UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB
x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
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| For the quarterly three month period ended December 31, 2006 |
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o | TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACT |
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| For the transition period from [ ] to [ ] |
Commission File Number: 000-26347
Sun New Media, Inc.
(Name of small business issuer as specified in its charter)
MINNESOTA |
| 410985135 |
(State or other jurisdiction of incorporation) |
| (IRS Employer |
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| Identification No.) |
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Fourth Floor 1120 Avenue of the Americas, New York, NY |
| 10036 |
(Address of principal executive offices) |
| (Zip Code) |
Issuer’s telephone number (212) 626-6744
Securities Registered under Section 12(b) of the Exchange Act: None
Securities Registered pursuant to Section 12(g) of the Act: |
| Common Stock, par value $0.01 per share |
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| (Title of class) |
This Quarterly Report on Form 10-QSB is the Registrant’s Quarterly Report for the quarter ended December 31, 2006 as filed with the Securities and Exchange Commission.
Check whether the Registrant (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the Registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days x Yes o No
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
o Yes x No
State the number of shares outstanding of each of the Registrant’s classes of common stock, as of the latest practicable date.
90,191,360 common shares issued and outstanding as of January 31, 2007
Transitional Small Business Disclosure Format (Check one): o Yes x No
TABLE OF CONTENTS
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| 3 |
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| Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations |
| 27 |
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| 50 |
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| 51 |
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| Item 2. Unregistered Sales of Equity Securities and Use of Proceeds |
| 51 |
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| 51 |
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| Item 4. Submissions of Matters to a Vote of Security Holders |
| 51 |
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| 51 |
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| 52 |
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| 55 |
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EXHIBIT 31.1 |
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EXHIBIT 31.2 |
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EXHIBIT 32.1 |
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EXHIBIT 32.2 |
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2
FORWARD LOOKING INFORMATION
This quarterly report contains forward-looking statements as that term is defined in the Private Securities Litigation Reform Act of 1995. These statements relate to future events or our future financial performance. In some cases, you can identify forward-looking statements by terminology such as “may”, “will”, “should”, “expects”, “plans”, “anticipates”, “believes”, “estimates”, “predicts”, “potential” or “continue” or the negative of these terms or other comparable terminology. These statements are only predictions and involve known and unknown risks, uncertainties and other factors, including the risks in the section entitled “Risk Factors”, that may cause our or our industry’s actual results, levels of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied by these forward-looking statements.
Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. Except as required by applicable law, including the securities laws of the United States, we do not intend to update any of the forward-looking statements to conform these statements to actual results.
Our financial statements are stated in United States Dollars and are prepared in accordance with United States Generally Accepted Accounting Principles. In this quarterly report, unless otherwise specified, all dollar amounts are expressed in United States Dollars.
As used in this quarterly report, the terms “we”, “us”, “our”, “SNMD”, and “the Company” mean Sun New Media, Inc. and its wholly-owned subsidiaries Sun New Media Group Limited, Sun Global Marketing Network Limited, SE Global Equity Inc, and SE Global Capital, Inc. unless otherwise indicated.
Item 1. Condensed Consolidated Financial Statements
Sun New Media, Inc.
Condensed Consolidated Financial Statements
December 31, 2006
(Unaudited)
(Expressed In United States Dollars)
Condensed Consolidated Balance Sheets
Condensed Consolidated Statement of Operations
Condensed Consolidated Statement of Cash Flows
Notes to Condensed Consolidated Financial Statements
3
SUN NEW MEDIA INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
As of December 31, 2006 and March 31, 2006
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| (Unaudited) |
| (Audited) |
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| December |
| March 31, 2006 |
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| US$’000 |
| US$’000 |
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ASSETS |
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Current Assets |
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Cash and bank balances |
| 1,590 |
| 1,374 |
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Accounts receivables, net of provision for doubtful debts $69,281 (Mar 31, 2006: $72,046) |
| 7,831 |
| 416 |
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Other receivables, prepayments and deposits |
| 1,938 |
| 466 |
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Inventories |
| 318 |
| 85 |
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Marketable securities |
| 15,765 |
| 8,140 |
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Amounts due from stockholders |
| 409 |
| 292 |
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Amounts due from related parties |
| 746 |
| 893 |
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Total current assets |
| 28,597 |
| 11,666 |
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Investment in affiliate |
| 241 |
| 25 |
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Goodwill and intangible assets |
| 35,597 |
| 61,795 |
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Plant and equipment |
| 5,516 |
| 2,205 |
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Clearing broker deposit |
| — |
| 37 |
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Total Assets |
| 69,951 |
| 75,728 |
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LIABILITIES AND STOCKHOLDERS’ EQUITY |
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Current Liabilities |
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Accounts payable |
| 1,009 |
| 987 |
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Other payables and accruals |
| 2,686 |
| 6,928 |
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Amounts due to related parties |
| — |
| 489 |
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Factoring loan |
| 185 |
| 233 |
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Income taxes payable |
| 286 |
| — |
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Total current liabilities |
| 4,166 |
| 8,637 |
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Minority interest |
| 1,286 |
| (102 | ) |
Convertible notes |
| — |
| 2,816 |
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Discount on warrants |
| — |
| (2,570 | ) |
Commitments and Contingencies (Note 16) |
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STOCKHOLDERS’ EQUITY |
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Common stock; authorized 750,000,000 shares, US$0.01 par value |
| — |
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Preference stock, authorized 250,000,000 shares, US$0.01 par value |
| — |
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90,153,628/ 84,055,510 shares of common stock issued and outstanding, US$0.01 par value |
| 902 |
| 841 |
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1,321,859/ 14,537,253 shares of common stock reserved to be issued, US$0.01 par value |
| 13 |
| 145 |
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Additional paid in capital |
| 94,859 |
| 79,439 |
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Accumulated other comprehensive (loss) income: |
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Unrealized loss on marketable securities |
| (9,186 | ) | — |
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Foreign currency translation adjustments |
| (2 | ) | 2 |
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Deficit |
| (22,087 | ) | (13,480 | ) |
Total stockholders’ equity |
| 64,499 |
| 66,947 |
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Total liabilities and stockholder’s equity |
| 69,951 |
| 75,728 |
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The accompanying notes are an integral part of these consolidated financial statements.
4
SUN NEW MEDIA INC.
CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS (UNAUDITED)
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| Three months ended |
| Nine months ended |
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| 2006 |
| 2005 |
| 2006 |
| 2005 (1) |
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| US$’000 |
| US$’000 |
| US$’000 |
| US$’000 |
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Revenues |
| 3,951 |
| 182 |
| 18,937 |
| 209 |
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Costs of revenue |
| 2,058 |
| 92 |
| 4,669 |
| 111 |
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Gross Profit |
| 1,893 |
| 90 |
| 14,268 |
| 98 |
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Operating Expenses |
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General and administrative |
| 1,516 |
| 263 |
| 4,901 |
| 280 |
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Marketing and sales |
| 69 |
| — |
| 179 |
| — |
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Depreciation and amortization |
| 665 |
| — |
| 1,980 |
| — |
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Stock-based compensation |
| — |
| — |
| 1,965 |
| — |
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Repurchase of stock grant |
| (537 | ) | — |
| (6,312 | ) | — |
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Consulting and professional fees |
| 306 |
| 196 |
| 1,311 |
| 228 |
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Finders’ fee |
| — |
| — |
| — |
| 55 |
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Impairment loss on intangible assets |
| 26,571 |
| — |
| 26,571 |
| — |
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Total operating expenses |
| 28,590 |
| 459 |
| 30,595 |
| 563 |
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Operating loss from continuing operations |
| (26,697 | ) | (369 | ) | (16,327 | ) | (465 | ) |
Loss from discontinued operations |
| — |
| — |
| (43 | ) | — |
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Interest expense |
| (5 | ) | — |
| (91 | ) | — |
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Amortization of discount on notes |
| — |
| — |
| (2,570 | ) | — |
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Interest income |
| 16 |
| — |
| 41 |
| — |
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Other income |
| 38 |
| 7 |
| 10,941 |
| 7 |
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Share of (losses) profits from affiliate |
| (85 | ) | — |
| 216 |
| — |
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Loss before income tax expense and minority interests |
| (26,733 | ) | (362 | ) | (7,833 | ) | (458 | ) |
Income tax expenses |
| (54 | ) | — |
| (237 | ) | — |
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Loss after income tax expense and before minority interests |
| (26,787 | ) | (362 | ) | (8,070 | ) | (458 | ) |
Minority interests |
| (67 | ) | — |
| (513 | ) | — |
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Loss after income tax expense and minority interests |
| (26,854 | ) | (362 | ) | (8,583 | ) | (458 | ) |
Other comprehensive loss – Currency translation adjustment |
| (5 | ) | — |
| (24 | ) | — |
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Net Loss |
| (26,859 | ) | (362 | ) | (8,607 | ) | (458 | ) |
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Basic loss per share |
| (0.27 | ) | (0.01 | ) | (0.08 | ) | (0.01 | ) |
Shares used in computing basic loss per share (‘000) |
| 99,630 |
| 64,516 |
| 101,820 |
| 41,397 |
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Diluted net loss per share |
| (0.27 | ) | (0.01 | ) | (0.06 | ) | (0.01 | ) |
Shares used in computing basic (loss) per share (‘000) |
| 99,630 |
| 64,516 |
| 101,820 |
| 41,397 |
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(1) Information is presented for the period from June 6, 2005 (date of commencement of operations) to December 31, 2005. The Company changed its financial year end from September 30 to March 31 on February 17, 2006.
The accompanying notes are an integral part of these consolidated financial statements.
5
SUN NEW MEDIA INC.
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS (UNAUDITED)
|
| Nine months ended |
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| 2006 |
| 2005 (1) |
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| US$’000 |
| US$’000 |
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Cash flows from operating activities |
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Net loss for the period before income taxes and minority interests |
| (7,833 | ) | (458 | ) |
Adjustments to reconcile net income (loss) to net cash used in operating activities; |
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Depreciation and amortization |
| 1,980 |
| — |
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Impairment loss on intangible assets |
| 26,571 |
| — |
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Share of profits from affiliate |
| (216 | ) | — |
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Gain on disposal of assets |
| (10,743 | ) | — |
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Gain on disposal of subsidiary companies |
| (74 | ) | — |
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Consultancy services |
| 150 |
| — |
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Stock-based compensation |
| 1,965 |
| — |
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Repurchase of stock grant* |
| (6,312 | ) | — |
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Finders’ fee |
| (1,600 | ) | 55 |
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Amortization of discount on notes |
| 2,570 |
| — |
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Changes in operating assets and liabilities: |
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Accounts receivable |
| (8,769 | ) | (51 | ) |
Other debtor, deposits and prepayments |
| (477 | ) | (354 | ) |
Inventories |
| 280 |
| — |
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Amounts due from related parties |
| 147 |
| (3 | ) |
Amounts due from stockholders |
| (117 | ) | 160 |
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Accounts payable |
| (892 | ) | 25 |
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Other payables and accruals |
| (35 | ) | 414 |
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Amounts due to related parties |
| (489 | ) | 1 |
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Net cash used in operating activities |
| (3,894 | ) | (211 | ) |
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Cash flows from investing activities |
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Proceeds from sale of plant and equipment |
| 467 |
| — |
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Purchase of plant and equipment |
| (2,300 | ) | (2 | ) |
Cash (used in)/ acquired in business combination, net |
| (2,224 | ) | 50 |
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Disposal of subsidiary companies, net |
| 23 |
| — |
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Capitalization of intangible assets |
| (384 | ) | — |
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Net cash used in investing activities |
| (4,418 | ) | 48 |
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Cash flows from financing activities |
|
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Issuance of common stock |
| 9,431 |
| 373 |
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Proceeds from convertible note |
| — |
| 918 |
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Expenses incurred on issuance of common stocks |
| (875 | ) | — |
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Repayment of factoring loans |
| (48 | ) | — |
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Net cash provided by financing activities |
| 8,508 |
| 1,291 |
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Net effect of exchange rate changes on consolidating subsidiaries |
| 20 |
| — |
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Net increase in cash and cash equivalents |
| 216 |
| 1,128 |
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Cash and cash equivalents, beginning of the period |
| 1,374 |
| — |
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Cash and cash equivalents, end of the period |
| 1,590 |
| 1,128 |
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* During the three months ended December 31, 2006, there was a repurchase of stock grant at no consideration which resulted in gain of $537,000 relating to stock options granted to Independent Directors. In addition, for the nine months ended December 31, 2006, there was a repurchase of stock grant at no consideration which resulted in gain of $5.8 million relating to 1.5 million performance shares that were granted and accrued for during the fiscal period ended March 31, 2006.
(1) Information is presented for the period from June 6, 2005 (date of commencement of operations) to December 31, 2005. The Company changed its year end from September 30 to March 31 on February 17, 2006.
The accompanying notes are an integral part of these consolidated financial statements.
6
SUN NEW MEDIA INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
1. NATURE OF OPERATIONS AND BASIS OF PRESENTATION
Sun New Media’s principal business activities are (i) provision of business-to-business interactive marketing and information services; and (ii) provision of e-solutions and online platform to better manage distribution networks by industry, and provision of turnkey management solutions as integral parts of our transactional services.
Our activities are based predominantly in People’s Republic of China (“PRC”).
Sun New Media Inc, a Minnesota corporation, and each of its subsidiaries are collectively referred to herein as the “Company” or “SNMD”.
Our principal operating subsidiaries include the following:
· Sun New Media Group Limited;
· Sun Global Marketing Network Limited;
· China Focus Channel Development (HK) Limited;
· China Tradex Limited;
· Sun New Media Holdings Limited;
· William Brand Administer Limited;
· Beijing Trans Global Logistics; and
· Lifestyle Magazines Publishing Pte Ltd.
2. SUMMARY OF THE COMPANY’S SIGNIFICANT ACCOUNTING POLICIES
Basis of Consolidation and Presentation
The consolidated financial statements include the accounts of the Company, its subsidiaries and variable interest entities, or VIEs for which the Company is the primary beneficiary. All significant inter-company accounts and transactions have been eliminated. Investments in entities in which the Company can exercise significant influence, but which are less than majority owned and not otherwise controlled by the Company, are accounted for under the equity method. The Company has adopted FASB Interpretation No. 46R consolidation of Variable Interest Entities, FIN 46R, an Interpretation of Accounting Research Bulletin No. 51. FIN 46R requires a VIE to be consolidated by a company if that company is subject to a majority of the risk of loss for the VIEs or is entitled to receive a majority of the VIE’s residual returns.The consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States.
We have the following significant domestic VIEs:
· Sun China Media (Beijing) Technology Co., Ltd., a PRC company controlled through us by contract and is owned equally by Qiong Zhou and Jacob Di, both of whom are non-executive employees of the Company.
· Suizhou Focus Trading Development Co., Ltd., a PRC company controlled by us by contract and is engaged in marketing, information and technology services to beverage and electronic device distributors. It is 60% owned by Qi Yang, one of our officers and 25% and 15% owned by Bingwei Wu and Quanyi Mao respectively, two non-executive employees of the Company.
· Shanghai Shengji Technology Co., Ltd, a PRC company controlled by us by contract, and is engaged in wireless mobile services. It is 40% owned by Hui Yan, 40% owned by Min Lin and 20% owned by Kezhou Luan, each a non-executive employee of the Company.
· Sun China Media (Beijing) International Advertising Co. Ltd, a China company controlled by us by contract which is engaged in the advertising business. It is 70% owned by Qiong Zhou, and 30% owned by Guosheng Wang, both of whom are non-executive employees of the Company.
· Dragon List Co. Ltd, a China company controlled by us by contract and is engaged in digital publishing business. It is 70% owned by Qiong Zhou, and 30% owned by Jacob Di, both of whom are non-executive employees of the Company.
7
SUN NEW MEDIA INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
2. SUMMARY OF THE COMPANY’S SIGNIFICANT ACCOUNTING POLICIES (CONT’D)
· Sun Trade Media (Beijing) Co. Ltd, a China company controlled by us by contract and is engaged in digital publishing business. It is 70% owned by Qiong Zhou, and 30% owned by Jacob Di, both of whom are non-executive employees of the Company.
· Sun Asia (Beijing) Investments Consultants Ltd, a company controlled by us by contract and is engaged in the provision of consultancy services. It is 60% owned by Qiong Zhou, and 40% owned by Xiaoang Li, both of whom are non-executive employees of the Company.
· Sun New Media Technology (Beijing) Co. Ltd, a company controlled by us by contract and is engaged in software development. It is 70% owned by Qiong Zhou, and 30% owned by Jacob Di, both of whom are non-executive employees of the Company.
· Wuhan Xinda Weiye Trade and Development Co. Ltd, a company controlled by us by contract and engaged in trading. It is 40% owned by Jin Liu, 30% owned by Wanzhi Zhu and 30% owned by Mingde Jiang, all of whom are non-executive employees of the Company.
· Beijing Trans Global Logistics, a company 80% by us by contract and engaged in trading. It is 80% owned by Qiong Zhou, 10% owned by Yong Li and 10% owned by Mianchun Wang, Qiong Zhou is a non-executive employees of the Company.
The capital investment in these VIEs is funded by the Company and registered as interest-free loans to these PRC employees. As of December 31, 2006, the total amount of interest-free loans to the employee shareholders of the VIEs listed above was US$3,270,000. Under various contractual agreements, employee shareholders of the VIEs are required to transfer their ownership in these entities to our subsidiaries in China when permitted by PRC laws and regulations or to our designees at any time for the amount of outstanding loans, and all voting rights of the VIEs are assigned to us. We have the power to appoint all directors and senior management personnel of the VIEs. Through our wholly-owned subsidiaries in China, we have also entered into exclusive technical agreements and other service agreements with the VIEs, under which these subsidiaries provide technical services.
