UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
 
FORM 10-Q
 
þ    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended March 31, 2013
 
or
 
o    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from  ____________________ to _____________________
   
Commission File Number: 000-53155
 
VLOV INC .
(Exact name of issuer as specified in its charter)

Nevada
 
20-8658254
(State or other jurisdiction of  incorporation or organization)
 
(I.R.S.  employer  identification number)
     
5F, No. 151 Taidong Road
Xiamen Guanyin Shan International Business Center
Siming District, Xiamen City
Fujian Province 361008
People’s Republic of China
 
 
 
 
361008
 (Address of principal executive offices and zip code)
 
(Zip Code)

+86-592-2345999
(Registrant’s telephone number, including area code)
 
N/A
(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes  þ    No  o
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every, Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (Sec.232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes  þ    No  o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act (Check one):
 
 
Large Accelerated Filer
o
Accelerated Filer
o
 
Non-accelerated filer
o
Smaller reporting company
þ
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).  Yes  o    No  þ
 
As of May 17, 2013, the registrant had 2,637,753 shares of common stock outstanding.
 



 
 
 
 
 
TABLE OF CONTENTS
 
TO QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTER ENDED MARCH 31, 2013

     
Page
PART I
FINANCIAL INFORMATION
   
       
Item 1.
Financial statements (unaudited)
 
4
 
Condensed consolidated balance sheets as of March 31, 2013 (unaudited) and December 31, 2012
 
4
 
Condensed consolidated statements of comprehensive income for the three months ended March 31, 2013 and 2012 (unaudited)
 
5
 
Condensed consolidated statements of stockholder’s equity for the three months ended March 31, 2013 (unaudited)
 
6
 
Condensed consolidated statements of cash flows for the three months ended March 31, 2013 and 2012 (unaudited)
 
 7
 
Notes to the unaudited condensed consolidated financial statements
 
 8
Item 2.
Management's discussion and analysis of financial condition and results of operations
 
23
Item 3.
Quantitative and qualitative disclosures about market risk
 
29
Item 4.
Controls and procedures
 
29
       
PART II
OTHER INFORMATION
   
       
Item 1.
Legal proceedings
 
29
Item 1A.
Risk factors
 
29
Item 2.
Unregistered sales of equity securities and use of proceeds
 
29
Item 3.
Defaults upon senior securities
 
29
Item 4.
Reserved
 
29
Item 5.
Other information
 
29
Item 6.
Exhibits
 
30
Signatures
 
31
 
 
 

 
 
Forward Looking Statements

All statements contained in this quarterly report on Form 10-Q (“Form 10-Q”), other than statements of historical facts, that address future activities, events or developments are forward-looking statements, including, but not limited to, statements containing the words “believe,” “anticipate,” “expect” and words of similar import.  These statements are based on certain assumptions and analyses made by us in light of our experience and our assessment of historical trends, current conditions and expected future developments as well as other factors we believe are appropriate under the circumstances.  However, whether actual results will conform to the expectations and predictions of management is subject to a number of risks and uncertainties that may cause actual results to differ materially.

Such risks include, among others, the following: national and local general economic and market conditions; our ability to sustain, manage or forecast our growth; raw material costs and availability; new product development and introduction; existing government regulations and changes in, or the failure to comply with, government regulations; adverse publicity; competition; the loss of significant customers or suppliers; fluctuations and difficulty in forecasting operating results; changes in business strategy or development plans; business disruptions; the ability to attract and retain qualified personnel; the ability to protect technology; and other factors referenced in this and previous filings.

Consequently, all of the forward-looking statements made in this Form 10-Q are qualified by these cautionary statements and there can be no assurance that the actual results anticipated by management will be realized or, even if substantially realized, that they will have the expected consequences to or effects on our business operations.
 
Other Pertinent Information
 
All share and per share information in this Form 10-Q give effect to the 1-for-2.5 reverse split of our common stock effected on December 9, 2011, and the 1-for-3 reverse split of our common stock effected on September 24, 2012.
 
