a recapitalization with no
adjustment to the historical basis of their assets and liabilities. The
restructuring has been accounted for using the “as if” pooling method of
accounting and the operations were consolidated as if the restructuring had
occurred as of the beginning of the earliest period presented in our
consolidated financial statements and the current corporate structure had been
in existence throughout the periods covered by our consolidated financial
statements.
NOTE
2 - BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING
POLICIES
Basis of
Presentation
The
accompanying unaudited consolidated interim financial statements of the Company
have been prepared in accordance with accounting principles generally accepted
in the United States of America and rules of the Securities and Exchange
Commission, and should be read in conjunction with the audited financial
statements and notes thereto contained in the Company’s annual financial
statements for the years ended December 31, 2008 and 2007 included in this Form
8-K. In the opinion of management, all adjustments, consisting of
normal recurring adjustments, necessary for a fair presentation of financial
position and the results of operations for the interim periods presented have
been reflected herein. The results of operations for interim periods are not
necessarily indicative of the results to be expected for the full year. Notes to
the financial statements which would substantially duplicate the disclosure
contained in the audited financial statements for the years ended December 31,
2008 and 2007 included in this document have been omitted.
Use of
Estimates
The
preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America (“US GAAP”) requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the dates of the financial statements and the amount of revenues and expenses
during the reporting periods. Management makes these estimates using
the best information available at the time the estimates are
made. However, actual results could differ materially from those
estimates.
Recent Accounting
Pronouncements
Fair Value Measurements and
Disclosures (Included in ASC 820, previously FSP No. 157-4, “Determining Whether
a Market is Not Active and a Transaction Is Not
Distressed”). FSP No. 157-4 clarifies when markets are
illiquid or that market pricing may not actually reflect the “real” value of an
asset. If a market is determined to be inactive and market price is
reflective of a distressed price then an alternative method of pricing can be
used, such as a present value technique to estimate fair value. FSP
No. 157-4 identifies factors to be considered when determining whether or not a
market is inactive. FSP No. 157-4 would be effective for interim and
annual periods ending after June 15, 2009, with early adoption permitted for
periods ending after March 15, 2009 and shall be applied
prospectively. The adoption of this standard had no material effect
on the Company's financial statements.
67
Interim Disclosures about Fair Value
of Financial Instruments (Included in ASC 825 “Financial Instruments”,
previously FSP SFAS No. 107-1). This guidance requires that
the fair value disclosures required for all financial instruments within the
scope of SFAS No. 107, “Disclosures about Fair Value of Financial Instruments”,
be included in interim financial statements. This guidance also
requires entities to disclose the method and significant assumptions used to
estimate the fair value of financial instruments on an interim and annual basis
and to highlight any changes from prior periods. FSP 107-1 was
effective for interim periods ending after September 15, 2009. The
adoption of FSP 107-1 had no material impact on the Company’s financial
statements.
Consolidation of Variable Interest
Entities – Amended (To be included in ASC 810 “Consolidation”, previously SFAS
167 “Amendments to FASB Interpretation No. 46(R)”). SFAS 167 amends FASB
Interpretation No. 46 (revised December 2003), “Consolidation of Variable
Interest Entities,” to require an enterprise to perform an analysis to determine
the primary beneficiary of a variable interest entity; to require ongoing
reassessments of whether an enterprise is the primary beneficiary of a variable
interest entity and to eliminate the quantitative approach previously required
for determining the primary beneficiary of a variable interest
entity. SFAS 167 also requires enhanced disclosures that will provide
users of financial statements with more transparent information about an
enterprise’s involvement in a variable interest entity. SFAS 167 is
effective for the first annual reporting period beginning after November 15,
2009 and will be effective for us as of January 1, 2010. The
management is in the process of evaluating the impact of adopting this standard
on the Company’s financial statements.
FASB Accounting Standards
Codification (Accounting Standards Update “ASU” 2009-1). In June 2009,
the Financial Accounting Standard Board (“FASB”) approved its Accounting
Standards Codification (“Codification”) as the single source of authoritative
United States accounting and reporting standards applicable for all
non-governmental entities, with the exception of the SEC and its
staff. The Codification is effective for interim or annual financial
periods ending after September 15, 2009 and impacts our financial statements as
all future references to authoritative accounting literature will be referenced
in accordance with the Codification. There have been no changes to
the content of our financial statements or disclosures as a result of
implementing the Codification.