Use of estimates
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amount of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amount of revenue and expenses for the periods that the financial statements are prepared. Actual amounts could differ from these estimates.
Financial instruments
The Company’s financial instruments include cash and cash equivalents, accounts receivable and payable. The fair values of these financial instruments approximate their carrying values due to the short-term maturity of the instruments.
Business combinations
The Company accounts for its business combinations using the purchase method of accounting. This method requires that the acquisition cost to be allocated to the assets and liabilities the Company acquired based on their fair values. The Company makes estimates and judgments in determining the fair value of the acquired assets and liabilities, based on independent appraisal reports for material purchases as well as its experience with similar assets and liabilities in similar industries. If different judgments or assumptions were used, the amounts assigned to the individual acquired assets or liabilities could be materially different. When considering whether an acquired assets group constitutes a business, the Company used the criteria defined by EITF 98-3 determining Whether a Non-monetary Transaction Involves Receipt of Productive Assets or of a Business.
8
SUN NEW MEDIA INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
2. SUMMARY OF THE COMPANY’S SIGNIFICANT ACCOUNTING POLICIES (CONT’D)
Goodwill and intangible assets, net
Goodwill represents the excess of the purchase price over the fair value of the identifiable assets and liabilities acquired as a result of the Company’s acquisitions of interests in its subsidiaries and VIEs. Under Statement of Financial Accounting Standards, FAS No. 142, Goodwill and Other Intangible Assets, FAS 142, goodwill is no longer amortized, but tested for impairment upon first adoption and annually, thereafter, or more frequently if events or changes in circumstances indicate that it might be impaired. The Company assesses goodwill for impairment periodically in accordance with SFAS 142.
The Company applies the criteria specified in SFAS No. 141, Business Combinations to determine whether an intangible asset should be recognized separately from goodwill. Intangible assets acquired through business acquisitions are recognized as assets separate from goodwill if they satisfy either the contractual-legal or separability criterion. Per SFAS 142, intangible assets with definite lives are amortized over their estimated useful life and reviewed for impairment in accordance with SFAS No. 144, accounting for the Impairment or Disposal of Long-lived Assets. The Company reviews the amortization methods and estimated useful lives of intangible assets at least annually or when events or changes in circumstances indicate that it might be impaired. The recoverability of an intangible asset to be held and used is evaluated by comparing the carrying amount of the intangible asset to its future net undiscounted cash flows. If the intangible asset is considered to be impaired, the impairment loss is measured as the amount by which the carrying amount of the intangible asset exceeds the fair value of the intangible asset, calculated using a discounted future cash flow analysis. The Company uses estimates and judgments in its impairment tests, and if different estimates or judgments had been utilized, the timing or the amount of the impairment charges could be different.
Inventories
Inventories are stated at the lower of cost (first-in, first out method) or market. Certain inventory goods purchased are subject to spoilage within a short period of time while in possession of the Company. Inventory costs do not exceed net realizable value.
Plant and equipment
Plant and equipment are stated at cost, net of depreciation. Depreciation is computed primarily on the straight-line method for financial reporting purposes over the following estimated useful lives:
| Years |
| |
Furniture, fixtures and equipment |
| 3 - 5 |
|
Motor vehicles |
| 5 |
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Leasehold buildings and improvements |
| 5 - 30 |
|
Revenue recognition
We earn revenue from provision of marketing, information and transactional services and sales of channel management software. The Company recognizes revenues from transaction and information services in accordance with Staff Accounting Bulletin (“SAB”) No. 104, “Revenue Recognition,” when all of the following conditions exist: persuasive evidence of an arrangement exists in the form of an accepted purchase order; delivery has occurred, based on shipping terms, or services have been rendered; the Company’s price to the buyer is fixed or determinable, as documented on the accepted purchase order; and collectibility is reasonably assured.
9
SUN NEW MEDIA INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
2. SUMMARY OF THE COMPANY’S SIGNIFICANT ACCOUNTING POLICIES (CONT’D)
Revenue recognition (cont’d)
The Company accounts for software sales in accordance with American Institute of Certified Public Accountants Statement of Position (“SOP”) 97-2, Software Revenue Recognition. The application of SOP 97-2 requires judgment, including whether a software arrangement includes multiple elements, and if so, whether vendor-specific objective evidence (“VSOE”) of fair value exists for those elements. Customers receive certain elements of our products over a period of time. Judgment is also required to assess whether future releases represent new products or upgrades and enhancements to existing products.
Cost of revenues
Cost of revenues includes the cost of product, salary and other related costs for our management services and technical support staff, as well as third-party contractor expenses. Additionally cost of revenues includes fees for hosting facilities, bandwidth costs, and equipment and related depreciation costs. Cost of revenues will vary significantly from period to period depending on whether we will take title of the product and the level of management services provided.
Earnings (loss) per share
Basic earnings (loss) per share includes no dilution and is computed by dividing income (loss) available to common stockholders by the weighted average number of common shares outstanding for the year. Diluted net earnings (loss) per share reflects the potential dilution of securities that could share in income (loss) of the Company.
Foreign currency transactions
The financial statements are presented in United States dollars. In accordance with Statement of Financial Accounting Standards (“SFAS”) No. 52, “Foreign Currency Translation”, since the functional currency of the Company is Renminbi, the foreign currency financial statements of the Company’s subsidiaries are re-measured into U.S. dollars. Monetary assets and liabilities are re-measured using the foreign rate that prevailed at the balance sheet date. Revenue and expenses are translated at weighted average rates of exchange during the year and stockholders’ equity accounts and capital asset accounts are translated by using historical exchange rates. Any re-measurement gain or loss incurred is reported in the consolidated statement of operations.
Income taxes
The Company follows the liability method of accounting for income taxes in accordance with SFAS No. 109. Under this method, future tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax balances. Future tax assets and liabilities are measured using enacted or substantially enacted tax rates expected to apply to the taxable income in the years in which those differences are expected to be recovered or settled. The effect on future tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the date of enactment or substantive enactment. A valuation allowance is provided for deferred tax assets if it is more likely than not that the Company will not realize the future benefit, or if the future deductibility is uncertain.
10
SUN NEW MEDIA INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
2. SUMMARY OF THE COMPANY’S SIGNIFICANT ACCOUNTING POLICIES (CONT’D)
Stock-based compensation
Effective January 1, 2006, the company adopted SFAS No. 123 (revised 2004), “Share Based Payment,” (“SFAS No. 123(R)”) which revises SFAS No. 123 and supersedes APB 25. SFAS No. 123(R) requires that all share-based payments to employees be recognized in the financial statements based on their fair values at the date of grant. The calculated fair value is recognized as expense (net of any capitalization) over the requisite service period, net of estimated forfeitures, using the straight-line method under SFAS No. 123(R). The Company considers many factors when estimating expected forfeitures, including types of awards, employee class and historical experience. The statement was adopted using the modified prospective method of application which requires compensation expense to be recognized in the financial statements for all unvested stock options beginning in the quarter of adoption. There were no unvested stock options at the beginning of this reporting period therefore no compensation expense was recognized in the period. No adjustments to prior periods have been made as a result of adopting SFAS No. 123(R).
As at September 30, 2005 the Company elected to account for stock-based employee compensation arrangements in accordance with the provisions of Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees”, (“APB No. 25”) and comply with the disclosure provisions of SFAS No. 123 as amended by SFAS No. 148. During the period from September 18, 2005 to September 30, 2005, no stock-based employee compensation arrangements have been effected and accordingly no disclosure of pro forma information is required. In accordance with SFAS No. 123 the Company applies the fair value method using the Black-Scholes option-pricing model in accounting for options granted to consultants.
The Company accounts for equity instruments issued in exchange for the receipt of goods or services from other than employees in accordance with SFAS No. 123 and the conclusions reached by the Emerging Issues Task Force in Issue No. 96-18, “Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring or in Conjunction with Selling Goods or Services” (“EITF 96-18”). Costs are measured at the estimated fair market value of the consideration received or the estimated fair value of the equity instruments issued, whichever is more reliably measurable. The value of equity instruments issued for consideration other than employee services is determined on the earlier of a performance commitment or completion of performance by the provider of goods or services as defined by EITF 96-18.
Recently Issued Accounting Pronouncements
In November 2004, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 151, “Inventory Costs”, which clarifies the accounting for abnormal amounts of idle facility expense, freight, handling costs, and wasted material. SFAS No. 151 will be effective for inventory costs incurred during fiscal years beginning after June 15, 2005. We do not believe the adoption of SFAS No. 151 will have a material impact on our consolidated financial statements.
In December 2004, the FASB issued SFAS No. 123R, “Share-Based Payment”, which requires that the compensation cost relating to share-based payment transactions (including the cost of all employee stock options) be recognized in the financial statements. The cost will be measured based on the estimate fair value of the equity or liability instruments issued. SFAS 123-R covers a wide range of share-based compensation arrangements including share options, restricted share plans, performance-based awards, share appreciation rights, and employee share purchase plans. Management believes the adoption of this pronouncement will not have a material effect on our consolidated financial statements.
11
SUN NEW MEDIA INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
2. SUMMARY OF THE COMPANY’S SIGNIFICANT ACCOUNTING POLICIES (CONT’D)
Recently Issued Accounting Pronouncements (cont’d)
Also, in December 2004, the FASB issued SFAS 153, “Exchanges of Non-monetary Assets, an amendment of APB Opinion No. 29, Accounting for Non-monetary Transactions”. The amendments made by SFAS No. 153 are based on the principle that the exchange of non-monetary assets should be measured using the estimated fair market value of the assets exchanged. SFAS No. 153 eliminates the narrow exception for non-monetary exchanges of similar productive assets, and replaces it with a broader exception for exchanges of non-monetary assets do not have commercial substance. A non-monetary exchange has “commercial substance” if the future cash flows of the entity are expected to change significantly as a result of the transaction. This pronouncement is effective for monetary exchanges in fiscal periods beginning after June 15, 2005. Management believes the adoption of this pronouncement will not have a material effect on our consolidated financial statements.
In March 2005, the FASB issued FASB Interpretation No. 47 (“FIN 47”), “Accounting for Conditional Asset Retirement Obligations”. FIN 47 clarifies that the term “conditional asset retirement obligation,” which as used in SFAS No. 143, “Accounting for Asset Retirement Obligations”, refers to a legal obligation to perform an asset retirement activity in which the timing and (or) method of settlement are conditional on a future event that may or may not be within the control of the entity. The entity must record a liability for a “conditional” asset retirement obligation if the fair value of the obligation can be reasonably estimated. FIN 47 also clarifies when an entity would have sufficient information to reasonably estimate the fair value of an asset retirement obligation. FIN 47 is effective no later than the end of fiscal years ending after December 15, 2005. Management believes the adoption of this statement does not have an immediate material impact on the consolidated financial statements of the Company.
In May 2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections”. This statement requires entities that voluntarily make a change in accounting principle to apply that change retrospectively to prior periods’ financial statements, unless this would be impracticable. SFAS No. 154 supersedes APB Opinion No. 20, “Accounting Changes”, which previously required that most voluntary changes in accounting principle be recognized by including in the current period’s net income the cumulative effect of changing to the new accounting principle. SFAS No. 154 also makes a distinction between “retrospective application” of an accounting principle and the “restatement” of financial statements to reflect the correction of an error. SFAS No. 154 applies to accounting changes and error corrections that are made in fiscal years beginning after December 15, 2005. Management believes the adoption of this statement will not have an immediate material impact on the consolidated financial statements of the Company.
The adoption of EITF Issue No. 03-13, “Applying the Conditions in Paragraph 42 of FASB Statement No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, in Determining Whether to Report Discontinued Operations” in the first quarter of 2005 did not have a material impact on the Company’s results of operations and financial condition.
In October 2005, the FASB issued FSP FAS 123(R)-2, “Practical Accommodation to the Application of Grant Date as Defined in FASB Statement No. 123(R)”, which provides clarification of the concept of mutual understanding between employer and employee with respect to the grant date of a share-based payment award. This FSP provides that a mutual understanding of the key terms and conditions of an award shall be presumed to exist on the date the award is approved by management if the recipient does not have the ability to negotiate the key terms and conditions of the award and those key terms and conditions will be communicated to the individual recipient within a relatively short time period after the date of approval. This guidance shall be applied upon initial adoption of SFAS 123R. The Company does not expect the adoption of the FSP will have a material impact on its consolidated results of operations and financial condition.
12
SUN NEW MEDIA INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
2. SUMMARY OF THE COMPANY’S SIGNIFICANT ACCOUNTING POLICIES (CONT’D)
Recently Issued Accounting Pronouncements (cont’d)
In November 2005, the FASB issued FSP FAS 123(R)-3, “Transition Election Related to Accounting for the Tax Effects of Share-Based Payment Awards”, which provides a practical transition election related to accounting for the tax effects of share-based payment awards to employees. An entity must follow either the transition guidance for the APIC pool in SFAS 123R or the alternative transition method described in the FSP. The alternative method comprises a computational component that establishes a beginning balance of the APIC pool and a simplified method to determine the subsequent impact on the APIC pool of awards that are fully vested and outstanding upon the adoption of SFAS 123R. The impact on the APIC pool of awards partially vested upon, or granted after, the adoption of SFAS 123R should be determined in accordance with the guidance in that statement. The FSP was effective November 10, 2005. As described in the FSP, an entity will be permitted to take up to one year to determine its transition alternatives to make its one-time election. The Company does not expect the adoption of the FSP will have a material impact on its consolidated results of operations and financial condition.
In February 2006, the FASB issued SFAS No. 155, “Accounting for Certain Hybrid Financial Instruments-an amendment of FASB Statements No. 133 and 140.” SFAS No. 155 amends SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities” to permit fair value remeasurement for any hybrid financial instrument with an embedded derivative that otherwise would require bifurcation, provided that the whole instrument is accounted for on a fair value basis. SFAS No. 155 amends SFAS No. 140, “Accounting for the Impairment or Disposal of Long-Lived Assets”, to allow a qualifying special-purpose entity (“SPE”) to hold a derivative financial instrument that pertains to a beneficial interest other than another derivative financial instrument. SFAS No. 155 applies to all financial instruments acquired or issued after the beginning of an entity’s first fiscal year that begins after September 15, 2006, with earlier application allowed. The Company does not expect the adoption of SFAS No. 155 to have a material impact on its consolidated results of operations and financial condition.
In March 2006, the FASB issued SFAS No. 156, “Accounting for Servicing of Financial Assets-an amendment of FASB Statement No. 140.” SFAS No. 156 requires that all separately recognized servicing rights be initially measured at fair value, if practicable. In addition, this Statement permits an entity to choose between two measurement methods (amortization method or fair value measurement method) for each class of separately recognized servicing assets and liabilities. This new accounting standard is effective January 1, 2007. The adoption of SFAS 156 is expected to have no material impact on our financial statements.
Other recent accounting pronouncements issued by the FASB (including its Emerging Issues Task Force), the AICPA, and the SEC did not or are not believed by management to have a material impact on the Company’s present or future consolidated financial statements.
Related Parties
Parties are considered to be related if one party has the ability, directly or indirectly, to control the other party, or exercise significant influence over the other party in making financial and operating decisions. Parties are also considered to be related if they are subject to common control or common significant influence.
Deferred Expenses
Payments made for future expenses were amortized over the life of service received.
13
SUN NEW MEDIA INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
2. SUMMARY OF THE COMPANY’S SIGNIFICANT ACCOUNTING POLICIES (CONT’D)
Marketable securities
The Company accounts for investments in marketable securities under Statement of Financial Accounting Standards (SFAS) No. 115, Accounting for Certain Investments in Debt and Equity Securities. Marketable equity securities are held as available for sale and are reported at fair value any unrealized gains and losses are included in accumulated other comprehensive income or loss within stockholders’ equity. The treatment of a decline in the fair value of an individual security is based on whether the decline is other-than-temporary. Significant judgment is required to assess whether the impairment is other-than-temporary, particularly for marketable equity securities that provide limited public information. Our judgment of whether impairment is other-than-temporary is based on an assessment of factors including our ability and intent to hold the individual security, severity of the impairment, expected duration of the impairment and forecasted recovery of fair value. Changes in the estimates and assumptions could affect our judgment of whether an identified impairment should be recorded as an unrealized loss in the equity section of our consolidated balance sheets or as a realized loss in the consolidated statements of operations.
3 CONCENTRATIONS AND CREDIT RISK
The Company operates principally in China and grants credit to its customers in this geographic region. Although China is considered economically stable, it is always possible that unanticipated events in foreign countries could disrupt the Company’s operations.
At December 31, 2006, the Company has a credit risk exposure of uninsured cash in banks of $1.59 million. The Company does not require collateral or other securities to support financial instruments that are subject to credit risk.
For the nine months ended December 31, 2006, 4 customers accounted for $14.9 million (79%) of total sales as follows:Customer A at $8.1 million (43%), Customer B at $1.6 million (8%), Customer C at $1 million (5%) and Customer D at $4.2 million (22%).
For the nine months ended December 31, 2005, there was no major concentration of credit risk.
4 INVENTORY
| December 31, |
| |
|
| US$’000 |
|
|
|
|
|
Work in progress |
| 104 |
|
Finished goods |
| 214 |
|
|
| 318 |
|
14
SUN NEW MEDIA INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
5 BUSINESS COMBINATIONS
Pursuant to FAS 141, paragraph 6, exchange transactions in which the consideration given is cash are measured by the amount of cash paid. However, if the consideration given is not in the form of cash (that is, in the form of non-cash assets, liabilities incurred, or equity interests issued), measurement is based on the fair value of the consideration given or the fair value of the asset (or net assets) acquired, whichever is more clearly evident and, thus, more reliably measurable.