 
 

 
PART I - FINANCIAL INFORMATION
 
ITEM 1. FINANCIAL STATEMENTS

VLOV INC.
CONDSENSED CONSOLIDATED BALANCE SHEETS
(Amounts in thousands, in U.S. Dollars)

   
March 31,
2013
(Unaudited)
   
December 31,
2012
 
             
ASSETS
Current Assets:
           
Cash and cash equivalents
 
$
29,972
   
$
26,923
 
Accounts and other receivables
   
50,884
     
44,388
 
Trade deposits
   
717
     
872
 
Inventories
   
2,531
     
1,712
 
Prepaid expenses
   
25
     
673
 
Total current assets
   
84,129
     
74,568
 
Property, plant and equipment, net
   
1,114
     
1,121
 
Goodwill
   
5,290
     
5,260
 
TOTAL ASSETS
 
$
90,533
   
$
80,949
 
                 
LIABILITIES AND STOCKHOLDERS’ EQUITY
 
Current Liabilities:
               
Accounts payable
 
$
10,552
   
$
5,855
 
Accrued expenses and other payables
   
1,635
     
1,758
 
Amounts due to directors/officers
   
947
     
812
 
Taxes payable
   
2,646
     
3,905
 
Total current liabilities
   
15,780
     
12,330
 
                 
Stockholders’ Equity:
               
Common stock, $0.00001 par value, 13,333,334 shares authorized, 2,603,481 and 2,603,481 shares issued and outstanding as of March 31, 2013 and December 31, 2012, respectively
   
1
     
1
 
Preferred stock, $0.00001 par value, 100,000,000 shares authorized, 394,478 and 394,478 shares issued and outstanding as of March 31, 2013 and December 31, 2012, respectively (liquidation preference $1,128,207 and $1,128,207)
   
561
     
561
 
Additional paid-in capital
   
10,628
     
10,575
 
Statutory reserve
   
4,100
     
4,100
 
Retained earnings
   
55,439
     
49,778
 
Accumulated other comprehensive income
   
4,024
     
3,604
 
Total stockholders' equity
   
74,753
     
68,619
 
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY
 
$
90,533
   
$
80,949
 

See accompanying notes to unaudited condensed consolidated financial statements
 
 
4

 
 
VLOV INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Amounts in thousands, in U.S. Dollars- except for share and per share data)
(Unaudited)

   
Three Months Ended March 31,
 
   
2013
   
2012
 
             
Net sales
 
$
26,610
   
$
15,164
 
Cost of sales
   
15,072
     
7,387
 
Gross profit
   
11,538
     
7,777
 
                 
Operating expenses:
               
Selling expenses
   
2,848
     
2,432
 
General and administrative expenses
   
1,108
     
998
 
     
3,956
     
3,430
 
                 
Income from operations
   
7,582
     
4,347
 
                 
Other income (expenses):
               
Change in fair value of derivative liability
   
-
     
318
 
Interest income
   
-
     
17
 
     
-
     
335
 
                 
Income before provision for income taxes
   
7,582
     
4,682
 
Provision for income taxes
   
1,921
     
2,191
 
     
  
     
  
 
Net income
   
5,661
     
2,491
 
                 
Other comprehensive income:
               
Foreign currency translation adjustment
   
420
     
355
 
     
  
     
  
 
Comprehensive income
 
$
6,081
   
$
2,846
 
                 
Allocation of net income for calculating basic earnings per share:
               
Net income attributable to common shareholders
   
5,549
     
2,412
 
Net income attributable to preferred shareholders
   
112
     
79
 
Net income
 
$
5,661
   
$
2,491
 
                 
Basic earnings per share- common
 
$
2.13
   
$
0.95
 
                 
Diluted earnings per share
 
$
2.13
   
$
0.95
 
                 
Weighted average number of common shares outstanding:
               
Basic
   
2,603,481
     
2,529,417
 
Diluted
   
2,656,078
     
2,613,294
 

See accompanying notes to unaudited condensed consolidated financial statements

 
5

 
 
VLOV INC.
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(Amounts in thousands, in U.S. Dollars – except for share and per share data)
(Unaudited)
 
   
Common stock
   
Preferred stock
   
Additional
paid-in
   
Statutory
   
Accumulated
other
comprehensive
   
Retained
   
Total
 
  
 
Shares
   
Amount
   
Shares
   
Amount
   
capital
   
reserve
   
income
   
earnings
   
Equity
 
                             
                                                     
Balance at January 1, 2013
   
2,603,481
   
1
     
394,478
   
$
561
   
10,575
   
$
4,100
   
$
3,604
   
$
49,778
   
$
68,619
 
                                                                         
Net income
                                                           
5,661
     
5,661
 
Issuance of shares to officers/directors
                                   
53
                             
53
 
Foreign currency translation adjustment
                                                   
420
             
420
 
                 
                                                                       