As a
result of our implementation of the Codification during the quarter ended
September 30, 2009, previous references to new accounting standards and
literature are no longer applicable. In the current quarter financial
statements, we will provide reference to both new and old guidance to assist in
understanding the impacts of recently adopted accounting literature,
particularly for guidance adopted since the beginning of the current fiscal year
but prior to the Codification.
In August
2009, the FASB issued Accounting Standards Update No. 2009-05 (“ASC Update
2009-05”), an update to ASC 820, Fair Value Measurements and
Disclosures. This update provides amendments to reduce potential
ambiguity in financial reporting when measuring the fair value of
liabilities. Among other provisions, this update provides
clarification that in circumstances in which a quoted price in an active market
for the identical liability is not available, a reporting entity is required to
measure fair value using one or more of the valuation techniques described in
ASC Update 2009-05. ASC Update 2009-05 will become effective for the
Company’s annual financial statements for the year ended December 31, 2009. The
management is in the process of evaluating the impact of adopting this standard
on the Company’s financial statements.
In
October 2009, the FASB issued Accounting Standards Update, 2009-13, Revenue
Recognition (Topic 605) “Multiple Deliverable Revenue Arrangements - A Consensus
of the FASB Emerging Issues Task Force”. This update provides
application guidance on whether multiple deliverables exist, how the
deliverables should be separated and how the consideration should be allocated
to one or more units of accounting. This update establishes a selling
price hierarchy for determining the selling price of a
deliverable. The selling price used for each deliverable will be
based on vendor-specific objective evidence, if available, third-party evidence
if vendor-specific objective evidence is not available, or estimated selling
price if neither vendor-specific or third-party evidence is
available. The Company will be required to apply this guidance
prospectively for revenue arrangements entered into or materially modified after
January 1, 2011; however, earlier application is permitted. The
management is in the process of evaluating the impact of adopting this standard
on the Company’s financial statements.
68
NOTE
3 - SHORT TERM LOANS
Short-term
loans are due to two financial institutions which are normally due within one
year. As of September 30, 2009 and December 31, 2008, the Company’s
short term loans consisted of the following:
|
September 30, 2009
|
December 31, 2008
|
|||||||
|
Jimo
Rural Cooperative Bank of Qingdao (JMRB), two 12-month bank loans both due
in November 2009, bear interest at 10.85% average, secured by third
parties
|
$ | 293,400 | $ | 293,400 | ||||
|
Bank
of Qingdao Jimo Branch (BOQ), 12-month bank loan due in September 2009,
bears interest at 8.25% average, pledged by Company's building and land
use right
|
- | 410,760 | ||||||
|
JMRB,
3-month bank loan due in October 2009, bears interest at 8.1% per annum,
secured by third parties
|
293,400 | - | ||||||
|
BOQ,
12-month bank loan due in September 2010, bears interest at 5.31% per
annum, pledged by Company's building and land use right
|
425,430 | - | ||||||
|
Total
short-term debt
|
$ | 1,012,230 | $ | 704,160 | ||||
The above
indebtedness to JMRB at September 30, 2009 and December 31, 2008 has been
guaranteed by two unrelated companies.
NOTE
4 - RELATED PARTY BALANCES AND TRANSCATIONS
Due from related
parties
Prior to
the acquisition by Datone, the Company forwarded a loan to Mr. Tao Wang, CEO and
major shareholder of the Company in the amount of $222,108 and $4,373,588 at
September 30, 2009 and December 31, 2008 respectively. Section 402 of the
Sarbanes-Oxley Act of 2002 prohibits loans or the extension of credit to
officers and directors of a public traded company or any of its subsidiaries.
On
December 31, 2009 the Company entered into agreements to settle all outstanding
balances due from the officer, Mr. Tao Wang, in accordance with the anticipated
related party policies and procedures associated with being a public reporting
company. This resulted in a $104,511 outstanding balance due to Mr.
Tao Wang as of December 31, 2009, the balance of which was partially settled in
January 2010.