The Company is a recently formed business with a very short history of operating and stock performance. At the time of completion of following acquisitions, the Company’s common stock was traded on the Over-the-Counter Bulletin Board (OTCBB) with a high volatility in both volume and price. Therefore management decided to use the discounted fair market value of the shares issued to measure our consideration when consideration is not in the form of cash.
Share Purchase Agreement between the Company, China Focus Channel Development Limited (“Focus”), China Electronic Appliances (“CEAC”), Mr Yong Li and Mr Mianchun Wang for the acquisition of Beijing Trans Global Logistics (“BTGL”) and its subsidiary, Beijing CEAC Trans Global Logistics (“BCTGL”) (BTGL and BCTGL collectively Beijing CEAC)
On October 19, 2006 we completed the acquisition of CEAC pursuant to a Sale and Purchase Agreement dated May 23, 2006 (the “CEAC Purchase Agreement”) by and between the Company, Focus, CEAC, Yong Li and Mianchun Wang and acquired an 80% controlling interest in BTGL. BTGL owns an 80% stake in BCTGL.
The consideration paid by the Company was US$1.125 million (RMB 9 million) in cash and 138,066 shares of the Company’s stocks. Pursuant to the CEAC Purchase Agreement, the sellers will receive an additional 138,066 of the Company’s stocks per year in each of the three years if Beijing CEAC meet the profit and revenue guarantee.
The purchase price was allocated as follows:
Cash |
| $ | 749,722 |
|
Current assets |
| 1,254,139 |
| |
Current liabilities |
| (911,698 | ) | |
Property, plant and equipment |
| 91,147 |
| |
Minority interest |
| (393,448 | ) | |
Goodwill on consolidation |
| 180,763 |
| |
Intangible assets |
| 675,899 |
| |
Purchase price |
| $ | 1,646,524 |
|
No proforma financials are required to be presented due to the materiality of the acquisition.
15
SUN NEW MEDIA INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
5 BUSINESS COMBINATIONS (CONT’D)
Share Purchase Agreement between the Company and Sun Media Investment Holdings Limited (“SMIH”) for the acquisition of Credential 114 Network Limited (“Credit 114”)
On July 21, 2006 we completed the acquisition of Credit 114 pursuant to a Sale and Purchase Agreement dated June 14, 2006 (the “Credit 114 Purchase Agreement”) by and between the Company and SMIH and acquired a 100% controlling interest in Credit 114.
The consideration paid by the Company was US$2.5 million cash.
The purchase price was allocated as follows:
Cash |
| $ | 1 |
|
Intangible assets |
| 2,499,999 |
| |
Purchase price |
| $ | 2,500,000 |
|
No proforma financials are required to be presented due to the materiality of the acquisition.
Share Purchase Agreement between the Company, China Focus Channel Development Limited (“Focus”) and Ren Huiliang for the acquisition of William Brand Administer Limited and its subsidiary William Textiles Limited (collectively “William Brand”)
On September 30, 2006 we completed the acquisition of William Brand pursuant to a Sale and Purchase Agreement dated June 8, 2006 (the “William Brand Purchase Agreement”) by and between the Company, (“Focus”) and Ren Huiliang and acquired a 100% controlling interest in William Brand. The company, Focus and Ren Huiliang agreed that the effective date of the acquisition will be July 1, 2006. William Brand is a China-based producer and distributor of women’s luxury apparel.
The consideration paid by the Company for the acquisition was satisfied through the issuance of 4,655,173 shares of the Company’s common stock. Pursuant to the William Brand Purchase Agreement, the shares are to be issued as follow:
· 1,165,793 shares on Completion;
· 1,165,793 shares to be issued if William Brand achieves a minimum of US$15 million revenue and US$3 million after-tax profits in Year 1;
· 1,165,793 shares to be issued if William Brand achieves a minimum of US$17.5 million revenue and US$3.5 million after-tax profits in Year 2; and
· 1,165,793 shares to be issued if William Brand achieves a minimum of US$20.0 million revenue and US$4.0 million after-tax profits in Year 3.
16
SUN NEW MEDIA INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
5 BUSINESS COMBINATIONS (CONT’D)
At the time of entering into the agreement on June 8, 2006, our common stock was traded on OTCBB with limited liquidity and a comparative short trading history. As such, the management decided to use the discounted fair market value of the shares issued to measure our consideration (the Company stock) paid. . The Company used independent valuation report as a guidance to record the intangibles arising from this transaction.
The purchase price was allocated as follows:
Cash |
| $ | 14,275 |
|
Current assets |
| 3,073,120 |
| |
Current liabilities |
| (1,865,294 | ) | |
Intangible assets |
| 2,904,709 |
| |
Purchase price |
| $ | 4,126,810 |
|
Proforma financials
The acquisition of all the issued and outstanding shares of William Brand is described as a “purchase acquisition”.
The accompanying pro forma condensed consolidated financial statements are provided for informational purposes only. The Pro Forma Consolidated Balance Sheet and Pro Forma Combined Statement of Operations are unaudited and are not necessarily indicative of the consolidated financial position which actually would have occurred if the above transaction had been consummated on September 30, nor does it purport to present the operating results that would be achieved for future periods.
The Unaudited Pro-Forma Consolidated Financial Statement reflect financial information which gives pro-forma effect to the acquisition of all the outstanding common shares of William Brand in exchange for 1,163,793 shares of common stock of the Company.
The acquisition is to be recorded as a purchase acquisition. The Pro Forma Consolidated Balance Sheet included herein reflects the use of the purchase method of accounting for the above transaction.
17
SUN NEW MEDIA INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
5 BUSINESS COMBINATIONS (CONT’D)
Unaudited Pro Forma Consolidated Balance Sheet
The acquisition was completed on September 30, 2006 and has been accounted for in the consolidated balance sheet presented in the Condensed Consolidated Balance Sheet as at September 30, 2006.
Unaudited Pro Forma Consolidated Statement of Operations
The Pro-Forma Combined Statement of Operations give effect to the above transaction as if it occurred on the earliest date of the period presented, i.e., April 1, 2006.
|
| (UNAUDITED) |
| (UNAUDITED) |
| ||||||
|
| SNMD |
| William Brand |
| Adjustments |
|
|
| William Brand |
|
|
| US$’000 |
| US$’000 |
| US$’000 |
| US$’000 |
| US$’000 |
|
REVENUES |
| 14,986 |
| 2,953 |
|
|
| 17,939 |
| 5,442 |
|
Cost of revenues |
| 2,611 |
| 2,352 |
|
|
| 4,963 |
| 3,137 |
|
Gross Profit |
| 12,375 |
| 601 |
|
|
| 12,976 |
| 2,305 |
|
|
|
|
|
|
|
|
|
|
|
|
|
OPERATING EXPENSES |
|
|
|
|
|
|
|
|
|
|
|
General and administrative |
| 3,385 |
| 304 |
|
|
| 3,689 |
| 338 |
|
Marketing and sales |
| 110 |
| — |
|
|
| 110 |
| — |
|
Depreciation and amortization |
| 1,315 |
| — |
| 242 | (1) | 1,557 |
| — |
|
Stock-based compensation |
| 1,965 |
| — |
|
|
| 1,965 |
| — |
|
Repurchase of stock grant |
| (5,775 | ) |
|
|
|
| (5,775 | ) |
|
|
Consulting and professional fees |
| 1,005 |
| — |
|
|
| 1,005 |
| — |
|
Total operating expenses |
| 2,005 |
| 304 |
|
|
| 2,551 |
| 338 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating income from continuing operations |
| 10,370 |
| 297 |
|
|
| 10,425 |
| 1,967 |
|
Loss from discontinued operations |
| (43 | ) | — |
|
|
| (43 | ) | — |
|
Interest expense |
| (86 | ) | — |
|
|
| (86 | ) | — |
|
Amortization of discount on notes |
| (2,570 | ) | — |
|
|
| (2,570 | ) | — |
|
Interest income |
| 25 |
| — |
|
|
| 25 |
| — |
|
Other income |
| 10,903 |
| — |
|
|
| 10,903 |
| — |
|
Share of profits from affiliates |
| 301 |
| — |
|
|
| 301 |
| — |
|
Income before income tax expense and minority interests |
| 18,900 |
| 297 |
|
|
| 18,955 |
| 1,967 |
|
Income tax expense |
| (183 | ) | — |
|
|
| (183 | ) | — |
|
Income after income tax expense and before minority interests |
| 18,717 |
| 297 |
|
|
| 18,772 |
| 1,967 |
|
Minority interests |
| (446 | ) | — |
|
|
| (446 | ) | — |
|
Income after income tax expense and minority interests |
| 18,271 |
| 297 |
|
|
| 18,326 |
| 1,967 |
|
Other comprehensive loss – Currency translation adjustment |
| (19 | ) | — |
|
|
| (19 | ) | — |
|
Net income |
| 18,252 |
| 297 |
|
|
| 18,307 |
| 1,967 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic net income per share |
| 0.18 |
|
|
|
|
| 0.18 |
|
|
|
Shares used in computing basic income per share (‘000) |
| 102,922 |
|
|
|
|
| 103,500 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted net income per share |
| 0.20 |
|
|
|
|
| 0.20 |
|
|
|
Shares used in computing diluted income per share (‘000) |
| 105,807 |
|
|
|
|
| 106,385 |
|
|
|
(1) Amortization for intangibles from Apr 1 to Jun 30, 2006.
(2) Information is presented for William Brand from Apr 1 to Sep 30, 2005 as it is not meaningful to present consolidated pro-forma financials since the Company commenced operations on June 6, 2005.
18
SUN NEW MEDIA INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
5 BUSINESS COMBINATIONS (CONT’D)
Share Purchase Agreement between the Company and SMIH
On September 3, 2006, pursuant to the Sale and Purchase agreement (the “SMIH Purchase Agreement”) dated April 20, 2006 between the Company and SMIH, the Company acquired a property, automobiles, program rights and 46,629,331 shares in Asia Premium Television Group Inc. The consideration paid by the Company for the acquisition is satisfied through the issuance of 850,647 shares of the Company’s common stock.
At the time of entering into the agreement on April 20, 2006, our common stock was traded on OTCBB with limited liquidity and short term trading history, while Asia Premium Television Group. Inc. has been traded on the OTCBB, for a comparably longer time, therefore management decided to use the discounted fair market value of the shares issued to measure our consideration (the Company stock) paid.
6 GOODWILL AND INTANGIBLE ASSETS, NET
The following table summarizes goodwill from the Company’s acquisitions:
| December 31, |
| March 31, |
| |
|
| US$’000 |
| US$’000 |
|
Focus |
| 7,800 |
| 7,800 |
|
Beijing CEAC |
| 181 |
| — |
|
Impairment loss |
| (7,800 | ) | — |
|
|
| 181 |
| 7,800 |
|
The following table summarizes intangible assets:
| December 31, |
| March 31, |
| |
|
| US$’000 |
| US$’000 |
|
Service agreements |
| 25,000 |
| 25,000 |
|
Magazines mastheads |
| 2,562 |
| 2,562 |
|
License |
| 23,245 |
| 24,452 |
|
Non-compete agreements and customer relationship |
| 2,904 |
| — |
|
Database |
| 2,500 |
| — |
|
Program rights |
| 1,792 |
| — |
|
Technology |
| 2,367 |
| 1,981 |
|
Partnership agreement & license |
| 1,056 |
| — |
|
|
| 61,426 |
| 53,995 |
|
Less: Accumulated amortization |
| (1,307 | ) | — |
|
: Impairment loss |
| (24,703 | ) | — |
|
|
| 35,416 |
| 53,995 |
|
The above intangible assets have original estimated useful lives as follow:
Service agreements |
| 30 years |
Non-compete agreements and customer relationship |
| 3 years |
Partnership agreements and license |
| 3 years |
Technology |
| 2 to 10 years |
Magazines mastheads, license and program rights have perpetual useful lives and thus are not amortized.
Please refer to the Company’s Annual Report on Form 10-KSB filed with the U.S. Securities and Exchange Commission on June 30, 2006, for more details on goodwill and intangible assets.
19
SUN NEW MEDIA INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
7. PLANT AND EQUIPMENT, NET
Plant and equipment is summarized as follows:
| December 31, |
| March 31, |
| |
|
| US$’000 |
| US$’000 |
|
Cost |
|
|
|
|
|
Motor vehicles |
| 552 |
| 124 |
|
Leasehold building and improvement |
| 3,130 |
| 1,401 |
|
Furniture, fixtures and equipments |
| 2,741 |
| 983 |
|
|
| 6,423 |
| 2,508 |
|
Accumulated depreciation |
| (907 | ) | (303 | ) |
|
| 5,516 |
| 2,205 |
|
8. OTHER RECEIVABLES, PREPAYMENTS AND DEPOSITS
Other receivables, prepayments and deposits are summarized as follow:
| December 31, |
| March 31, |
| |
|
| US$’000 |
| US$’000 |
|
|
|
|
|
|
|
Other receivables |
| 1,535 |
| 115 |
|
Staff advances |
| 35 |
| 34 |
|
Deferred expenses |
| 1 |
| 2 |
|
Rental deposits |
| 46 |
| 9 |
|
Prepaid administrative expenses |
| 321 |
| 306 |
|
|
| 1,938 |
| 466 |
|
Deferred expense represents a prepayment for management fees under a management agreement between the Company and Capital Alliance Group Inc. (“CAG”) which lasts for two years effective September 18, 2005. As part of the reverse acquisition transaction pursuant to which Sun Media Investment Holdings Limited acquired a controlling interest in the Company (the “Transaction”), the Company entered into a management agreement (“Management Agreement”) with CAG, a minority shareholder of the Company. Under the Management Agreement, CAG provides the Company with advisory services, which include general corporate, administrative, technical and management advisory services as is reasonably considered necessary or advisable by Company to achieve the goals and needs of the Company as determined by the policies and proceedings of management and the Board of Directors and the requirements of the Securities and Exchange Commission. The Company is required to issue 250,000 shares to CAG in return as consideration. The fair value of the Company’s Common Stock as of September 18, 2005 was US$0.01108.
20
SUN NEW MEDIA INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
9. AMOUNTS DUE FROM/ (TO) STOCKHOLDERS/ RELATED PARTIES
As of December 31, 2006, the Company has the following amounts due from related parties:
Advances due from
| December 31, |
| |
|
| US$’000 |
|
Related Parties |
|
|
|
Sun3C Media Plc and its subsidiaries |
| 134 |
|
Global Woman Multimedia Holdings Limited and its subsidiaries |
| 67 |
|
Sun Business Network Limited and its subsidiaries |
| 521 |
|
Sun Culture Foundation Limited |
| 24 |
|
|
| 746 |
|
Stockholders |
|
|
|
Capital Alliance Group Inc |
| 63 |
|
Sun Media Investment Holdings Limited and its subsidiaries |
| 346 |
|
|
| 409 |
|
The amounts are non-trade, interest free and with no fixed terms of repayment.
10. OTHER PAYABLES AND ACCRUALS
Other payables and accruals are summarized as follow:
| December 31, |
| March 31, |
| |
|
| US$’000 |
| US$’000 |
|
|
|
|
|
|
|
Other payables |
| 1,496 |
| 127 |
|
Accrued operating expenses |
| 927 |
| 6,727 |
|
Prepayment from customers |
| 263 |
| 74 |
|
|
| 2,686 |
| 6,928 |
|
Included in accrued operating expenses is an accrual of stock-based compensation payable to senior management of $0 (March 31, 2006: $5,775,000).
11. FACTORING LOAN
This relates to amount which has been obtained from a finance company under a factoring facility. Interest is charged at 1.5% per annum above the prevailing Singapore Inter-Bank offer rate. These loans are secured by a guarantee given by Sun Business Network Ltd, a related party and floating charge over accounts receivables amounting to $185,000 (March 31, 2006: $233,000).
21
SUN NEW MEDIA INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
12. CONVERTIBLE NOTES WITH DETACHABLE WARRANTS
Convertible Notes with Detachable Warrants
On December 31, 2005, when the per share market price of the Company’s stock was $4.09, the Company issued a $918,000 convertible note with detachable warrants to one accredited investor. The note is convertible into the Company’s common stock at the rate of $2.04 per share. On March 6, 2006, when the market price of the Company’s stock was $3.93, the Company issued a $1,898,000 convertible note with detachable warrants to the same accredited investor. The note is convertible into the Company’s common stock at the rate of $2.04 per share. Under the terms of the notes, the Company agreed to undertake certain obligations to file and maintain effective a registration statement for shares of the common stock underlying the notes.
In accordance with the guidelines of APB No. 14, “Accounting for Convertible Debt and Debt Issued with Stock Purchase Warrants”, EITF Issue No. 98-5, “Accounting for Convertible Securities with Beneficial Conversion Features or Contingently Adjustable Conversion Ratios” and EITF Issue No. 00-27, “Application of issue No. 98-5 to Certain Convertible Instruments”, the Company has determined that each of the above notes was issued with a beneficial conversion feature. The intrinsic value was calculated at the date of issue as the difference between the conversion price of the note and the fair value of the Company’s common stock into which the note was convertible, multiplied by the number of common shares into which the note was convertible, limited by the face amount of the note. The Company has treated the beneficial conversion features as a discount to the face amount of the notes and is amortizing them over the term of the respective notes. Upon conversion of all or a portion of the note, the proportionate share of unamortized discount has been charged to interest expense.
During the three months ended June 30, 2006, the convertible notes were fully converted to 1,380,392 shares of common stock.
Detachable Warrants
On December 31, 2005, and March 6, 2006 we issued warrants for the purchase of an aggregate of 11 million and 4 million shares respectively, of common stock to one accredited investor. The exercise price of the warrants ranges from $2.04 to $4.80.
During the three months ended June 30, 2006, warrants for 3,454,023 shares were exercised and the Company received net proceeds of $8.3 million.