Balance at March 31, 2013
   
2,603,481
   
$
1
     
394,478
   
$
561
   
$
10,628
   
$
4,100
   
$
4,024
   
$
55,439
   
$
74,753
 

See accompanying notes to unaudited condensed consolidated financial statements

 
6

 
 
VLOV INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Amounts in thousands, in U.S. Dollars)
(Unaudited)

 
Three Months Ended March 31,
 
 
2013
   
2012
 
             
Cash flows from operating activities:
           
Net income
 
$
5,661
   
$
2,491
 
Adjustments to reconcile net income to net cash provided by operating activities:
               
Depreciation and amortization
   
152
     
207
 
Stock compensation expense
   
53
     
53
 
Loss on disposal of property, plant and equipment
   
21
     
-
 
Change in fair value of derivative liability
   
-
     
(318
(Increase) decrease in assets:
               
Accounts and other receivables
   
(6,238
   
18,626
 
Trade deposits
   
159
     
(3,495
Inventories
   
(808
   
(57
Prepaid expenses
   
650
     
9
 
Increase (decrease) in liabilities:
               
Accounts payable
   
4,658
     
(4,712
)
Accrued expenses and other payables
   
(81
   
(218
Taxes payable
   
(1,279
)
   
(296
)
                 
Net cash provided by operating activities
 
$
2,948
   
$
12,290
 
                 
Cash flows from investing activities:
               
Purchases of property, plant and equipment
 
$
(158
 
$
-
 
Net cash used in investing activities
 
$
(158
 
$
-
 
                 
Cash flows from financing activities:
               
Amounts due to director
 
$
102
   
$
(1,076
Net cash provided by (used in) financing activities
 
$
102
   
$
(1,076
Effect of exchange rate changes
   
157
     
85
 
Net increase in cash and cash equivalents
   
3,049
     
11,299
 
Cash and cash equivalents, beginning of period
   
26,923
     
14,725
 
Cash and cash equivalents, end of period
 
$
29,972
   
$
26,024
 
                 
Supplemental disclosure of cash flow information:
               
Interest paid
 
$
-
   
$
-
 
Income taxes paid
 
$
2,420
   
$
1,800
 
 
See accompanying notes to unaudited condensed consolidated financial statements
 
 
7

 
 
VLOV INC.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2013

(1)           SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

(a)            Description of business and organization

VLOV Inc. (the “Company”) was incorporated on October 30, 2006 in the State of Nevada, under the name “Sino Charter, Inc.”  The Company changed its name to “VLOV Inc.” on March 20, 2009 in connection with the stock exchange transaction described below.

On February 13, 2009, the Company completed a stock exchange transaction with the stockholders of Peng Xiang Peng Fei Investments Limited (“PXPF”), whereby 1,941,334 restricted shares of common stock were issued to the stockholders of PXPF in exchange for 100% of the common stock of PXPF (the “Share Exchange”).  The completion of the Share Exchange resulted in a change of control.

The Share Exchange has been accounted for as a reverse acquisition and recapitalization of the Company whereby PXPF is deemed to be the accounting acquirer (legal acquiree) and the Company is the accounting acquiree (legal acquirer).  At the time of the Share Exchange, the Company had no assets or liabilities, and the 193,923 shares of its common stock outstanding immediately prior to the Share Exchange have been accounted for at their par value at the time of the Share Exchange.
 
The Company designs, markets and distributes “VLOV” brand men’s apparel and related products in the People’s Republic of China (“PRC” or “China”).  The Company also owns and operates retail stores (“company stores”) in Fujian Province.  All of the Company’s business operations are carried out by the Company’s subsidiary in China, Dong Rong (China) Co., Ltd. (“China Dong Rong”).  The Company also controls another company in China, Jinjiang Yinglin Jinduren Fashion Limited (“Yinglin Jinduren”), through contractual arrangements between Yinglin Jinduren and the Company’s subsidiary in Hong Kong, Dong Rong Capital Investment Limited (“HK Dong Rong”).  All of the Company’s business operations were conducted by Yinglin Jinduren until December 31, 2010.
 