Related party
transactions
Mr. Tao
Wang entered into the contract with the Company to assume fiscal
responsibilities for all tax liabilities recorded and potential penalties
relating to all tax liabilities before December 31, 2009. As of
September 30, 2009 and December 31, 2008 the assumed amount was $3,464,650 and
$3,799,872 respectively, which mainly included VAT tax payable and income tax
payable. According to PRC tax law, late or deficient tax payment could subject
to significant tax penalty. On December 25, 2009, the local tax authority in
Jimo City issued a “Tax Review Report”, stating that the tax authority reviewed
the Company’s income tax, VAT tax, stamp tax and invoices for the period between
June 2006 and November 2009 and noting that the Company had paid off all its tax
liability by December 21, 2009.
69
The
Company leases one of its stores from Mr. Tao Wang under a four-year operating
lease expiring August 2011. For the nine months ended September 30, 2009 and
2008, related party rent expense of $13,193 and $12,903, respectively, was
included in total rent expense of the period.
The
Company leases one of its warehouse buildings to Weidong, Liang, brother-in-law
of Mr. Tao Wang, for three years starting May 2008. Per the agreement, the
lessee shall pay equal amount of advertising expense on behalf of the lessor as
the lease payment. For the nine months ended September 30, 2009 and 2008, the
Company recorded other income of $65,966 and $35,843, respectively, from leasing
the aforementioned building and advertising expense of the same amount
respectively.
NOTE
5 - INCOME TAX
The
Company is governed by the Income Tax Law of the PRC concerning the private-run
enterprises, which are generally subject to tax at a statutory rate of 25% on
income reported in the statutory financial statements.
|
Nine Months Ended
September 30, 2009
|
Nine Months Ended
September 30, 2008
|
|||||||
|
Income
before income taxes
|
$ | 4,753,316 | $ | 3,124,231 | ||||
|
Income
taxes (25%)
|
$ | 1,188,329 | $ | 781,058 | ||||
There is
no significant temporary difference between book and tax income.
See Note
4 – Related Party Transactions for the transfer of tax liabilities to the
majority shareholder. On December 25, 2009, the local tax authority in Jimo City
issued a “Tax Review Report”, stating that the tax authority reviewed the
Company’s income tax, VAT tax, stamp tax and invoices for the period between
June 2006 and November 2009 and noted that the Company had paid off all its tax
liability by December 21, 2009.
NOTE
6 – SHAREHOLDERS’ EQUITY
During
the nine months ended September 30, 2009, the Company distributed $6,860,412 to
its two owners.
NOTE
7 – COMMITMENTS AND CONTINGECIES
Guarantees
At
September 30, 2009, we had two outstanding guarantees provided to two unrelated
companies for the amount of $146,700 and $513,450, respectively. The two
unrelated companies also provided guarantees to us for our bank loan totaled
$586,800 (Note 3).
At
December 31, 2008, we had two outstanding guarantees provided to two unrelated
companies for the amount of $176,040 and $73,350, respectively. The two
unrelated companies also provided guarantees to us for our bank loan totaled
$293,400.
Tax
liabilities
The tax
authority of the PRC Government conducts periodic and ad hoc tax filing reviews
on business enterprises operating in the PRC after those enterprises had
completed their relevant tax filings, hence the Company’s tax filings may not be
finalized. It is therefore uncertain as to whether the PRC tax authority
may take different views about the Company’s tax filings which may lead to
additional tax liabilities.
70
Mr. Tao
Wang entered into the contract with the Company to assume fiscal
responsibilities for all tax liabilities recorded and potential penalties
relating to all the tax liabilities before December 31, 2009. As of
September 30, 2009 and December 31, 2008, the assumed amount was $3,464,650 and
$3,799,872, which mainly included VAT tax payable and income tax payable.
According to PRC tax law, late or deficient tax payment could subject to
significant tax penalty. On December 25, 2009, the local tax authority in Jimo
City issued a “Tax Review Report”, stating that the tax authority reviewed the
Company’s income tax, VAT tax, stamp tax and invoices for the period between
June 2006 and November 2009 and noting that the Company had paid off all its tax
liability by December 21, 2009.