13. INCOME TAXES
The Company is incorporated in the Minnesota, United States and has operations in the PRC, British Virgin Islands and the United States of America. The Company has incurred net accumulated operating losses for income tax purposes. The Company believes that it is more likely than not that these net accumulated operating losses will not be utilized in the future. Therefore, the Company has provided full valuation allowance for the deferred tax assets arising from the losses at these locations as of September 30, 2006.
The components of income before income taxes are as follows:
| Three months ended |
| Nine months ended |
| |||||
|
| 2006 |
| 2005 |
| 2006 |
| 2005 |
|
|
| US$’000 |
| US$’000 |
| US$’000 |
| US$’000 |
|
|
|
|
|
|
|
|
|
|
|
Loss subject to non-China operations |
| (26,177 | ) | (362 | ) | (6,407 | ) | (458 | ) |
Loss subject to China operations |
| (556 | ) | — |
| (1,426 | ) | — |
|
Loss before taxes |
| (26,733 | ) | (362 | ) | (7,833 | ) | (458 | ) |
Income taxes subject to China operations |
| 54 |
| — |
| 237 |
| — |
|
Effective tax rate for China operations |
| 10 | % | — |
| 30 | % | — |
|
22
SUN NEW MEDIA INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
13. INCOME TAXES (CONT’D)
Pursuant to the PRC Income Tax Laws, the Company’s subsidiaries and VIEs are generally subject to Enterprise Income Taxes, EIT, at a statutory rate of 33%, which comprises 30% national income tax and 3% local income tax. Some of these subsidiaries and VIEs are qualified new technology enterprises and under PRC Income Tax Laws, they are subject to a preferential tax rate of 15%. In addition, some of the Company’s subsidiaries are Foreign Investment Enterprises and under PRC Income Tax Laws, they are entitled to either a three-year tax exemption followed by three years with a 50% reduction in the tax rate, commencing the first operating year, or a two-year tax exemption followed by three years with a 50% reduction in the tax rate, commencing the first profitable year. The VIEs are wholly owned by the Company’s employees and controlled by the Company through various contractual agreements. To the extent that these VIEs have undistributed after-tax net income, the Company has to pay taxes on behalf of its employees when dividends are distributed from these local entities in the future. The dividend tax rate is 20%.
The provisions for income taxes for the three and nine months ended December 31, 2006 differ from the amounts computed by applying the EIT primarily due to the tax holidays enjoyed by certain of its entities in the British Virgin Islands and losses incurred by certain of the Company’s entities in the PRC.
14. NET LOSS PER SHARE
Basic net loss per share is computed using the weighted average number of the ordinary shares outstanding during the period. Diluted net loss per share is computed using the weighted average number of ordinary shares and ordinary share equivalents outstanding during the period. Options to purchase ordinary shares that were anti-dilutive and were excluded from the calculation of diluted net loss per share were 763,164 for both the three and nine months ended December 31, 2006 and were 461,000 for both the three months ended December 31, 2005 and for the period from June 6, 2005 to December 31, 2005. Warrants to purchase ordinary shares that were anti-dilutive and were excluded from the calculation of diluted net loss per share were approximately 12.1 million for both the three and nine months ended December 31, 2006 and were 11.0 million for both the three months ended December 31, 2005 and for the period from June 6, 2005 to December 31, 2005. Convertible notes into ordinary shares that were anti-dilutive and were excluded from the calculation of diluted net loss per share were 0 for both the three and nine months ended December 31, 2006 and 450,000 for the three months ended December 31, 2005 and for the period from June 6, 2005 to December 31, 2005.
The following table sets forth the computation of basic and diluted net loss per share for the periods indicated:
| Three months ended |
| Nine months ended |
| |||||
|
| 2006 |
| 2005 |
| 2006 |
| 2005 |
|
|
| (in thousands, except per share data) |
| ||||||
Basic net income per share calculation |
|
|
|
|
|
|
|
|
|
Numerator: |
|
|
|
|
|
|
|
|
|
Net loss used in computing basic net income per share |
| (26,859 | ) | (362 | ) | (8,607 | ) | (458 | ) |
Denominator: |
|
|
|
|
|
|
|
|
|
Weighted average ordinary shares outstanding |
| 99,630 |
| 64,516 |
| 101,820 |
| 41,397 |
|
Basic net loss per share |
| (0.27 | ) | (0.01 | ) | (0.08 | ) | (0.01 | ) |
Numerator: |
|
|
|
|
|
|
|
|
|
Net loss |
| (26,859 | ) | (362 | ) | (8,607 | ) | (458 | ) |
Amortization of discount on notes |
| — |
| — |
| 2,570 |
| — |
|
Interest on convertible notes |
| — |
| — |
| 77 |
| — |
|
Net loss used in computing diluted net loss per share |
| (26,859 | ) | (362 | ) | (5,960 | ) | (458 | ) |
Denominator: |
|
|
|
|
|
|
|
|
|
Weighted average ordinary shares outstanding |
| 99,630 |
| 64,516 |
| 101,820 |
| 41,397 |
|
Diluted net income per share |
| (0.27 | ) | (0.01 | ) | (0.06 | ) | (0.01 | ) |
23
SUN NEW MEDIA INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
15. STOCK-BASED COMPENSATION
The Company’s stock option program is a long-term retention program that is intended to attract, retain and incentivize talented employees, and to align stockholder and employee interests. The Company currently grant options pursuant to the 1) 2001 Stock Option Plan, 2) 2004 Stock Option Plan 3) 2006 Stock Option Plan.
2001 Stock Option Plan
Effective October 10, 2001, the Company adopted the 2001 Stock Option Plan (the “2001 Plan”) allowing for the awarding of options to acquire shares of common stock.
2004 Stock Option Plan
Effective January 22, 2004, the Company adopted the 2004 Stock Option Plan (the “2004 Plan”) allowing for the awarding of options to acquire shares of common stock.
2006 Stock Option Plan
In April 2006, the 2006 Stock Option Plan (the 2006 Plan) was approved by the Company’s Board of Directors. The purpose of the 2006 Plan is to reward employees, officers and directors and consultants and advisors to the Company who are expected to contribute to the growth and success of the Company. The 2006 Plan provides for the award of options to purchase shares of the Company’s common stock. Stock options granted under the 2006 Plan may be either incentive stock options or nonqualified stock options.
During the three months ended September 30, 2006, the Company granted 283,230 options to directors and 1,200,000 to the Company’s Chief Financial Officer. No stock awards were granted during the three months ended September 30, 2006.
During the three months ended December 31, 2006, the Company repurchased 226,584 options from directors at zero consideration. No stock awards were granted during the three months ended December 31, 2006.
Stock Compensation
Effective January 1, 2006, Company adopted SFAS 123R. See Note 2 for a description of the Company’s adoption of SFAS 123R. The fair value of stock-based compensation awards is determined using the Black-Scholes option pricing model, which is consistent with the valuation techniques previously utilized for options in footnote disclosures required under SFAS 123, as amended by FASB Statement No. 148, “Accounting for Stock-Based Compensation—Transition and Disclosure.” The determination of the fair value of stock-based compensation awards on the date of grant using an option-pricing model is affected by the Company’s stock price as well as assumptions regarding a number of complex and subjective variables, including the expected volatility of the Company’s stock price over the term of the awards, actual and projected employee stock option exercise behaviors, risk-free interest rate and expected dividends.
The assumptions used to value stock-based compensation awards for the three and nine months ended December 31, 2006 and 2005 are as follows:
| Three months ended |
| Nine months ended |
| |||||
|
| 2006 |
| 2005 |
| 2006 |
| 2005 |
|
|
| US$’000 |
| US$’000 |
| US$’000 |
| US$’000 |
|
Expected term (in years) |
| N/A |
| N/A |
| 5.0-5.4 |
| N/A |
|
Expected volatility |
| N/A |
| N/A |
| 69.7%-70% |
| N/A |
|
Risk-free interest rate |
| N/A |
| N/A |
| 4.85%-4.77% |
| N/A |
|
Expected dividend yield |
| N/A |
| N/A |
| 0 |
| N/A |
|
24
SUN NEW MEDIA INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
15. STOCK-BASED COMPENSATION (CONT’D)
Expected term represents the average of the expiration period and the vesting term. Expected volatilities are based on the weekly closing prices of the Company’s stock after the Company’s reverse takeover in September 18, 2005. Risk-free rate is based on US Treasury zero-coupon issues with remaining terms similar to the expected term on the stock-based awards. The Company does not anticipate paying any cash dividends in the foreseeable future. Forfeitures are estimated at the time of grant and revised in subsequent periods if actual forfeitures differ from those estimates. The Company uses historical data to estimate pre-vesting option forfeitures and record stock-based compensation expense only for those awards that are expected to vest.
Stock based compensation recognized on the Company’s Condensed Consolidated Statement of Operations for the three and nine months ended December 31, 2006 is 0 and $1,964,450 respectively.
As of December 31, 2006, there was $1.23 million of unrecognized compensation cost, adjusted for estimated forfeitures, related to non-vested stock-based awards granted to the Company’s employees. This cost is expected to be recognized over a period of 2 years. Total unrecognized compensation cost may be adjusted for future changes in estimated forfeitures.
The following table sets forth the summary of option activity under the Company’s stock option program for the six months ended December 31, 2006:
|
|
| Weighted |
| Weighted Average |
| |
|
|
|
| US$ |
| Years |
|
March 31, 2006 |
| 445,500 |
| 0.741 |
|
|
|
Exercise |
| (339,000 | ) | 0.74 |
|
|
|
Granted |
| 1,483,230 |
| 3.20 |
|
|
|
Cancelled |
| (226,584 | ) | 3.85 |
|
|
|
December 31, 2006 |
| 1,363,146 |
| 2.91 |
|
|
|
Vested and expected to vest as of December 31, 2006 |
| 763,146 |
| 2.80 |
| 9.17 |
|
Exercisable as of September 30, 2006 |
| 763,146 |
| 2.80 |
| 9.17 |
|
The weighted average estimated fair value of options granted during the three months and nine months ended December 31, 2006 was both $2.11.
Information regarding the stock options outstanding as at December 31, 2006 is summarized as below:
Exercise Price |
|
|
| Weighted Average |
|
|
| Weighted |
| |
|
|
|
| Years |
|
|
|
|
| |
$0.56 - $1.14 |
| 106,500 |
| 5.65 |
| 106,500 |
| $ | 0.84 |
|
$3.05 - $3.85 |
| 1,256,646 |
| 9.74 |
| 656,646 |
| $ | 1.63 |
|
2006 Stock Award
On September 18, 2006, the board awarded 20,000 shares of common stock to the Company’s Chief Financial Officer. The Company recorded $63,200 as stock-based compensation in the statement of operations.
On March 31, 2006, the board awarded 1,044,600 shares of common stock to employees. The Company recorded $3,879,099 as stock-based employee compensation in the statement of operations.
For the financial period ended March 31, 2006, the Company also recorded an expense of $5,775,000 relating to the award of 1,500,000 shares of common stock to senior management as stock based compensation in the statement of operations. The stock grant was subsequently cancelled by the Board during the three months ended September 2006 and a gain of $5,775,000 was recognized by the Company.
25
SUN NEW MEDIA INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
16. COMMITMENTS AND CONTINGENCIES
Commitments
The Company leases office premises for its operations in PRC and United States under operating leases. Rental expenses under operating lease for the three and nine months ended December 31, 2006 was US$97,394 and US$352,156 respectively. Rental expenses under operating lease for the three months ended December 31, 2005 and for the period from June 6, 2005 to December 31, 2005 was US$10,317.
Future minimum rental payments under non-cancelable operating leases are approximately as follows:
| December 31, |
| March 31, |
| |
|
| US$’000 |
| US$’000 |
|
|
|
|
|
|
|
Within one year |
| 273 |
| 175 |
|
Within two tofive years |
| 46 |
| 62 |
|
|
| 319 |
| 237 |
|
17 REPORT OF SEGMENT INFORMATION
We determine our business segments based upon our management and internal reporting structure. Our reportable segments are transactional services segment, marketing & information services segment, HQ & investments segment and Online Brokerage segment (discontinued operations). The Company does not allocate any operating costs or assets to its transactional services, marketing & information services, HQ & investments and online brokerage segments as management does not use this information to measure the performance of these operating segments. Management does not believe that allocating these expenses or assets is necessary in evaluating these segments’ performance.
Information regarding our business segments is as follows:
| Three months ended |
| Nine months ended |
| |||||
|
| 2006 |
| 2005 |
| 2006 |
| 2005 (1) |
|
|
| US$’000 |
| US$’000 |
| US$’000 |
| US$’000 |
|
|
|
|
|
|
|
|
|
|
|
Revenue |
|
|
|
|
|
|
|
|
|
Transactional Services |
| 2,712 |
| — |
| 14,809 |
| — |
|
Marketing & Information Services |
| 1,239 |
| — |
| 4,128 |
| — |
|
HQ & investments |
| — |
| — |
| — |
| — |
|
Online Brokerage (Discontinued operations) |
| — |
| 182 |
| — |
| 209 |
|
Gross profit |
|
|
|
|
|
|
|
|
|
Transactional Service |
| 857 |
| — |
| 10,810 |
| — |
|
Marketing & Information Services |
| 1,036 |
| — |
| 3,458 |
| — |
|
HQ & investments |
| — |
| — |
| — |
| — |
|
Online Brokerage (Discontinued operations) |
| — |
| 90 |
| — |
| 98 |
|
Depreciation and amortization |
|
|
|
|
|
|
|
|
|
Transactional Service |
| 17 |
| — |
| 17 |
| — |
|
Marketing & Information Service |
| 8 |
| — |
| 24 |
| — |
|
HQ & investments |
| 640 |
| — |
| 1,939 |
| — |
|
Online Brokerage (Discontinued operations) |
| — |
| — |
| — |
| — |
|
(1) Information is presented for the period from June 6, 2005 (date of commencement of operations) to December 31, 2005. The Company changed its financial year end from September 30 to March 31 on February 17, 2006.
26
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
The following discussion should be read in conjunction with our Financial Statements and the notes thereto presented in “Item 1 — Financial Statements.” The matters discussed in this report on Form 10-QSB include “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, Any statements contained in this Form 10-QSB that are not statements of historical fact may be deemed to be forward-looking statements. Words such as “may”, “will”, “expect”, “believe”, “anticipate”, “intend”, “could”, “plan”, “estimate” or “continue” or similar words are intended to identify forward-looking statements, although not all forward-looking statements are identified by those words. While forward-looking statements are sometimes presented with numerical specificity, they are based on current expectations and various assumptions made by management regarding future circumstances over which we may have little or no control. These statements are inherently predictive, speculative and subject to risk and uncertainties, and it should not be assumed that they will prove to be correct. A number of important factors, including those identified under the caption “Risk Factors” in our annual report on Form 10-KSB filed with the SEC, which is hereby incorporated by reference, as well as factors discussed elsewhere in this Form 10-QSB, could cause our actual results to differ materially from those in forward-looking statements or forward-looking financial information. Actual results may differ from forward-looking results for a number of reasons, including market acceptance of our services, adverse market conditions affecting the Internet sector, retention of major clients, competitive factors, failure to keep pace with changing technologies and failure to protect our intellectual property. Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, our actual results may vary materially from those anticipated, estimated or projected. These forward looking statements are made only as of the date hereof, and we undertake no obligation to update or revise these forward looking statements, whether as a result of new information, future events or otherwise.
Overview
Sun New Media’s principal business activities are the (i) provision of business-to-business interactive marketing and information services; and (ii) provision of e-solutions and online platform to better manage distribution networks by industry, and provision of turnkey management solutions as integral parts of our transactional services.
Our activities are based predominantly in People’s Republic of China (“PRC”).
Because our results for the three months ended December 31, 2005 and period from June 6, 2005 to December 31, 2005 were principally the result of operations which have since been discontinued, a comparative analysis with the three months and nine months ended December 31, 2006 is not meaningful.
Results of Operations
Three Months and Nine Months Ended December 31, 2006
Revenue Our revenue for the three months ended December 31, 2006 was $3.9 million, of which 69% were derived from our Transactional Services and the remaining 31% from our Marketing and Information Services. During the three months ended December 31, 2006, Transactional Services was positively impacted by the completed acquisition of our electronic components vertical business which contributed to the revenue from Transactional Services. Transactional Services revenue was negatively impacted during the three months ended December 31, 2006 by a decline of 81% as compared to the three months ended September 30, 2006 in our beverage distribution business. Marketing and Information Services revenue was negatively impacted during the three months ended December 31, 2006 by a decline of 49% as compared to the three months ended September 30, 2006 in our in our media and marketing business.
Our revenue for the nine months ended December 31, 2006 was $18.9 million, of which 78% were derived from our Transactional Services and the remaining 22% from our Marketing and Information Services. During the nine months ended December 31, 2006, Transactional Services revenue was positively impacted by the completed acquisition of our electronic components and apparels vertical business and the first full quarter of operations of our beverage distribution business, which contributed to the revenues from Transactional Services. Transactional Services revenue was negatively impacted during the nine months ended December 31, 2006 by a decline of 81% in the beverage distribution business during the three months ended December 31, 2006 as compared to the three months ended September 30, 2006. The reduction in our beverage distribution business in the latter half of the nine months ended December 31, 2006 was due to a combination of factors, including: financial difficulties suffered by our beverage distribution partner; an increase in inventory financing requirements
27
from the distribution partner’s largest supplier; and, an increased reliance on large retail chain customers. Marketing and Information Services revenue was positively impacted by the inception of media marketing and services business, which accounted for the majority of the Marketing and Information Services revenues for the six months ended December 31, 2006.