As a result of the foregoing, the accompanying consolidated financial statements reflect the activities of the Company and each of the following entities:

Name
 
Background
 
Ownership
PXPF
 
A British Virgin Islands limited liability company
 
100%
   
Incorporated on April 30, 2008
   
           
HK Dong Rong
 
A Hong Kong limited liability company
 
100%
   
Incorporated on January 5, 2005 originally under the name “Korea Jinduren International Dress Limited”
   
   
Acquired by PXPF from the majority shareholders of PXPF on September 22, 2008
   
           
China Dong Rong
 
A PRC limited liability company and deemed a wholly foreign owned enterprise (“WFOE”)
 
100% 
   
Incorporated on November 19, 2009
   
   
Registered capital of $8 million fully funded
   
           
Yinglin Jinduren
 
A PRC limited liability company
 
VIE by
   
Incorporated on January 19, 2002
 
contractual
   
Registered capital of RMB 10,000,000 ($1,237,000) fully paid by Qingqing Wu, the Company’s Chief Executive Officer and Chairman of the Board of Directors, and his brother Zhifan Wu.
 
arrangements (1)
   
65.91% and 34.09% of outstanding equity interests held by Qingqing Wu and Zhifan Wu, respectively
   

(1)  
On December 28, 2005, HK Dong Rong (then known as Korea Jinduren International Dress Limited) entered into certain exclusive agreements with Yinglin Jinduren and its equity owners.  Pursuant to these agreements, HK Dong Rong provides exclusive consulting services to Yinglin Jinduren in return for a consulting services fee which is equal to Yinglin Jinduren’s net profits.  Prior to the Share Exchange, however, certain dividends were declared and paid from Yinglin Jinduren’s net income to the equity owners of Yinglin Jinduren.  In addition, Yinglin Jinduren’s equity owners have pledged their equity interests in Yinglin Jinduren to HK Dong Rong, irrevocably granted HK Dong Rong an exclusive option to purchase all or part of the equity interests in Yinglin Jinduren and agreed to entrust all the rights to exercise their voting power to the person(s) appointed by HK Dong Rong.
 
 
8

 
 
 
Through these contractual arrangements, HK Dong Rong has the ability to control Yinglin Jinduren’s daily operations and financial affairs, appoint its senior executives and approve all matters requiring shareholder approval. As part of these contractual arrangements, HK Dong Rong and Yinglin Jinduren entered into an operating agreement which, amongst other matters, precludes Yinglin Jinduren from borrowing money, selling or acquiring assets, including intellectual property rights, providing guarantees to third parties or assigning any business agreements, without the prior written consent of HK Dong Rong. HK Dong Rong also agreed that, if any guarantee for Yinglin Jinduren’s performance of any contract or loan was required, HK Dong Rong would provide such guarantee to Yinglin Jinduren.
 
As a result of these contractual arrangements, HK Dong Rong is entitled to receive the expected residual returns of Yinglin Jinduren. Additionally, although Yinglin Jinduren has been profitable, in the event that Yinglin Jinduren were to incur losses, HK Dong Rong would be obligated to absorb a majority of the risk of loss from Yinglin Jinduren’s activities as a result of its inability to receive payment for its accumulated consulting fees that are equal to Yinglin Jinduren’s net income.
 
The Company believes that the equity owners of Yinglin Jinduren do not have the characteristics of a controlling financial interest, and that the Company is the primary beneficiary of the operations and residual returns of Yinglin Jinduren and, in the event of losses, would be required to absorb a majority of such losses. Accordingly, the Company consolidates Yinglin Jinduren’s results, assets and liabilities in the accompanying financial statements. Due to the contractual arrangements, the net income and interest allocable to the non-controlling interest is zero.
 
The Company’s consolidated assets do not include any collateral for Yinglin Jinduren’s obligations. The creditors of Yinglin Jinduren do not have recourse to the general credit of the Company.
 
Since Yinglin Jinduren has no operations, the Company may dissolve it and exit from the contractual arrangements sometime in the future. Until then, however, the Company will continue operate its business through China Dong Rong while controlling Yinglin Jinduren through the contractual arrangements.
 
 (b)            Basis of presentation and consolidation

The accompanying unaudited condensed consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”).

The condensed consolidated financial statements include the financial statements of the Company, its subsidiaries and Yinglin Jinduren, which is considered a variable interest entity (“VIE”).  Yinglin Jinduren is considered a VIE because the Company is deemed to be its primary beneficiary by virtue of the contractual arrangements between HK Dong Rong and Yinglin Jinduren.  Because the Company and Yinglin Jinduren are under common control, the initial measurement of the assets and liabilities of Yinglin Jinduren for the purpose of consolidation by the Company is at book value.  All significant inter-company transactions and balances between the Company, its subsidiaries and the VIE are eliminated upon consolidation.  As of March 31, 2013, Yinglin Jinduren had no operations.
 