NOTE 8
- SUBSEQUENT EVENTS
In
February, 2010, the Company completed a reverse acquisition transaction through
a share exchange with Datone, Inc. (“Datone”), whereby Datone acquired 100% of
the issued and outstanding capital stock of the Company in exchange for 10,000
shares of the Series A Convertible Preferred Stock of Dadone. As a result of the
reverse acquisition, the Company became Datone’s wholly-owned subsidiary and the
former shareholders of the Company became controlling stockholders of
Datone. The share exchange transaction with Datone was treated as a
reverse acquisition, with the Company as the accounting acquirer and Datone as
the acquired party.
The
Company obtained a 60-day loan from JMRB on October 23, 2009, with principal
amount of $440,100 bearing interest at 9.72% per annum and the loan has been
paid off on December 20, 2009.
The
Company obtained a short term loan from JMRB on November 11, 2009, with
principle amount of $146,259 bearing interest of 9.72% per annum and matures on
November 8, 2010.
The
Company obtained a short term loan from JMRB on November 18, 2009, with
principle amount of $146,259 bearing interest of 8% per annum and matures on
November 17, 2010.
The
Company obtained a long term loan from JMRB on December 16, 2009, with principle
amount of $248,640 bearing interest of 8% per annum and matures on December 10,
2011.
The
Company obtained a long term loan from JMRB on January 20, 2010, with principle
amount of $438,776 bearing interest of 9.72% per annum and matures on December
14, 2010.
The
Company entered into the agreements to settle all outstanding balance of due
from the officer, Mr. Tao Wang in accordance with the relevant related party
policy and procedures on December 31, 2009, which resulted in amounted to
$104,511 outstanding balance of due to Mr. Tao Wang as of December 31,
2009
The
Company has evaluated all subsequent events through February 12, 2010, the date
of this filing.
71
UNAUDITED
PRO FORMA CONSOLIDATED BALANCE SHEET
SEPTEMPER
30, 2009
GLORY
REACH INTERNATIONAL LIMITED
(UNAUDITED)
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|
PRO-FORMA
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GLORY REACH INTERNATIONAL |
PRO-FORMA
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CONSOLIDATED
BALANCE
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|||||||||||||||||
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LIMITED
|
DATONE, INC
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ADJUSTMENTS
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SHEET
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ASSETS
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Current
assets
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Cash
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$ | 464,914 | $ | - | $ | 0 | $ | 464,914 | |||||||||||
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Accounts
receivable
|
72,554 | 29,151 | (29,151 | ) |
a
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72,554 | |||||||||||||
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Inventories
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598,575 | - | 0 | 598,575 | |||||||||||||||
|
Prepaid
expenses
|
96,451 | - | 0 | 96,451 | |||||||||||||||
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Due
from related party
|
222,108 | - | 0 | 222,108 | |||||||||||||||
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Total
current assets
|
1,454,602 | 29,151 | (29,151 | ) |
a
|
1,454,602 | |||||||||||||
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Property,
plant and equipment, net
|
939,363 | 5,669 | (5,669 | ) |
a
|
939,363 | |||||||||||||
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Intangible
assets
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209,378 | 209,378 | |||||||||||||||||
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Total
Assets
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$ | 2,603,343 | $ | 34,820 | $ | (34,820 | ) | $ | 2,603,343 | ||||||||||
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LIABILITIES
AND SHAREHOLDERS' EQUITY
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Current
liabilities
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Accounts
payable
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$ | 27,065 | $ | 148,447 | $ | (148,447 | ) |
a
|
$ | 27,065 | |||||||||
|
Bank
overdraft
|
8,313 | (8,313 | ) |
a
|
0 | ||||||||||||||
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Accrued
liabilities
|
64,572 | (64,572 | ) |
a
|
0 | ||||||||||||||
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Taxes
payable
|
9,247 | - | 0 | 9,247 | |||||||||||||||
|
Short-term
debt - related parties
|
338,234 | (338,234 | ) |
a
|
0 | ||||||||||||||
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Short-term
loans
|
1,012,230 | 7,091 | (7,091 | ) |
a
|
1,012,230 | |||||||||||||
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Total
current liabilities
|
1,048,542 | 566,657 | (566,657 | ) | 1,048,542 | ||||||||||||||
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Shareholders'
Equity
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|||||||||||||||||||
|
Convertible
Series A Preferred stock, 1,000,000 authorized, 10,000 shares issued and
outstanding, par value $.0001
|
1 |
c
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1 | ||||||||||||||||
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Common
Stock
|
1,290 | 496 | (1,290 | ) |
b
|
496 | |||||||||||||
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Additional
paid-in capital
|
319,190 | 1,687,871 | (1,687,078 | ) |
b
|
319,983 | |||||||||||||
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Accumulated
other comprehensive income
|
435,191 | 435,191 | |||||||||||||||||
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Retained
earnings
|
799,130 | (2,220,204 | ) | 2,220,204 |
b
|
799,130 | |||||||||||||
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Total
Shareholders' Equity
|
1,554,801 | (531,837 | ) | 531,837 | 1,554,801 | ||||||||||||||
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Total
Liabilities and Shareholders' Equity
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$ | 2,603,343 | $ | 34,820 | $ | (34,820 | ) | $ | 2,603,343 | ||||||||||
The
accompanying notes are an integral part of these financial
statements.