Costs of Revenue Cost of revenue for the three months ended December 31, 2006 was $2.1 million. Transactional Services costs were 90% of the total or approximately $1.9 million. The remaining costs for the three months ended December 31, 2006 was $0.2 million or 10% and related to direct costs, such as printing costs, editorial costs and distribution costs within our Marketing and Information Services businesses. The cost of revenue decreased for the three months ended December 31, 2006 as compared to the three months ended September 30, 2006. .
Cost of revenue for the nine months ended December 31, 2006 was $4.7 million. Transactional Services costs were 86% of the total, or approximately $4.0 million. The remaining cost for the nine months ended December 31, 2006 were $0.7 million or 14% and related to direct costs, such as printing costs, editorial costs and distribution costs within our Marketing and Information Services businesses. Transactional Services cost of revenue increased for the latter six months ended December 31, 2006 as compared to the prior three months ended June 30, 2006 with the completed acquisition of our electronics components and apparels vertical business.
Operating Expenses Total operating expenses for the three months ended December 31, 2006 were approximately $28.6 million. This was significantly higher than the total operating expenses of $(0.53) million in the prior three months ended September 30, 2006, due mainly to an impairment loss of $26.5 million for the intangibles and goodwill arising out of the Focus acquisition and a gain of $0.5 million recognized for the repurchase of stock grant at no consideration in the three months ended December 31, 2006 and a gain of $5.8 million recognized for the repurchase of stock grant at no consideration in the three months ended September 30, 2006. The gain of $5.8 million relates to 1.5 million performance shares that were granted during the fiscal period ended March 31, 2006. An expense was accrued for this grant in the fiscal period ended March 31, 2006 but the shares remained unissued, until the accrued grant was repurchased in the three months ended September 30, 2006. Excluding the impairment loss of $26.5 million and the gain of $0.5 million, operating expenses were approximately $2.6 million for the three months ended December 31, 2006. The total operating expenses included expenses related to general & administrative and marketing & sales of $1.6 million, depreciation and amortization of $0.7 million and consulting and professional fees of $0.3 million for the three months ended December 31, 2006.
Total operating expenses for the nine months ended December 31, 2006 were approximately $33.3 million. This was significantly increased due to an impairment loss of $26.5 million for the intangibles and goodwill arising out of the Focus acquisition and a gain of $6.3 million recognized for the repurchase of stock grant at no consideration in the nine months ended December 31, 2006. Excluding the impairment loss of $26.5 million and gain of $6.3 million recognized for the repurchase of stock grants at no consideration, operating expenses were approximately $13.1 million for the nine months ended December 31, 2006. The total operating expenses include expenses related to general & administrative and marketing & sales of $5.1 million, depreciation and amortization of $2.0 million, consulting and professional fees of $1.3 million, interest on convertible note of $0.1 million, stock-based compensation of $2.0 million and amortization of discount on notes of $2.6 million for the nine months ended December 31, 2006.
Other Income Other income for the three months ended December 31, 2006 was $38,000.
Other income for the nine months ended December 31, 2006 was $10.9 million comprise mainly $10.7 million arising from the sale of non-core business-to-consumer (“B2C”) business assets to Sun TV Shop. Of the $10.7 million, approximately 94% is attributed to the divestments of our interests in the digital mail order catalogue publishing and merchandising that we have been recently developing with two parties. On June 30, 2006, we entered into a Sale and Purchase Agreement with Sun TV Shop, Plc (“STVS”, a related party) to sell certain of our assets in exchange for 32.6 million shares in STVS. These shares account for approximately 9% of STVS’ shares outstanding and as of July 6, 2006 were valued at approximately US$11.9 million based upon the last traded price.
Net Loss Our net loss for three months ended December 31, 2006 was $26.9 million. This included an impairment loss of $26.6 million on for the intangibles and goodwill arising out of the Focus acquisition and a gain of $0.5 million recognized for the repurchase of stock grant at no consideration in the three months ended December 31, 2006. The repurchase of stock grants relates to the cancellation of 226,584 options granted to directors in the three months ended September 30, 2006.
28
Our net loss for the nine months ended December 31, 2006 was $8.6 million. This included an impairment loss of $26.6 million on for the intangibles and goodwill arising out of the Focus acquisition and a gain of $6.3 million recognized for the repurchase of stock grant at no consideration in the nine months ended September 30, 2006.
Three Months Ended December 31, 2005
Our results for the three months ended December 31, 2005 include the results of our interactive marketing and sales services business and our brokerage business (discontinued operations).
Revenue Brokerage commission revenue for the three months ended December 31, 2005 was $182,114. We had no revenue related to our interactive marketing and sales services business during the three months ended December 31, 2005.
Expenses Our total expenses for three months ended December 31, 2005 were $551,251. These included expenses relating to our brokerage business of clearing firm charges of $30,369, commission expenses of $60,416 and general and administrative expenses of $104,619 and general and administrative expenses relating to our interactive marketing and sales services business of $355,117.
Net Loss Our net loss for three months ended December 31, 2005 was $362,227.
Liquidity and Capital Resources
As of December 31, 2006, we had $1.59 million cash, all of which was available for general working capital purposes.
We anticipate needing additional liquidity over the next 12 months in order to assist the company in executing its current business plan. We anticipate raising capital through additional private placements of our equity securities, proceeds received from the exercise of outstanding warrants and options, and, if available on satisfactory terms, debt financing.
We plan to use additional capital for marketing and advertising, as well as for strategic acquisition of existing businesses that complement our market niche, and for general working capital purposes.
Off-Balance Sheet Arrangements
As of December 31, 2006, we had no off-balance sheet arrangements.
Capital Expenditure Commitments
As at December 31, 2006, we had no outstanding commitments for capital expenditures. However, we expect to invest approximately $0.13 million in capital expenditure over the next 6 months.
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Strategic Acquisitions and Recent Developments
There have been no new acquisitions and significant developments except as disclosed in our 10-QSB on September 30, 2006.
· On December 5, 2006, we appointed Mr. Walter Beach to serve as an independent member of our Board of Directors and as Chariman of the Compensation Committee.
· On November 30, 2006, Grant Thornton Hong Kong (“GTHK”), which was engaged on September 13, 2006 (see below), resigned as our independent auditor. Concurrent with GTHK’s resignation, we re-engaged Bernstein & Pinchuk LLP (“B&P”) to serve as our independent auditor.
After preliminary consultations with GTHK, on November 13, 2006, the Company announced that its previously released financial statements could not be relied upon and that the Company would be restating certain historical financial statements. Specifically, the Company noted the following non-cash issues (the “Issues”):
Accounting for business combinations, where historically the Company recorded the cost of the transactions (the Company used the criteria defined under SFAS 141, para 6) using the discounted fair market value of the shares issued which is equivalent to the fair value of the acquired assets and GTHK advised that the Company restate the financial statements to reflect use of the quoted stock market price. Substantially all of the Company’s acquisitions have been paid using consideration in the form of the Company’s stock. The financial impact of the restatement would have increased Goodwill and intangible assets by approximately $39.2 million as of March 31, 2006, $39.2 million as of June 30, 2006 and $39.5 million as of September 30, 2006. Additional paid in capital would have increased by approximately $39.2 million as of March 31, 2006, $39.2 million as of June 30, 2006 and $39.5 million as of September 30, 2006. Amortization expense would have increased by approximately $0 for fiscal period ended March 31, 2006, $79,000 for the three months ended June 30, 2006 and $537,000 for the three months ended September 30, 2006
Expensing of stock-based compensation, where historically the Company recorded expenses for stock based compensation that had been anticipated to be granted in a future period (the Company used the criteria defined under SFAS 123(r) (paragraph 57)), but not yet granted. GTHK advised that the Company reverse this accrual in the period ended March 31, 2006. The financial impact of the restatement would have decreased Stock-based compensation by approximately $5.8 million as of March 31, 2006, and increased Stock-based compensation expense by $5.8 million as of September 30, 2006.
GTHK advised that the Company adjust the allocation of the interest expense (the Company used the criteria defined under APB 14 and EITF 98-5) associated with the beneficial conversion feature and the attached warrants of the Company’s convertible debt. The financial impact of the restatement would have increased Amortization of Discount on notes by approximately $29,000 for the three months ended December 31 2005 and $282,000 for the fiscal period ended March 31, 2006 and decreased Amortization of Discount on notes by $143,000 for the three months ended June 30, 2006.
After further review of the Issues and in consultation with Bernstein & Pinchuk LLP (“B&P”), the Company’s immediate prior independent auditors, the Company has determined that its previous accounting treatment was correct and that its announcement of November 13, 2006, which was made in conjunction with the required Securities and Exchange Commission (“SEC”) filing deadline, was premature. GTHK does not agree with the Company’s conclusion. As a result of this disagreement, the Company has accepted the resignation of GTHK as its independent accountants effective as of November 30, 2006. However, it is the mutual understanding between the Company and GTHK that, after the completion of the audit for the current fiscal year, both parties will explore the possibility of reappointing GTHK as the independent auditors, with any such appointment being subject to resolution of any disagreements regarding accounting treatment and GTHK’s then applicable new client acceptance processes.
Because it was only recently appointed, GTHK has not issued any report on the Company’s financial statements to date. However, if unresolved, the Issues would have caused GTHK to make reference to such matters in any report issued by GTHK.
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Effective as of November 30, 2006, the Company has re-engaged B&P as its independent auditors. The Company’s decision to re-engage B&P was approved by its board of directors. Prior to re-engaging B&P as the Company’s independent accountant, the Company consulted with B&P regarding the Issues. The Company has authorized GTHK to respond fully to any inquiries of B&P regarding the Issues.
· On November 21, 2006, we entered into an agreement with Mr. Yang Qi, Mr. Wu Bing Wei and Mr. Mao Quanyi, collectively the owners of Hubei Zhengyuan Trade Development (“HZTD”) to unwind our past business relationship and dealings with HZTD. Our past business relationship is characterized by two previous agreements with the owners of HZTD: A Supplemental Agreement dated January 27, 2006 and a Management Services Agreement dated March 31, 2006 (see Strategic Acquisitions and Recent Developments section above.)
According to the terms of the agreement signed on November 21, we relinquished certain rights under the management services agreement dated March 31, 2006 and $4.75 million in past due account receivables for 14.9 million shares of SNMD stock held by the owners of HZTD. HZTD regained the right to distribute TsingTao beer to large scale wholesalers and retail chains, and we retained select personnel, intellectual property, systems and access to the distribution network. In addition, the we retained distribution rights of Tsingtao beer to small commercial enterprises.
· On October 31, 2006, we accepted the resignation of Mr. William Adamopoulos as a member of the Board of Directors.
· On October 30, 2006, the independent members of our Board of Directors returned to the Company the entirety of their SNMD stock grants and Board equity compensation. The directors, Kay Koplovitz, Mark Newburg, William Adamopoulos and Yu Bing each returned a total of 56,646 options to buy Company stock at $3.85 per share. 25,000 of these options were granted to each director upon his/her election to the Board by the SNMD shareholders; 31,646 options were granted to each director as part of his/her annual equity compensation package for serving the Board. The issuance of these options were initially disclosed with the Securities & Exchange Commission on Form 4 on October 9, 2006.
· On October 19, 2006 we entered into and subsequently completed a Supplementary Agreement with Mr. Li Yong, Mr. Wang Jingchun, and the China Electronic Appliance Company (CEAC), a subsidiary of the China Electronics Company (CEC), to revise the terms of the original agreement dated May 23, 2006 (see Strategic Acquisitions and Recent Developments above).
Through the revised agreement, we gained an 80% stake in Beijing Trans Global Logistics (“BTGL”) and the exclusive right to operate the online exhibitions of the China Electronic Parts Exhibition Company, a subsidiary of CEAC and the dominant player in Electronic Exhibition industry, in exchange for 9 million RMB cash plus 552,264 new SNMD shares. The 552,264 shares will be issued in four installments as follows: 138,066 shares upon completion of the deal, and 138,066 shares in years one, two and three following the completion of the deal if and only if the revenue guarantees (listed below) are met. Other key points of the revised agreement include: CEAC will no longer provide revenue guarantees of 400 million RMB in year one, 450 million in year two, and 500 million in year three; Sun New Media will no longer provide US $4 million cash or bank credit to finance the offline parts business, and instead, CEAC guarantees 25 million RMB in advertising revenue to the joint venture for year one, 27.5 million RMB for year two, and 30 million for year three. We expect to maintain a 80% net margin on operating costs of about 2 million RMB/year.
· On October 11, 2006, we accepted the resignation of Dr. Herbert Kloiber as a member of the Board of Directors.
· On October 5, 2006, we accepted the resignation of Mr. Ricky Ang as both Chief Executive Officer and a member of the Board of Directors. Concurrent with Mr. Ang’s resignation and effective as of October 5, 2006, we appointed Executive Chairman Dr. Bruno Wu as Chief Executive Officer.
· On September 30, 2006 we completed the acquisition of William Brand pursuant to a Sale and Purchase Agreement dated June 8, 2006 (the “William Brand Purchase Agreement”) by and between the Company, China Focus Channel Development Limtied (“Focus”) and Ren Huiliang and acquired a 100% controlling interest in William Brand. The company, Focus and Ren Huiliang agreed that the effective date of the acquisition will be July 1, 2006. William Brand is a China-based producer and distributor of women’s luxury apparel. The consideration paid by the Company for the acquisition was satisfied through the issuance of 4,655,173 shares of the Company’s common stock. Pursuant to the William Brand Purchase Agreement, the shares are to be issued as follow: 1,165,793 shares on Completion; 1,165,793 shares to be issued if William Brand achieves a minimum of US$15 million revenue and US$3 million after-tax profits in Year 1; 1,165,793 shares to be issued if William Brand achieves a minimum of US$17.5 million revenue and US$3.5
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million after-tax profits in Year 2; and 1,165,793 shares to be issued if William Brand achieves a minimum of US$20.0 million revenue and US$4.0 million after-tax profits in Year 3.
· On September 19, 2006, we accepted the resignation of Mr. Frank Zhao as Chief Financial Officer of the Company. Concurrently, we appointed Mr. Thomas A. Schuler as Chief Financial Officer of the Company.
· On September 13, 2006 we appointed Grant Thornton, Hong Kong (“GTHK”) as our independent auditor.
· On September 7, 2006, we completed our acquisition of property, automobiles, program rights and 46,629,331 shares in Asia Premium Television Group Inc. pursuant to the Sale and Purchase agreement dated April 20, 2006 between the Company and SMIH. The consideration for the acquisition was 850,647 shares of SNMD stock.
· On August 18, 2006, we accepted the resignation of Mr. Qi Yang as a member of the Board of Directors.
· On July 21, 2006 we completed the acquisition of Credit 114 pursuant to a Sale and Purchase Agreement dated June 14, 2006 (the “Credit 114 Purchase Agreement”) by and between the Company and Sun Media Investment Holdings (“SMIH”). The consideration paid by the Company was US$2.5 million cash. We also signed a Supplementary Agreement with SMIH to acquire search engine technology and additional on-line business media content. This Supplementary Agreement was dated June 14, 2006.
· On June 30, 2006, we entered into a Sale and Purchase Agreementwith Sun TV Shop, Plc. (“STVS”), a company listed on the Alternative Investment Market of the United Kingdom, to sell certain assets in exchange for 32.6 million shares in STVS. According to the Agreement, 50% of the STVS stock paid to the Registrant will be restricted from trading for one year, and the remainder will remain restricted until the second anniversary of the date of the Agreement.
· On May 23, 2006, we signed a strategic cooperative and sales purchase agreement (the “CEAC Agreement”) with China Electronic Appliances Corporation (“CEAC”), a subsidiary of the China Electronics Corporation (“CEC”), and two individuals, Mr. Yong Li and Mr. Mianchun Wang, management designees from CEAC. The CEAC Agreement provides that the Registrant and its subsidiary Focus shall purchase a 49% stake in Beijing Trans Global Logistics (“BTGL”) and its subsidiary from Messrs. Wang and Li and a 31% stake in BTGL from CEAC. As a result, the Company will effectively own 80% of shares of BTGL and will effectively own 64% of the shares in Beijing CEAC Trans Global Logistics. The consideration for the acquisition is 15,710,000 RMB to be satisfied by the Company with 9,000,000 RMB in cash and 6.71 million RMB in 139,792 shares of the Company’s common stock. As part of the transaction, CEAC and Mr. Yong Li and Mr. Mianchun Wang have provided a revenue and profit guarantee to the Company. Assuming BTGL and its subsidiary meet this guarantee in each of the three years following the signing of the agreement, the sellers will receive an additional 139,792 shares of the Company’s common stock per year. Assuming management meets all performance targets, a maximum aggregate of 559,168 shares may be issued in this transaction.
· On April 20, 2006, pursuant to the Sale and Purchase Agreement (the “GAI Purchase Agreement”) dated April 20, 2006 by and among the Company and Kingston Capital Group Limited (“Kingston”), the Company sold 100% of the issued and outstanding shares of Global American Investments Inc. to Kingston in exchange for US$40,000. Kingston is unrelated to the Company and the transaction was negotiated at arm’s length.
· On January 27, 2006, we completed the acquisition of China Focus Channel Development Co. Ltd. (“Focus”), pursuant to a Sale and Purchase agreement (the “Focus Purchase Agreement”) dated November 22, 2005 with Yang Qi, Mao Quan Yi and Wu Bing Wei
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(collectively, the “Sellers”) in exchange for 14,900,000 shares of our common stock. We have based our beverages vertical business on the business of Focus.
The terms of the Focus Purchase Agreement also provide that we must issue an additional 2,000,000 shares of its common stock to the Sellers, if:
a) the audited net profit after tax (“PAT”) of Suizhou Focus Channel Development Limited (“SFC”), wholly owned subsidiary of Focus, is in excess of $4.5 million for the fiscal year ending December 31, 2006;
b) the audited PAT of SFC is in excess of $5.0 million for the fiscal year ending December 31, 2007; and
c) the audited PAT of SFC for the fiscal year ending December 31, 2008 is in excess of $5.5 million.