In the opinion of management, the accompanying unaudited condensed consolidated financial statements of the Company contain all adjustments, consisting of normal recurring adjustments, considered necessary for a fair presentation of the condensed consolidated balance sheets as of March 31, 2013 and December 31, 2012, the condensed consolidated statements of comprehensive income for the three months ended March 31, 2013 and 2012, and the condensed consolidated statements of cash flows for the three months ended March 31, 2013 and 2012.  The accompanying unaudited consolidated financial statements have been prepared in accordance with GAAP for interim financial information and the instructions to Rule 10-01 of Regulation S-X of the Securities and Exchange Commission (the “SEC”).  Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements.  The results of operations for the three months ended March 31, 2013 are not necessarily indicative of the results of operations to be expected for the full fiscal year.  These financial statements should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2012 .
 
(c)            Use of estimates

The preparation of condensed consolidated financial statements in conformity with GAAP requires the Company’s management to make certain estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the condensed consolidated financial statements.  The reported amounts of revenues and expenses during the reporting period may be affected by the estimates and assumptions that the management is required to make.  Estimates that are critical to the accompanying consolidated financial statements relate primarily to returns, sales allowances and customer chargebacks, allowance for doubtful accounts on receivables, reserves for inventory, the identification and valuation of derivative instruments, income taxes and impairment of goodwill.  Estimates and assumptions are reviewed periodically and the effects of revisions are reflected in the period that they are determined to be necessary.  Actual results could differ from these estimates .

(d)           Revenue recognition

Sales of goods - distributors

All of the Company’s products sold to its distributors are manufactured on its behalf by third-parties, based on orders from the distributors.  The Company is responsible for product design, product specification, pricing to the customer, the choice of third-party manufacturer, product quality and credit risk associated with the customer receivable.  As such, the Company acts as a principal and records revenues on a gross basis.
 
 
9

 
 
The Company recognizes revenue when (a) the price to the customer is fixed or determinable, (b) persuasive evidence of an arrangement exists, (c) delivery has occurred, and (d) collectability of the resulting receivable is reasonably assured.  Revenue from the sales of goods is recognized on the transfer of significant risks and rewards of ownership, which generally coincides with the time when the goods are delivered and the title has passed to the customer.  Revenue excludes value-added tax (“VAT”) and is stated after deduction of trade discounts and allowances.
 
Returns within three days of purchase are accepted only for quality reasons.  The Company has not yet had the experience to estimate and provide for such returns at the time of sale, and returns have been minimal to date.
 
In addition, the Company does not have any arrangements with its distributors to accept returns of obsolete or out-of-season stock.
 
Sales of goods - retail

In July 2011, the Company began operating company stores selling its products.  Revenue from retail sales is recognized at each point of sale.  During the three months ended March 31, 2013 and 2012, such sales accounted for 4.2% and 6.9% of the Company’s total revenue, respectively.
 
The Company’s retail revenue is net of VAT collected on behalf of PRC tax authorities in respect of the sale of merchandise.  VAT collected from customers, net of VAT paid for purchases, is recorded as a liability in the accompanying consolidated balance sheets until it is paid to the relevant PRC tax authorities.

Retail sales returns within seven days of purchase are accepted only for quality reasons.  The Company has not yet had the experience to estimate and provide for such returns at the time of sale, and returns have been minimal to date.

(e)           Cash and cash equivalents

For purposes of the  consolidated statements of cash flows, the Company considers all highly liquid instruments with original maturities of three months or less to be cash equivalents.  Cash and cash equivalents comprise cash at bank and on hand and demand deposits with banks.

(f)            Accounts receivable
 
Accounts receivable, including associated VAT, are unsecured, and are stated at the amount the Company expects to collect.  The Company maintains allowances for doubtful accounts for estimated losses resulting from the inability of its customers to make required payments.  The Company evaluates the collectability of its accounts receivable based on a combination of factors, including customer credit-worthiness and historical collection experience.  Management reviews the receivable aging and adjusts the allowance based on historical experience, financial condition of the customer and other relevant current economic factors.  Interest is not normally charged on accounts receivables.  As of May 13, 2013, there was $5,106 in accounts receivable aged over 120 days at March 31, 2013 that had not been collected.  Management believes that the remaining accounts receivable are collectable.  As of March 31, 2013 and December 31, 2012, there was no allowance for uncollectible accounts receivable.
 
(g)            Trade deposits

The Company places trade deposits with third-party manufacturers in order to secure its ability to order products.  The trade deposits are recorded at the amount paid to the manufacturers.  Trade deposits are applied against the manufacturers’ invoices for inventory purchases.  Inventory is recorded when received or title transfers to the Company.
 