72
UNAUDITED
PRO FORMA CONSOLIDATED STATEMENT OF OPERATION
FOR
THE YEARS ENDED DECEMBER 31, 2008
GLORY
REACH INTERNATIONAL LIMITED
(UNAUDITED)
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PRO-FORMA
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GLORY REACH
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CONSOLIDATED
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INTERNATIONAL
|
PRO-FORMA
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STATEMENT OF
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|||||||||||||||||
|
LIMITED
|
DATON, INC
|
ADJUSTMENTS
|
OPERATION
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||||||||||||||||
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Net
sales
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$ | 13,904,314 | $ | 121,436 | $ | (121,436 | ) |
a
|
$ | 13,904,314 | |||||||||
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Cost
of sales
|
8,246,592 | 27,346 | (27,346 | ) |
a
|
8,246,592 | |||||||||||||
|
Gross
profit
|
5,657,722 | 94,090 | (94,090 | ) | 5,657,722 | ||||||||||||||
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Operating
expenses:
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|||||||||||||||||||
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Selling,
general and administrative expenses
|
759,470 | 182,698 | 942,168 | ||||||||||||||||
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Depreciation
and amortization expense
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55,360 | 55,360 | |||||||||||||||||
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Profit
from operations
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4,842,892 | (88,608 | ) | (94,090 | ) | 4,660,194 | |||||||||||||
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Other
income (expenses):
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|||||||||||||||||||
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Other
income
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57,660 | 0 | 57,660 | ||||||||||||||||
|
Interest
income
|
8,949 | 8,949 | |||||||||||||||||
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Interest
expense
|
(61,905 | ) | (30,183 | ) | (92,088 | ) | |||||||||||||
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Income
before income taxes
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4,847,596 | (118,791 | ) | (94,090 | ) | 4,634,715 | |||||||||||||
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Income
taxes
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1,211,899 | 1,211,899 | |||||||||||||||||
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Net
income
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$ | 3,635,697 | $ | (118,791 | ) | $ | (94,090 | ) | $ | 3,422,816 | |||||||||
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Other
comprehensive income
|
|||||||||||||||||||
|
Foreign
currency translation
|
232,047 | 232,047 | |||||||||||||||||
|
Comprehensive
income
|
$ | 3,867,744 | $ | (118,791 | ) | $ | (94,090 | ) | $ | 3,654,863 | |||||||||
The
accompanying notes are an integral part of these financial
statements.