In the event that the audited PAT is less than the guaranteed amounts for each of the fiscal years, the Sellers shall either make-up the shortfall in cash, or forfeit their rights to receive the shares of our common stock.
Concurrently, on January 27, 2006, we entered into a supplemental agreement with the sellers to provide for a 90-day period for the transfer of the business and assets of Hubei Zhengyuan Trade Development Ltd. (“HZTD”), a PRC company, to SFC.
On March 31, 2006, SFC and HZTD, entered into a management services agreement (the “New Agreement”) which took effect on April 1, 2006. Under the terms of the New Agreement, HZTD will pay SFC and/ or its nominees a management fee equal to 12% of its total cash sales. In addition, the Sellers will guarantee SFC that the management fee payable to SFC arising from this New Agreement shall not be less than RMB4 million (approximately US$500,000) per month, and that the operating costs of SFC including staff costs shall not be more than RMB8 million (approximately US$1 million) per annum subject to an inflationary cost increase of no more than 10% per annum for the duration of the New Agreement.
Notwithstanding the above, the profit guarantees as provided by the Sellers as per the original Purchase Agreement remained unchanged.
In addition to the New Agreement, the Company and the Sellers have entered in to a separate Supplemental Agreement (the “New Supplemental Agreement) to the original Purchase Agreement to alter the following terms:
a) the profit related shares shall be reduced to 700,000 shares per year from the original 2,000,000 shares per year for which the profit guarantees are met;
b) the Company shall pay the Sellers a cash component of RMB40 million (approximately US$5 million); and
c) the business and assets of HZTD shall remain with HZTD and will not be transferred to SFC as provided in the original Purchase Agreement.
In summary, assuming that profit guarantee for each of the three years are met, total consideration for the acquisition of Focus shall be 17 million shares and cash of RMB40 million (approximately US$5 million) instead of 20.9 million shares.
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Subsequent Events
The following is a list of events that occurred after the fiscal quarter ended December 31, 2006.
· On February 1, 2007, we entered into a supplementary agreement with Barron Partners LLP to modify the terms of our original stock purchase agreement, dated December 31, 2005. Following the Supplementary Agreement, only 3 million of the original 11,545,977 million unexercised warrants remain, and Barron has agreed to limit selling of the shares underlying the warrants to 10% per month for the first 10 months following the date of the agreement.
· On January 29, 2007, we announced that Mr. Mark Newburg had resigned both as the Chairman of the Audit Committee and as a member of the Board of Directors. Mr. Newburg’s decision resulted from personal reasons and from the restructuring of the Company’s Board. He remains involved with the Company as a strategic business consultant.
· On January 22, 2007, our Board of Directors appointed Mr. Chen Zhaobin to serve as a non-independent member of the Board. Mr. Chen does not receive compensation in return for his service to the Company.
Critical Accounting Policies and Estimates
Our unaudited financial statements and accompanying notes are prepared in accordance with generally accepted accounting principles used in the United States. Preparing financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, and expenses. These estimates and assumptions are affected by management’s application of accounting policies. We believe that understanding the basis and nature of the estimates and assumptions involved with the following aspects of our consolidated financial statements is critical to an understanding of our financials.
Revenue recognition
We earn revenue from provision of marketing, information and transactional services and sales of channel management software. The Company recognizes revenues from transaction and information services in accordance with Staff Accounting Bulletin (“SAB”) No. 104, “Revenue Recognition,” when all of the following conditions exist: persuasive evidence of an arrangement exists in the form of an accepted purchase order; delivery has occurred, based on shipping terms, or services have been rendered; the Company’s price to the buyer is fixed or determinable, as documented on the accepted purchase order; and collectibility is reasonably assured.
The Company accounts for software sales in accordance with American Institute of Certified Public Accountants Statement of Position (“SOP”) 97-2, Software Revenue Recognition. The application of SOP 97-2 requires judgment, including whether a software arrangement includes multiple elements, and if so, whether vendor-specific objective evidence (“VSOE”) of fair value exists for those elements. Customers receive certain elements of our products over a period of time. Judgment is also required to assess whether future releases represent new products or upgrades and enhancements to existing products.
Share-based compensation
Effective January 1, 2006, the company adopted SFAS No. 123 (revised 2004), “Share Based Payment,” (“SFAS No. 123(R)”) which revises SFAS No. 123 and supersedes APB 25. SFAS No. 123(R) requires that all share-based payments to employees be recognized in the financial statements based on their fair values at the date of grant. The calculated fair value is recognized as expense (net of any capitalization) over the requisite service period, net of estimated forfeitures, using the straight-line method under SFAS No. 123(R). The Company considers many factors when estimating expected forfeitures, including types of awards, employee class and historical experience. The statement was adopted using the modified prospective method of application which requires compensation expense to be recognized in the financial statements for all unvested stock options beginning in the quarter of adoption. There were no unvested stock options at the beginning of this reporting period therefore no compensation expense was recognized in the period. No adjustments to prior periods have been made as a result of adopting SFAS No. 123(R).
As at September 30, 2005 the Company elected to account for stock-based employee compensation arrangements in accordance with the provisions of Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees”, (“APB No. 25”) and comply with the disclosure provisions of SFAS No. 123 as amended by SFAS No. 148. During the period from September 18, 2005 to September 30, 2005, no stock-based employee compensation arrangements
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have been effected and accordingly no disclosure of pro forma information is required. In accordance with SFAS No. 123 the Company applies the fair value method using the Black-Scholes option-pricing model in accounting for options granted to consultants.
The Company accounts for equity instruments issued in exchange for the receipt of goods or services from other than employees in accordance with SFAS No. 123 and the conclusions reached by the Emerging Issues Task Force in Issue No. 96-18, “Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring or in Conjunction with Selling Goods or Services” (“EITF 96-18”). Costs are measured at the estimated fair market value of the consideration received or the estimated fair value of the equity instruments issued, whichever is more reliably measurable. The value of equity instruments issued for consideration other than employee services is determined on the earlier of a performance commitment or completion of performance by the provider of goods or services as defined by EITF 96-18.
Risk Factors
You should consider carefully all of the information in this Quarterly Report on Form 10-QSB, including the risks and uncertainties described below, before making an investment in our common stock. Any of the following risks could have a material adverse effect on our business, financial condition and results of operations. In any such case, the market price of our common stock could decline, and you may lose all or part of your investment.
Risks Related to Our Business
Our short operating history and rapidly evolving business makes it difficult for us to accurately forecast revenues and expenses.
We commenced our interactive marketing and sales services operations in June 2005 and have a very limited operating history for this division. Our previously reported operating results related principally to the legacy brokerage business that we operated prior to the reverse acquisition. Such business was disposed of during the quarter ended June 30, 2006 and the results of such operations are reported as discontinued operations. The quarter ended June 30, 2006 represented the first quarter during which we had meaningful operating results relating to our ongoing operations. Accordingly, you should consider our future prospects in light of the risks and uncertainties experienced by early stage companies in evolving industries in China. Since inception, we have announced a number of proposed transactions to develop this business and which will have a material impact on our operations for the fiscal year ending March 31, 2007 and beyond. As a result, it is difficult for us to predict future revenues and operating expenses. We based our expense levels, in part, on our expectations of future revenues from these transactions. If our interactive marketing and sales services business develops slower than we expect, our losses may be higher than anticipated and may cause our stock price to decline.
Some of the other risks and uncertainties of our business relate to our ability to:
· offer new and innovative products and services to attract and retain a larger consumer base;
· attract customers;
· increase awareness of our brand and continue to develop consumer and customer loyalty;
· respond to competitive market conditions;
· respond to changes in our regulatory environment;
· manage risks associated with intellectual property rights;
· maintain effective control of our costs and expenses;
· raise sufficient capital to sustain and expand our business;
· attract, retain and motivate qualified personnel; and
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· upgrade our technology to support increased traffic and expanded services.
If we are unsuccessful in addressing any of these risks and uncertainties, our business may be materially and adversely affected.
The development of our business is dependent upon the completion and integration of acquisitions and other transactions that have only recently or not yet closed.
Our principal focus is on our PRC-based Marketing, Information and Transactional Services, which we are creating through the acquisition of various entities and assets. Certain of these transactions have only recently closed. Accordingly, it is difficult to evaluate our business based upon our historical financial results, including those for the quarter ended June 30, 2006. If we are unable to successfully operate and integrate the businesses we acquire, our business will not be successful. We expect to continually look for new businesses to acquire to maintain and sustain our operations. If we fail to identify such business, are unable to acquire such businesses on reasonable terms, or fail to successfully integrate such businesses, our operating results and prospects could be harmed.
We recognized a large gain in the quarter ended June 30, 2006 which may not be repeated. Our consolidation and de-consolidation activities may result in substantial non-operating gains or losses which may mean that our results of operations may be materially impacted by non-operating factors.
In the quarter ended June 30, 2006 we recorded net gains of approximately $10.7 million relating to the disposition of assets. As part of our strategy we expect to continue to engage in a significant level of merger and acquisitions and investment activities as we seek to build our business. When we decide to dispose of assets or operations which we determine to be non-core to our continuing operations, we may recognize gains or losses. As in the quarter ended June 30, 2006 these may involve significant gains or losses. Such gains and losses are not predictable and the fluctuating impact on our net income may have an adverse affect on the valuation of the Company and our share price.
If the Internet and, in particular, interactive marketing are not broadly adopted in China, our ability to increase revenue and sustain profitability could be materially and adversely affected.
The use of the Internet as a marketing channel is at an early stage in China. Internet and broadband penetration rates in China are both relatively low compared to those in most developed countries. Many of our current and potential customers have limited experience with the Internet as a marketing channel, and have not historically devoted a significant portion of their marketing budgets to online marketing and promotion. As a result, they may not consider the Internet effective in promoting their products and services as compared to traditional print and broadcast media. Our ability to generate significant revenues may be negatively impacted by a number of factors, many of which are beyond our control, including:
· difficulties associated with developing a larger consumer base with demographic characteristics attractive to customers;
· increased competition and potential downward pressure on online marketing prices;
· ineffectiveness of our online marketing delivery, tracking and reporting systems; and
· lack of increase in Internet usage in China.
We face significant competition and may suffer from a loss of users and customers as a result.
We expect to face significant competition in our interactive marketing and sales services business, particularly from other companies that seek to provide online marketing services. Our main competitors include Sohu.com, Tom Online, Beijing Media in China and Next Media Group in Hong Kong. Many of these competitors have significantly greater financial resources than we do. They also have longer operating histories and more experience in attracting and retaining users and managing customers than we do. They may use their experience and resources to compete with us in a variety of ways, including by competing more heavily for users, customers, distributors and networks of third-party websites, investing more heavily in research and development and making acquisitions.
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We also face competition from traditional advertising media, such as newspapers, magazines, yellow pages, billboards and other forms of outdoor media, television and radio. Most large companies in China allocate, and will likely continue to allocate, the bulk of their marketing budgets to traditional advertising media and only a small portion of their budgets to online marketing. If these companies do not devote a larger portion of their marketing budgets to online marketing services provided by us, or if our existing customers reduce the amount they spend on online marketing, our results of operations and future growth prospects could be adversely affected.
Our business depends on a strong brand, and if we are not able to maintain and enhance our brand, our business and operating results may be harmed.
We believe that recognition of our brand will contribute significantly to the success of our business. We also believe that maintaining and enhancing our brand is critical to expanding our base of consumers and customers. As our market becomes increasingly competitive, maintaining and enhancing our brand will depend largely on our ability to remain as an Internet marketing leader in China, which may be increasingly difficult and expensive.
If we fail to continue to innovate and provide relevant services, we may not be able to generate sufficient user traffic levels to remain competitive.
We must continue to invest significant resources in research and development to enhance services and introduce additional high quality services to attract and retain consumers. If we are unable to anticipate consumer preferences or industry changes, or if we are unable to modify our services on a timely basis, we may lose consumers and customers. Our operating results would also suffer if our innovations do not respond to the needs of our consumers and customers, are not appropriately timed with market opportunities or are not effectively brought to market.
If we fail to keep up with rapid technological changes, our future success may be adversely affected.
The online marketing industry is subject to rapid technological changes. Our future success will depend on our ability to respond to rapidly changing technologies, adapt our services to evolving industry standards and improve the performance and reliability of our services. Our failure to adapt to such changes could harm our business. New marketing media could also adversely affect us. For example, the number of people accessing the Internet through devices other than personal computers, including mobile telephones and hand-held devices, has increased in recent years. If we are slow to develop products and technologies that are more compatible with non-PC communications devices, we may not be successful in capturing a significant share of this increasingly important market for media and other services. In addition, the widespread adoption of new Internet, networking or telecommunications technologies or other technological changes could require substantial expenditures to modify or adapt our products, services or infrastructure. If we fail to keep up with rapid technological changes to remain competitive in our rapidly evolving industry, our future success may be adversely affected.
We may face intellectual property infringement claims and other related claims, that could be time-consuming and costly to defend and may result in our inability to continue providing certain of our existing services.
Internet, technology and media companies are frequently involved in litigation based on allegations of infringement of intellectual property rights, unfair competition, invasion of privacy, defamation and other violations of third-party rights. The validity, enforceability and scope of protection of intellectual property in Internet-related industries, particularly in China, are uncertain and still evolving. In addition, many parties are actively developing and seeking protection for Internet-related technologies, including seeking patent protection. There may be patents issued or pending that are held by others that cover significant aspects of our technologies, products, business methods or services. As we face increasing competition and as litigation becomes more common in China for resolving commercial disputes, we face a higher risk of being the subject of intellectual property infringement claims.
Intellectual property litigation is expensive and time consuming and could divert resources and management attention from the operations of our businesses. If there is a successful claim of infringement, we may be required to pay substantial fines and damages or enter into royalty or license agreements that may not be available on commercially acceptable terms, if at all. Our failure to obtain a license of the rights on a timely basis could harm our business. Any intellectual property litigation could have a material adverse effect on our business, financial condition or results of operations.
We may not be able to prevent others from unauthorized use of our intellectual property, which could harm our business and competitive position.
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We rely on a combination of copyright, trademark and trade secret laws, as well as nondisclosure agreements and other methods to protect our intellectual property rights. The protection of intellectual property rights in China may not be as effective as those in the United States or other countries. The steps we have taken may be inadequate to prevent the misappropriation of our technology. Reverse engineering, unauthorized copying or other misappropriation of our technologies could enable third parties to benefit from our technologies without paying us. From time to time, we may have to enforce our intellectual property rights through litigation. Such litigation may result in substantial costs and diversion of resources and management attention.
If we fail to attract customers for our online marketing services, our business and growth prospects could be seriously harmed.
Our online marketing customers will not maintain a business relationship with us if their investment does not generate sales leads and ultimately consumers. Failure to retain our existing online marketing customers or attract new customers for our online marketing services could seriously harm our business and growth prospects.
Because we primarily rely on distributors in providing our e-marketing services, our failure to retain key distributors or attract additional distributors could materially and adversely affect our business.
Online marketing is at an early stage of development in China and is not as widely accepted by or available to businesses in China as in the United States. As a result, we rely heavily on a nationwide distribution network of third-party distributors for our sales to, and collection of payment from, our corporate and consumer customers. If our distributors do not provide quality services to our consumer customers or otherwise breach their contracts with our consumer customers, we may lose customers and our results of operations may be materially and adversely affected. We do not have long-term agreements with any of our distributors, including our key distributors, and cannot assure you that we will continue to maintain favorable relationships with them. Our distribution arrangements are non-exclusive. Furthermore, some of our distributors may have contracts with our competitors or potential competitors and may not renew their distribution agreements with us. In addition, as new methods for accessing the Internet, including the use of wireless devices, become available, we may need to expand our distribution network to cater to the new technologies. If we fail to retain our key distributors or attract additional distributors on terms that are commercially reasonable, our business and results of operations could be materially and adversely affected.
Our strategy of acquiring complementary businesses, assets and technologies may fail.
As part of our business strategy, we have pursued, and intend to continue to pursue, selective strategic acquisitions of businesses, assets and technologies that complement our existing business. Our acquisitions involve uncertainties and risks, including:
· potential ongoing financial obligations and unforeseen or hidden liabilities;
· failure to achieve the intended objectives, benefits or revenue-enhancing opportunities;
· costs and difficulties of integrating acquired businesses and managing a larger business; and
· diversion of resources and management attention.
Our failure to address these risks successfully may have a material adverse effect on our financial condition and results of operations. Any such acquisition may require a significant amount of capital investment, which would decrease the amount of cash available for working capital or capital expenditures. In addition, if we use our equity securities to pay for acquisitions, we may dilute the value of our common stock. If we borrow funds to finance acquisitions, such debt instruments may contain restrictive covenants that could, among other things, restrict us from distributing dividends. Such acquisitions may also generate significant amortization expenses related to intangible assets.
We may not be able to manage our expanding operations effectively.
We commenced our interactive marketing and sales services operations in 2005 and are expanding our operations rapidly. We anticipate significant continued expansion of our business as we address growth in our consumer and customer base and market opportunities. To manage the potential growth of our operations and personnel, we will be required to improve operational and financial systems, procedures and controls, and expand, train and manage our growing employee base.
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Furthermore, our management will be required to maintain and expand our relationships with other websites, Internet companies, and other third parties. We cannot assure you that our current and planned personnel, systems, procedures and controls will be adequate to support our future operations.
Our operating results may fluctuate, which makes our results difficult to predict and could cause our results to fall short of expectations.
Our operating results may fluctuate as a result of a number of factors, many of which are outside of our control. For these reasons, comparing our operating results on a period-to-period basis may not be meaningful, and you should not rely on our past results as an indication of our future performance. Our quarterly and annual revenues and costs and expenses as a percentage of our revenues may be significantly different from our historical or projected rates. Our operating results in future quarters may fall below expectations. Any of these events could cause the price of our Common Stock to fall. Any of the risk factors listed in this “Risk Factors” section, and in particular, the following risk factors, could cause our operating results to fluctuate from quarter to quarter:
· general economic conditions in China and economic conditions specific to the Internet, Internet search and online marketing;
· our ability to attract additional customers;
· the announcement or introduction of new or enhanced products and services by us or our competitors;
· the amount and timing of operating costs and capital expenditures related to the maintenance and expansion of our businesses, operations and infrastructure;
· the results of our acquisitions of, or investments in, other businesses or assets;
· PRC regulations or actions pertaining to activities on the Internet, including gambling, online games and other forms of entertainment; and
· geopolitical events or natural disasters such as war, threat of war, Severe Acute Respiratory Syndrome, or SARS, or other epidemics.
Because of our limited operating history and our rapidly growing business, our historical operating results may not be useful to you in predicting our future operating results. Advertising spending in China has historically been cyclical, reflecting overall economic conditions as well as budgeting and buying patterns. Our rapid growth has lessened the impact of the cyclicality and seasonality of our business. As we continue to grow, we expect that the cyclicality and seasonality in our business may cause our operating results to fluctuate.
The successful operation of our business depends upon the performance and reliability of the Internet infrastructure and fixed telecommunications networks in China.
Our business depends on the performance and reliability of the Internet infrastructure in China. Almost all access to the Internet is maintained through state-owned telecommunication operators under the administrative control and regulatory supervision of the Ministry of Information Industry of China. In addition, the national networks in China are connected to the Internet through international gateways controlled by the PRC government. These international gateways are the only channels through which a domestic user can connect to the Internet. We cannot assure you that a more sophisticated Internet infrastructure will be developed in China. We may not have access to alternative networks in the event of disruptions, failures or other problems with China’s Internet infrastructure. In addition, the Internet infrastructure in China may not support the demands associated with continued growth in Internet usage.
Our success depends on the continuing efforts of our senior management team and other key personnel and our business may be harmed if we lose their services.
Our future success depends heavily upon the continuing services of the members of our senior management team, in particular our chairman Dr. Bruno Wu. If one or more of our senior executives or other key personnel are unable or unwilling
39
to continue in their present positions, we may not be able to replace them easily or at all, and our business may be disrupted and our financial condition and results of operations may be materially and adversely affected. Competition for senior management and key personnel is intense, the pool of qualified candidates is very limited, and we may not be able to retain the services of our senior executives or key personnel, or attract and retain high-quality senior executives or key personnel in the future.
In addition, if any member of our senior management team or any of our other key personnel joins a competitor or forms a competing company, we may lose customers, distributors, know-how and key professionals and staff members. Each of our executive officers and key employees has entered into an employment agreement with us, which contains confidentiality and non-competition
40
provisions. If any disputes arise between any of our senior executives or key personnel and us, we cannot assure you the extent to which any of these agreements may be enforced.
We rely on highly skilled personnel and, if we are unable to retain or motivate key personnel or hire qualified personnel, we may not be able to grow effectively.
Our performance and future success depends on the talents and efforts of highly skilled individuals. We will need to continue to identify, hire, develop, motivate and retain highly skilled personnel for all areas of our organization. Competition in our industry for qualified employees is intense. Our continued ability to compete effectively depends on our ability to attract new employees and to retain and motivate our existing employees.
As competition in our industry intensifies, it may be more difficult for us to hire, motivate and retain highly skilled personnel. If we do not succeed in attracting additional highly skilled personnel or retaining or motivating our existing personnel, we may be unable to grow effectively.
Interruption or failure of our information technology and communications systems could impair our ability to effectively provide our products and services, which could damage our reputation and harm our operating results.
Our ability to provide our services depends on the continuing operation of our information technology and communications systems. Any damage to or failure of our systems could interrupt our service. Service interruptions could reduce our revenues and profits, and damage our brand if our system is perceived to be unreliable. Our systems are vulnerable to damage or interruption as a result of terrorist attacks, war, earthquakes, floods, fires, power loss, telecommunications failures, computer viruses, interruptions in access to our websites through the use of “denial of service” or similar attacks, hacking or other attempts to harm our systems, and similar events. Our servers, which are hosted at third-party Internet data centers, are also vulnerable to break-ins, sabotage and vandalism. Some of our systems are not fully redundant, and our disaster recovery planning does not account for all possible scenarios. The occurrence of a natural disaster or a closure of an Internet data center by a third-party provider without adequate notice could result in lengthy service interruptions.
Our business could be adversely affected if our software contains bugs.
Our online systems, including our websites, and other software applications and products, could contain undetected errors or “bugs” that could adversely affect their performance. We regularly update and enhance our websites and our other online systems and introduce new versions of our software products and applications. The occurrence of errors in any of these may cause us to lose market share, damage our reputation and brand name, and materially and adversely affect our business.
Concerns about the security of electronic commerce transactions and confidentiality of information on the Internet may reduce use of our network and impede our growth.
A significant barrier to electronic commerce and communications over the Internet in general has been public concern over security and privacy, including the transmission of confidential information. If these concerns are not adequately addressed, they may inhibit the growth of the Internet and other online services generally, especially as a means of conducting commercial transactions. If a well-publicized Internet breach of security were to occur, general Internet usage could decline, which could reduce traffic to our destination websites and impede our growth.
We have limited business insurance coverage.
The insurance industry in China is still at an early stage of development. Insurance companies in China offer limited business insurance products. We do not have any business liability or disruption insurance coverage for our operations in China. Any business disruption, litigation or natural disaster may result in our incurring substantial costs and the diversion of our resources.
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Fluctuation and impairment of marketable securities will materially impact our net income
Marketable securities are carried at fair market value, fluctuation of market price of those securities could adversely impact net income and earnings per share, we have no control over the market price of those securities and cannot predict the possible impact to our financial result.
Any change of the indefinite status of any of our intangible assets may require us to record additional amortization expenses
Some of our intangible assets are characterized as indefinite intangible assets and therefore are not required to be amortized. Any changes of the conditions upon which we based categorization of these intangible asset as indefinite will likely require us to amortize these intangible assets over their economic life. Such additional amortization cost could adversely impact our net income and earnings per share.
Risks Related to Our Corporate Structure
PRC laws and regulations governing our businesses and the validity of certain of our contractual arrangements are uncertain. If we are found to be in violation, we could be subject to sanctions. In addition, changes in such PRC laws and regulations may materially and adversely affect our business.
Although we are a Minnesota corporation and our stockholders have approved reincorporation of our Company into the State of Delaware, most of our operations and employees are located in the PRC. As such, there are substantial uncertainties regarding the interpretation and application of PRC laws and regulations, including, but not limited to, the laws and regulations governing our business, or the enforcement and performance of our contractual arrangements with certain of our affiliated Chinese entities. We are considered foreign persons or foreign invested enterprises under PRC law. As a result, we are subject to PRC law limitations on foreign ownership of Internet and advertising companies. These laws and regulations are relatively new and may be subject to change, and their official interpretation and enforcement may involve substantial uncertainty. The effectiveness of newly enacted laws, regulations or amendments may be delayed, resulting in detrimental reliance by foreign investors. New laws and regulations that affect existing and proposed future businesses may also be applied retroactively.
The PRC government has broad discretion in dealing with violations of laws and regulations, including levying fines, revoking business and other licenses and requiring actions necessary for compliance. In particular, licenses and permits issued or granted to us by relevant governmental bodies may be revoked at a later time by higher regulatory bodies. We cannot predict the effect of the interpretation of existing or new PRC laws or regulations on our businesses. We cannot assure you that our current ownership and operating structure would not be found in violation of any current or future PRC laws or regulations. As a result, we may be subject to sanctions, including fines, and could be required to restructure our operations or cease to provide certain services. Any of these or similar actions could significantly disrupt our business operations or restrict us from conducting a substantial portion of our business operations, which could materially and adversely affect our business, financial condition and results of operations.
Our corporate actions are substantially controlled by our principal shareholders and affiliated entities.
As of November 30, 2006, our principal shareholders and their affiliated entities own approximately 41% of our outstanding common stock (which will be reduced to approximately 40% after completion of announced but not yet closed transactions). These shareholders, acting individually or as a group, could exert substantial influence over matters such as electing directors and approving mergers or other business combination transactions. This concentration of ownership may also discourage, delay or prevent a change in control of our company, which could deprive our shareholders of an opportunity to receive a premium for their shares as part of a sale of our company and might reduce the price of our Common stock. These actions may be taken even if they are opposed by our other shareholders.
Risks Related to Doing Business in China
Adverse changes in economic and political policies of the PRC government could have a material adverse effect on the overall economic growth of China, which could adversely affect our business.
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As our interactive marketing and sales services business expands, we expect an increasing portion of our business operations to be conducted in China. Accordingly, our results of operations, financial condition and prospects are subject to a significant degree to economic, political and legal developments in China. China’s economy differs from the economies of most developed countries in many
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respects, including the amount of government involvement, level of development, growth rate, control of foreign exchange and allocation of resources. While China’s economy has experienced significant growth in the past 20 years, growth has been uneven across different regions and among various economic sectors of China. The PRC government has implemented various measures to encourage economic development and guide the allocation of resources. Some of these measures benefit the overall PRC economy, but may also have a negative effect on us. For example, our financial condition and results of operations may be adversely affected by governmental control over capital investments or changes in tax regulations that are applicable to us. Since early 2004, the PRC government has implemented certain measures to control the pace of economic growth. Such measures may cause a decrease in the level of economic activity in China, which in turn could adversely affect our results of operations and financial condition.
Our subsidiaries and affiliates are subject to restrictions on paying dividends and making other payments to us.
As our interactive marketing and sales services business develops, we expect to increasingly rely on dividends payments from our subsidiaries and affiliated entities in China. However, PRC regulations currently permit payment of dividends only out of accumulated profits, as determined in accordance with PRC accounting standards and regulations. Our subsidiaries and affiliated entities in China are also required to set aside a portion of their after-tax profits according to PRC accounting standards and regulations for certain reserve funds. The PRC government also imposes controls on the conversion of RMB into foreign currencies and the remittance of currencies out of China. We may experience difficulties in completing the administrative procedures necessary to obtain and remit foreign currency. Furthermore, if our subsidiaries or affiliated entities in China incur debt on their own in the future, the instruments governing the debt may restrict their ability to pay dividends or make other payments. If either we or our subsidiaries is unable to receive all of the revenues from our operations through these contractual or dividend arrangements, we may be unable to declare dividends on our common stock.
Uncertainties with respect to the PRC legal system could adversely affect us.
We conduct a substantial and increasing portion our business through subsidiaries and affiliated entities based in China. Our operations in China are governed by PRC laws and regulations. Our subsidiaries are generally subject to laws and regulations applicable to foreign investments in China and, in particular, laws applicable to wholly foreign-owned enterprises. The PRC legal system is based on written statutes. Prior court decisions may be cited for reference but have limited precedent value.
Since 1979, PRC legislation and regulations have significantly enhanced the protections afforded to various forms of foreign investments in China. However, China has not developed a fully integrated legal system and recently-enacted laws and regulations may not sufficiently cover all aspects of economic activities in China. In particular, because these laws and regulations are relatively new, and because of the limited published decisions and their non-binding nature, the interpretation and enforcement of these laws and regulations involve uncertainties. In addition, the PRC legal system is based in part on governmental policies and internal rules (some of which are not published on a timely basis or at all) that may have a retroactive effect. As a result, we may not be aware of our violation of these policies and rules until after the occurrence of the violation. In addition, any litigation in China may be protracted and result in substantial costs and diversion of resources and management attention.
You may experience difficulties in effecting service of legal process, enforcing foreign judgments or bringing original actions in China based on United States or other foreign laws against us or our management.
We conduct a substantial and increasing portion of our operations in China and a substantial portion of our assets will be located in China. In addition, all of our senior executive officers reside within China. As a result, it may not be possible to effect service of process within the United States or elsewhere outside China on our senior executive officers, including matters arising under U.S. federal securities laws or applicable state securities laws. Moreover, our PRC counsel has advised us that PRC does not have treaties with the United States or many other countries providing for the reciprocal recognition and enforcement of judgment of courts.
Governmental control of currency conversion may affect the value of your investment.
The PRC government imposes controls on the conversion of RMB to foreign currencies and, in certain cases, the remittance of currencies out of China. As our interactive marketing and sales services business expands, we expect to derive an increasing percentage of our revenues in RMB. Under our current structure, we expect our income will be primarily derived from dividend payments from our PRC subsidiaries. Shortages in the availability of foreign currency may restrict the ability of our PRC subsidiaries and our affiliated entities to remit sufficient foreign currency to pay dividends or other payments to
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us, or otherwise satisfy their foreign currency denominated obligations. Under existing PRC foreign exchange regulations, payments of current account items, including profit distributions, interest payments and expenditures from trade-related transactions, can be made in foreign currencies without prior
45
approval from the PRC State Administration of Foreign Exchange by complying with certain procedural requirements. However, approval from appropriate government authorities is required when RMB is to be converted into foreign currency and remitted out of China to pay capital expenses such as the repayment of bank loans denominated in foreign currencies. The PRC government may also at its discretion restrict access in the future to foreign currencies for current account transactions. If the foreign exchange control system prevents us from obtaining sufficient foreign currency to satisfy our demands, we may not be able to pay dividends in foreign currencies to our shareholders, including holders of our Common stock.
Fluctuation in the value of RMB may have a material adverse effect on your investment.
The value of RMB against the U.S. dollar and other currencies may fluctuate and is affected by, among other things, changes in political and economic conditions. On July 21, 2005, the PRC government changed its decade-old policy of pegging the value of the RMB to the U.S. dollar. Under the new policy, the RMB is permitted to fluctuate within a narrow and managed band against a basket of foreign currencies. This change in policy has resulted in an approximately 2.0% appreciation of the RMB against the U.S. dollar. While the international reaction to the RMB revaluation has generally been positive, there remains significant international pressure on the PRC government to adopt a more flexible currency policy, which could result in a further and significant appreciation of the RMB against the U.S. dollar. As our interactive marketing and sales services business continues to grow, a greater portion of our revenues and costs will be denominated in RMB, while a significant portion of our financial assets may be denominated in U.S. dollars. We expect to rely significantly on dividends and other fees paid to us by our subsidiaries and affiliated entities in China. Any significant revaluation of RMB may materially and adversely affect our cash flows, revenues, earnings and financial position, and the value of, and any dividends payable on, our Common stock in U.S. dollars. For example, an appreciation of RMB against the U.S. dollar would make any new RMB denominated investments or expenditures more costly to us, to the extent that we need to convert U.S. dollars into RMB for such purposes.
We may not be able to consolidate the financial results of some of our affiliated companies or such consolidation could materially adversely affect our operating results and financial condition.
For PRC regulatory reasons, much of our operations are conducted through affiliated companies which currently are considered for accounting purposes as variable interest entities (VIE’s”), and we are considered the primary beneficiary, enabling us to consolidate its financial results in our consolidated financial statements. In the event that in the future a company we hold as a VIE would no longer meet the definition of a VIE, or we are deemed not to be the primary beneficiary, we would not be able to consolidate line by line that entity’s financial results in our consolidated financial statements. Also, if in the future an affiliate company becomes a VIE and we become the primary beneficiary, we would be required to consolidate that entity’s financial results in our consolidated financial statements. If such entity’s financial results were negative, this could have a corresponding negative impact on our operating results.
We face risks related to health epidemics and other outbreaks.
Our business could be adversely affected by the effects of SARS or another epidemic or outbreak. China reported a number of cases of SARS in April 2004. Any prolonged recurrence of SARS or other adverse public health developments in China may have a material adverse effect on our business operations. For instance, health or other governmental regulations adopted in response may require temporary closure of Internet cafes, which is one of the avenues where users could access our websites, or of our offices. Such closures would severely disrupt our business operations and adversely affect our results of operations. We have not adopted any written preventive measures or contingency plans to combat any future outbreak of SARS or any other epidemic.
Risks Related to Our Common Stock
There has been only a limited public market for our common stock to date.
To date, there has been only a limited public market for our common stock on the Over-the-Counter Bulletin Board. Our common stock is currently not listed on any exchange. If an active trading market for our common stock does not develop, the market price and liquidity of our common stock will be materially and adversely affected.
The market price for our common stock may be volatile.
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The market price for our common stock may be volatile and subject to wide fluctuations in response to factors including the following:
· actual or anticipated fluctuations in our quarterly operating results;
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· changes in financial estimates by securities research analysts, if any;
· conditions in the China consumer goods and online marketing markets;
· changes in the economic performance or market valuations of other U.S. public companies with substantial operations in China;
· announcements by us or our competitors of new products, acquisitions, strategic partnerships, joint ventures or capital commitments;
· addition or departure of key personnel;
· fluctuations of exchange rates between RMB and the U.S. dollar;
· intellectual property litigation; and
· general economic or political conditions in China.
In addition, the securities market has from time to time experienced significant price and volume fluctuations that are not related to the operating performance of particular companies. These market fluctuations may also materially and adversely affect the market price of our Common stock.
We will need additional capital, and the sale of additional common stock or other equity securities could result in additional dilution to our shareholders.
We expect to require additional cash resources to fund our operations, as well as investments or acquisitions which we may decide to pursue. To satisfy our cash requirements, we may seek to sell additional equity or debt securities or obtain a credit facility. The sale of additional equity securities could result in additional dilution to our shareholders. The incurrence of indebtedness would result in increased debt service obligations and could result in operating and financing covenants that would restrict our operations. We cannot assure you that financing will be available in amounts or on terms acceptable to us, if at all.
Substantial future sales or the perception of sales of our common stock in the public market could cause the price of our common stock to decline.