73
UNAUDITED
PRO FORMA CONSOLIDATED STATEMENT OF OPERATION
FOR
THE NINE MONTHS PERIOD ENDED SEPTEMBER 30, 2009
GLORY
REACH INTERNATIONAL LIMITED
(UNAUDITED)
|
PRO-FORMA
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|||||||||||||||||||
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GLORY REACH
|
CONSOLIDATED
|
||||||||||||||||||
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INTERNATIONAL
|
PRO-FORMA
|
STATEMENT OF
|
|||||||||||||||||
|
LIMITED
|
DATON, INC
|
ADJUSTMENTS
|
OPERATION
|
||||||||||||||||
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Net
sales
|
$ | 12,517,751 | $ | 72,457 | $ | (72,457 | ) |
a
|
$ | 12,517,751 | |||||||||
|
Cost
of sales
|
7,102,669 | 23,154 | (23,154 | ) |
a
|
7,102,669 | |||||||||||||
|
Gross
profit
|
5,415,082 | 49,303 | (49,303 | ) | 5,415,082 | ||||||||||||||
|
Operating
expenses:
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|||||||||||||||||||
|
Selling,
general and administrative expenses
|
642,681 | 134,718 | 777,399 | ||||||||||||||||
|
Depreciation
and amortization expense
|
43,964 | 43,964 | |||||||||||||||||
|
Impairment
loss on assets
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|||||||||||||||||||
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Profit
from operations
|
4,728,437 | (85,415 | ) | (49,303 | ) | 4,593,719 | |||||||||||||
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Other
income (expenses):
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|||||||||||||||||||
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Other
income
|
65,966 | (107 | ) | 65,859 | |||||||||||||||
|
Interest
income
|
|||||||||||||||||||
|
Interest
expense
|
(41,087 | ) | (41,274 | ) | -82,361 | ||||||||||||||
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Income
before income taxes
|
4,753,316 | (126,796 | ) | (49,303 | ) | 4,577,217 | |||||||||||||
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Income
taxes
|
1,188,329 | 1,188,329 | |||||||||||||||||
|
Net
income
|
$ | 3,564,987 | $ | -126,796 | $ | (49,303 | ) | $ | 3,388,888 | ||||||||||
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Other
comprehensive income
|
|||||||||||||||||||
|
Foreign
currency translation
|
(2,473 | ) | (2,473 | ) | |||||||||||||||
|
Comprehensive
income
|
$ | 3,562,514 | $ | (126,796 | ) | $ | (49,303 | ) | $ | 3,386,415 | |||||||||
The
accompanying notes are an integral part of these financial
statements.
74
NOTES TO
THE UNAUDITED PRO FORMA CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Note 1 –
BASIS OF PRESENTATION
In
February, 2010, Glory Reach International Limited (the “Company”) completed a
reverse acquisition transaction through a share exchange with Datone, Inc.
(“Datone”), whereby Datone acquired 100% of the issued and outstanding capital
stock of the Company in exchange for 10,000 shares of the Series A Convertible
Preferred Stock of Dadone. As a result of the reverse acquisition, the Company
became Datone’s wholly-owned subsidiary and the former shareholders of the
Company became controlling stockholders of Datone. The share exchange
transaction with Datone was treated as a reverse acquisition, with the Company
as the accounting acquirer and Datone as the acquired party
Consequently,
the assets and liabilities and the historical operations that will be reflected
in the consolidated financial statements for periods prior to the Share Exchange
Agreement will be those of the Comapny and will be recorded at the historical
cost basis. After the completion of the Share Exchange Agreement, the
Company’s consolidated financial statements will include the assets and
liabilities of both the Company and Datone, the historical operations of the
Company and the operations of Datone from the closing date of the Share Exchange
Agreement.
These pro
forma consolidated financial statements are prepared assuming the above
transaction occurred on September 30, 2009 (as to the balance sheet) and on
January 1, 2008 (as to the income statements).
Audited
financial statements of the Company and Datone have been used in the preparation
of these pro forma consolidated financial statements. These pro forma
consolidated financial statements should be read in conjunction with the
historical financial statements of Glory and the Company.
Note 2 –
PRO FORMA ASSUMPTIONS AND ADJUSTMENTS
|
(a)
|
To
reflect the spinoff of Datone Inc’s assets and liabilities to DT
Communications, Inc. As part of the agreement, the assets and liabilities
of Datone, Inc will be spun off to DT Communications, Inc. after the
reverse merger
|
|
(b)
|
To
eliminate the equity of the accounting acquiree, Datone Inc., and to
reflect the recapitalization of the common stock and additional paid in
capital of the Company as a result of the reverse
merger.
|
|
(c)
|
To
reflect the issuance of the convertible Series A preferred stock of 10,000
shares per the Share Exchange
Agreement.
|
75