Sales of our common stock in the public market or the perception that these sales could occur, could cause the market price of our common stock to decline. As of November 30, 2006, approximately 63,967,197 shares, or 71% of our outstanding shares will be freely transferable without restriction or additional registration under the Securities Act of 1933, as amended, or the Securities Act or are subject to a pending registration statement. The remaining common stock outstanding as of such date will be available for sale, subject to volume and other restrictions as applicable under Rule 144 under the Securities Act.
You may face difficulties in protecting your interests, and your ability to protect your rights through the U.S. federal courts may be limited, because we conduct a significant portion of our operations in China and all of our officers reside outside the United States.
We conduct a substantial portion of our operations in China through our wholly owned subsidiaries in China. All of our officers reside outside the United States and some or all of the assets of those persons are located outside the United States. As a result, it may be difficult or impossible for you to bring an action against us or against these individuals in China in the event that you believe that your rights have been infringed under the securities laws or otherwise. Even if you are successful in bringing an action of this kind, the laws of China may render you unable to enforce a judgment against our assets or the assets of our directors and officers.
If we fail to maintain an effective system of internal control over financial reporting, we may not be able to accurately report our financial results or prevent fraud.
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We are subject to reporting obligations under the U.S. securities laws. The Securities and Exchange Commission, or the SEC, as required by Section 404 of the Sarbanes-Oxley Act of 2002, adopted rules requiring every public company to include a management report on such company’s internal controls over financial reporting in its annual report, which contains management’s assessment of the effectiveness of the company’s internal controls over financial reporting. In addition, an independent registered public accounting firm must attest to and report on management’s assessment of the effectiveness of the company’s internal controls over financial reporting.
These requirements may first apply to our annual report on Form 10-K for the fiscal year ending March 31, 2007. Our management may conclude that our internal controls over our financial reporting are not effective. Moreover, even if our management concludes that our internal controls over financial reporting are effective, our independent registered public accounting firm may still decline to attest to our management’s assessment or may issue a report that is qualified if they are not satisfied with our controls or the level at which our controls are documented, designed, operated or reviewed, or if it interprets the relevant requirements differently from us. Our reporting obligations as a public company will place a significant strain on our management, operational and financial resources and systems for the foreseeable future. We are a young company with limited accounting personnel and other resources with which to address our internal controls and procedures. If we fail to timely achieve and maintain the adequacy of our internal controls, we may not be able to conclude that we have effective internal controls over financial reporting at a reasonable assurance level. Moreover, effective internal controls over financial reporting are necessary for us to produce reliable financial reports and are important to help prevent fraud. As a result, our failure to achieve and maintain effective internal controls over financial reporting could result in the loss of investor confidence in the reliability of our financial statements, which in turn could harm our business and negatively impact the trading price of our common stock. Furthermore, we anticipate that we will incur considerable costs and use significant management time and other resources in an effort to comply with Section 404 and other requirements of the Sarbanes-Oxley Act.
We will incur increased costs as a result of being a public company.
As a public company, we will incur significant legal, accounting and other expenses that we did not incur as a private company. In addition, the Sarbanes-Oxley Act, as well as rules subsequently implemented by SEC has required changes in corporate governance practices of public companies. We expect these new rules and regulations to increase our legal, accounting and financial compliance costs and make certain corporate activities more time-consuming and costly. In addition, we will incur additional costs associated with our public company reporting requirements. We are currently evaluating and monitoring developments with respect to these new rules, and we cannot predict or estimate the amount of additional costs we may incur or the timing of such costs.
There is a limited public float of our common stock, which can result in increased volatility in our stock price and prevent the realization of a profit on resale of the Company’s common stock
There is a limited public float of our common stock. The term “public float” refers to shares freely and actively tradable on the Over-the-Counter Bulletin Board System and not owned by officers, directors or affiliates, as such term is defined under the Securities Act. Due to our relatively small public float and the limited trading volume of our common stock, purchases and sales of relatively small amounts of our common stock can have a disproportionate effect on the market price for our common stock. As a result, the market price of our common stock can have increased volatility which may affect a stockholder’s ability to sell our shares in a timely manner.
Our common stock is subject to restrictions on sales by broker-dealers and penny stock rules, which may be detrimental to investors.
Our common stock is subject to Rules 15g-1 through 15g-9 under the Exchange Act, which impose certain sales practice requirements on broker-dealers who sell our common stock to persons other than established customers and “accredited investors” (as defined in Rule 501(c) of the Securities Act). For transactions covered by this rule, 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 the sale. This rule adversely affects the ability of broker-dealers to sell our common stock and purchasers of our common stock to sell their shares of our common stock.
Additionally, our common stock is subject to SEC regulations applicable to “penny stock.” Penny stock includes any non-Nasdaq equity security that has a market price of less than $5.00 per share, subject to certain exceptions. The regulations require that prior to any non-exempt buy/sell transaction in a penny stock, a disclosure schedule proscribed by the SEC
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relating to the penny stock market must be delivered by a broker-dealer to the purchaser of such penny stock. This disclosure must include the amount of commissions payable to both the broker-dealer and the registered representative and current price quotations for our common stock. The regulations also require that monthly statements be sent to holders of penny stock that disclose recent price information for the penny stock and information of the limited market for penny stocks. These requirements adversely affect the market liquidity of our common stock.
When we account for employee share options using the fair value method, such accounting treatment could significantly reduce our net income.
On December 16, 2004, the Financial Accounting Standard Board, or FASB, issued FASB Statement No. 123(R), Share-Based Payment, which requires a public company to recognize, as an expense, the fair value of stock options and other share-based compensation to employees at the first fiscal year that begins on or after June 15, 2005. Currently, we record share-based compensation to the extent that the fair value of the shares on the date of grant exceeds the exercise price of the option. We recognize compensation expense over the related vesting periods. For the periods after December 31, 2005, we could have ongoing accounting charges significantly greater than those we would have recorded under our current method of accounting for share options. See “Management’s Discussion and Analysis of Financial Conditions and Results of Operations—Critical Accounting Policies for a more detailed presentation of accounting for share-based compensation plans.
Item 3. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
As at the end of the period covered by this report, the Company carried out an evaluation, under the supervision and with the participation of its Principal Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures. Based on this evaluation, the Principal Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective as of the end of the period covered by this report to ensure that information required to be disclosed by the Company in the reports filed by it under the Securities and Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and include controls and procedures designed to ensure that information required to be disclosed by the Company in such reports is accumulated and communicated to the Company’s management, including the Principal Executive Officer and Chief Financial Officer of the Company, as appropriate, to allow timely decisions regarding required disclosure.
Section 404 Compliance Project
Beginning with the fiscal year ending March 31, 2008, Section 404 of the Sarbanes-Oxley Act of 2002 will require us to include management’s report on our internal control over financial reporting in our Annual Report on Form 10-KSB. The internal control report must contain (1) a statement of management’s responsibility for establishing and maintaining adequate internal control over our financial reporting, (2) a statement identifying the framework used by management to conduct the required evaluation of the effectiveness of our internal control over financial reporting, (3) management’s assessment of the effectiveness of our internal control over financial reporting as of the end of our most recent fiscal year, including a statement as to whether or not our internal control over financial reporting is effective, and (4) a statement that our registered independent public accounting firm has issued an attestation report on management’s assessment of our internal control over financial reporting.
We plan to initiate a Section 404 compliance project pursuant to which management expects to adopt a detailed project work plan to assess the adequacy of our internal control over financial reporting, remediate any control deficiencies that may be identified, validate through testing that controls are functioning as documented and implement a continuous reporting and improvement process for internal control over financial reporting. During fiscal 2007 there have been no changes in ourinternal control over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Inherent Limitation of the Effectiveness of Internal Control
A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the internal control system are met. Because of the inherent limitations of any internal control system, no evaluation of controls can provide absolute assurance that all control issues, if any, within a company have been detected.
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None.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
During the quarter ended December 31, 2006, we issued shares in the following transactions pursuant to exemptions from the registration requirements of the Securities Act of 1933, as amended (the “Act”).
· In November 2006, we issued 153,000 shares of common stock at price of $2.30 per share and warrants to purchase an aggregate of 153,000 shares of common stock at an exercise price of $4.90 per share. These issuances were to an investor pursuant to Regulation S of the Act.
Item 3. Defaults Upon Senior Securities.
None.
Item 4. Submissions of Matters to a Vote of Security Holders
None.
None.
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Item 6. Exhibits and Reports on Form 8-K
No. |
| Description |
2.1 |
| Sale and Purchase Agreement dated June 30, 2006 to sell certain of the Registrant’s assets to Sun TV Shop, Plc. (incorporated by reference from our Current Report on Form 8-K filed on July 7, 2006) |
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2.2 |
| Updated letter from Moores Rowland Mazars, the Registrant’s former accountant (incorporated by reference from our Current Report on Form 8-K/A filed on July 11, 2006) |
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2.3 |
| Financials for the Sale and Purchase Agreement to Acquire Magzone Asia Pte Ltd, dated January 4, 2006 by and among Sun New Media, Inc. (the “Company”), Seeds Capital Pte Ltd, Wong Sing Lam, Tay Koon Chuan, and Wang Jian (collectively, the “Sellers”) (incorporated by reference from our Current Report on Form 8-K/A filed on July 21, 2006) |
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2.4 |
| Financials for the Sale and Purchase Agreement to acquire Lifestyle Magazines Publishing Pte. Ltd (“Lifestyle Magazine”). dated February 14, 2006 by and between Sun New Media, Inc. and United Home Limited (incorporated by reference from our Current Report on Form 8-K/A filed on August 7, 2006) |
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2.5 |
| Announcement of operating and financial results for the three months ended June 30, 2006 (incorporated by reference from our Current Report on Form 8-K filed on August 7, 2006), |
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2.6 |
| Financials for the Sale and Purchase agreement to acquire of Telefaith Holdings Ltd. dated December 8, 2005 by and among Sun New Media, Inc., Yan Hui, Lin Min, and Luan Kezhou (incorporated by reference from our Current Report on Form 8-K/A filed on August 8, 2006) |
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2.7 |
| Resignation of Mr. Qi Yang as Director of the Registrant (incorporated by reference from our Current Report on Form 8-K filed on August 24, 2006) |
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2.8 |
| Appointment of Grant Thornton HK as independent auditor for the fiscal period ending March 31, 2007 (incorporated by reference from our Current Report on Form 8-K filed on September 19, 2006) |
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2.9 |
| Appointment of Thomas A. Schuler as Chief Financial Officer (incorporated by reference from our Current Report on Form 8-K filed on September 25, 2006) |
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3.0 |
| Completion of the acquisition of William Brand Administer Limited and its subsidiary William Textiles Limited (incorporated by reference from our Current Report on Form 8-K filed on September 30, 2006) |
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3.1 |
| Resignation of Mr. Ricky Ang as CEO of the Company and Appointment of Dr. Bruno Wu as CEO of the Company (incorporated by reference from our Current Report on Form 8-K filed on October 5, 2006) |
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3.2 |
| Resignation of Dr. Herbert Kloiber as a member of the Board of Directors (incorporated by reference from our Current Report on Form 8-K filed on October 11, 2006) |
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3.3 |
| Resignation of Mr. William Adamopoulos as a member of the Board of Directors (incorporated by reference from our Current Report on Form 8-K filed on November 03, 2006) |
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3.5 |
| Sale and Purchase Agreement with the Sellers of Hubei Zhengyuan Co., Ltd, dated November 21, 2006 (incorporated by reference from our Current Report on Form 8-K filed on November 27, 2006) |
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3.6 |
| Resignation of Grant Thornton HK as independent auditor for the fiscal period ending March 31, 2007, and Reappointment of Bernstein & Pinchuk as independent auditor for the fiscal period ending March 31, 2007 (incorporated by reference from our Current Report on Form 8-K filed on December 6, 2006) |
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3.7 |
| Appointment of Mr. Walter Beach as a member of the Board of Directors (incorporated by reference from our Current Report on Form 8-K filed on December 6, 2006) |
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3.8 |
| Supplementary Agreement with Barron Partners LLP (“Barron”) to modify the terms of a Stock Purchase Agreement between Barron and the Company, dated December 31, 2007 (incorporated by reference from our Current Report on Form 8-K filed on February 6, 2007) |
52
31.1 |
| Certificate of CEO as Required by Rule 13a-14(a)/15d-14 |
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31.2 |
| Certificate of CFO as Required by Rule 13a-14(a)/15d-14 |
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32.1 |
| Certificate of CEO as Required by Rule 13a-14(b) and Rule 15d-14(b) (17 CFR 240.15d-14(b)) and Section 1350 of Chapter 63 of Title 18 of the United States Code |
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32.2 |
| Certificate of CFO as Required by Rule 13a-14(b) and Rule 15d-14(b) (17 CFR 240.15d-14(b)) and Section 1350 of Chapter 63 of Title 18 of the United States Code |
53
In accordance with the requirements of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
SUN NEW MEDIA, INC. |
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| |
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Date: Februrary 14, 2007 |
| By: | /s/ Bruno Wu Zheng |
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| Bruno Wu Zheng | |
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| Executive Chairman and Chief Executive Officer | |
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| |
Date: Februrary 14, 2007 |
| By: | /s/ Thomas A. Schuler |
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| Thomas A. Schuler | |
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| Chief Financial Officer |
54
No. |
| Description |
2.1 |
| Sale and Purchase Agreement dated June 30, 2006 to sell certain of the Registrant’s assets to Sun TV Shop, Plc. (incorporated by reference from our Current Report on Form 8-K filed on July 7, 2006) |
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2.2 |
| Updated letter from Moores Rowland Mazars, the Registrant’s former accountant (incorporated by reference from our Current Report on Form 8-K/A filed on July 11, 2006) |
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2.3 |
| Financials for the Sale and Purchase Agreement to Acquire Magzone Asia Pte Ltd, dated January 4, 2006 by and among Sun New Media, Inc. (the “Company”), Seeds Capital Pte Ltd, Wong Sing Lam, Tay Koon Chuan, and Wang Jian (collectively, the “Sellers”) (incorporated by reference from our Current Report on Form 8-K/A filed on July 21, 2006) |
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2.4 |
| Financials for the Sale and Purchase Agreement to acquire Lifestyle Magazines Publishing Pte. Ltd (“Lifestyle Magazine”). dated February 14, 2006 by and between Sun New Media, Inc. and United Home Limited (incorporated by reference from our Current Report on Form 8-K/A filed on August 7, 2006) |
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2.5 |
| Announcement of operating and financial results for the three months ended June 30, 2006 (incorporated by reference from our Current Report on Form 8-K filed on August 7, 2006), |
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2.6 |
| Financials for the Sale and Purchase agreement to acquire of Telefaith Holdings Ltd. dated December 8, 2005 by and among Sun New Media, Inc., Yan Hui, Lin Min, and Luan Kezhou (incorporated by reference from our Current Report on Form 8-K/A filed on August 8, 2006) |
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2.7 |
| Resignation of Mr. Qi Yang as Director of the Registrant (incorporated by reference from our Current Report on Form 8-K filed on August 24, 2006) |
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2.8 |
| Appointment of Grant Thornton HK as independent auditor for the fiscal period ending March 31, 2007 (incorporated by reference from our Current Report on Form 8-K filed on September 19, 2006) |
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2.9 |
| Appointment of Thomas A. Schuler as Chief Financial Officer (incorporated by reference from our Current Report on Form 8-K filed on September 25, 2006) |
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3.0 |
| Completion of the acquisition of William Brand Administer Limited and its subsidiary William Textiles Limited (incorporated by reference from our Current Report on Form 8-K filed on September 30, 2006) |
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|
3.1 |
| Resignation of Mr. Ricky Ang as CEO of the Company and Appointment of Dr. Bruno Wu as CEO of the Company (incorporated by reference from our Current Report on Form 8-K filed on October 5, 2006) |
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3.2 |
| Resignation of Dr. Herbert Kloiber as a member of the Board of Directors (incorporated by reference from our Current Report on Form 8-K filed on October 11, 2006) |
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3.3 |
| Resignation of Mr. William Adamopoulos as a member of the Board of Directors (incorporated by reference from our Current Report on Form 8-K filed on November 3, 2006) |
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3.5 |
| Sale and Purchase Agreement with the Sellers of Hubei Zhengyuan Co., Ltd, dated November 21, 2006 (incorporated by reference from our Current Report on Form 8-K filed on November 27, 2006) |
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3.6 |
| Resignation of Grant Thornton HK as independent auditor for the fiscal period ending March 31, 2007, and Reappointment of Bernstein & Pinchuk as independent auditor for the fiscal period ending March 31, 2007 (incorporated by reference from our Current Report on Form 8-K filed on December 6, 2006) |
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3.7 |
| Appointment of Mr. Walter Beach as a member of the Board of Directors (incorporated by reference from our Current Report on Form 8-K filed on December 6, 2006) |
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3.8 |
| Supplementary Agreement with Barron Partners LLP (“Barron”) to modify the terms of a Stock Purchase Agreement between Barron and the Company, dated December 31, 2007 (incorporated by reference from our Current Report on Form 8-K filed on February 6, 2007) |
55
31.1 |
| Certificate of CEO as Required by Rule 13a-14(a)/15d-14 |
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|
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31.2 |
| Certificate of CFO as Required by Rule 13a-14(a)/15d-14 |
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|
|
32.1 |
| Certificate of CEO as Required by Rule 13a-14(b) and Rule 15d-14(b) (17 CFR 240.15d-14(b)) and Section 1350 of Chapter 63 of Title 18 of the United States Code |
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32.2 |
| Certificate of CFO as Required by Rule 13a-14(b) and Rule 15d-14(b) (17 CFR 240.15d-14(b)) and Section 1350 of Chapter 63 of Title 18 of the United States Code |
56