(h)           Inventories
 
Inventories are stated at the lower of cost, determined by the weighted average method, or market value.  For the company stores, the Company carries out physical inventory counts on a monthly basis to ensure that the amounts reflected in the consolidated financial statements at each reporting period are properly stated and valued.  The Company records write-downs to inventories for shrinkage losses and damaged merchandise that are identified during the inventory counts. To date, such amounts have not been material to the consolidated financial statements. The Company also estimates an inventory allowance for excessive, slow moving and/or obsolete inventories as well as inventory which carrying value is in excess of net realizable value. As of March 31, 2013 and December 31, 2012, there was no allowance for inventory.  
 
(i)           Property, plant and equipment

Property, plant and equipment are stated at cost less accumulated depreciation and impairment losses.  Depreciation of property, plant and equipment is computed using the straight-line method based on the following estimated useful lives:
 
Leasehold improvements
1 to 5 years (amortized over the shorter of their economic lives or the remaining lease terms)
Motor vehicles
5 years
Office equipment
3 to 5 years
 
 
10

 

(j)            Impairment of long-lived assets
 
The Company estimates the future undiscounted cash flows to be derived from an asset to assess whether or not a potential impairment exists when events or circumstances indicate the carrying value of a long-lived asset may be impaired.  If the carrying value exceeds the Company’s estimate, the Company then calculates the impairment as the excess of the carrying value of the asset over the Company’s estimate of its fair market value. There was no indication of impairment to long-lived assets as of March 31, 2013 and December 31, 2012.
 
(k)            Goodwill

In September 2011, the Financial Accounting Standards Board (“FASB”) issued an authoritative pronouncement related to testing goodwill for impairment.  The guidance permits the Company to first assess qualitative factors to determine whether it is “more likely than not” that the fair value of a reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two-step goodwill impairment test.  The Company adopted this pronouncement as of the first quarter of 2012.  If it is more likely than not that the fair value of a reporting unit is less than its carrying amount, goodwill is then tested following a two-step process.  The first step compares the fair value of each reporting unit to its carrying amount, including goodwill.  If the fair value of each reporting unit exceeds its carrying amount, goodwill is not considered to be impaired and the second step will not be required.  If the carrying amount of a reporting unit exceeds its fair value, the second step compares the implied fair value of goodwill to the carrying value of a reporting unit’s goodwill.  The implied fair value of goodwill is determined in a manner similar to accounting for a business combination with the allocation of the assessed fair value determined in the first step to the assets and liabilities of the reporting unit.  The excess of the fair value of the reporting unit over the amounts assigned to the assets and liabilities is the implied fair value of goodwill.  An impairment loss is recognized for any excess in the carrying value of goodwill over the implied fair value of goodwill.
 
There was no indication of impairment to goodwill as of March 31, 2013 and December 31, 2012.
 
(l)            Foreign currency translation

The Company’s functional currency is the Renminbi (“RMB”).  The accompanying condensed consolidated financial statements of the Company are translated from RMB into U.S. dollars (“$”).  Accordingly, all assets and liabilities are translated at the exchange rates prevailing at the balance sheet dates, all income and expenditure items are translated at the average rates for each of the periods and equity accounts, except for retained earnings, are translated at the rate at the transaction date.  Retained earnings reflect the cumulative net income (loss) translated at the average rates for the respective periods since inception, less dividends translated at the rate at the transaction date .

RMB is not a fully convertible currency.  All foreign exchange transactions involving RMB must take place either through the People's Bank of China (the “PBOC”) or other institutions authorized to buy and sell foreign exchange.  The exchange rates adopted for the foreign exchange transactions are the rates of exchange quoted by www.oanda.com, which are determined largely by supply and demand.  The rates of exchange quoted by www.oanda.com on March 31, 2013 and December 31, 2012 were $1.00 to RMB 6.27 and RMB 6.31, respectively.  The average translation rates of $1.00 to RMB 6.28 and RMB 6.31 were applied to the income statement accounts for the three months ended March 31, 2013 and 2012, respectively.

No representation is made that the RMB amounts could have been, or could be, converted into U.S. dollars at the above rates. The value of RMB against U.S. dollars and other currencies may fluctuate and is affected by, among other things, changes in China’s political and economic conditions. Any significant revaluation of RMB may materially affect the Company’s financial condition in terms of U.S. dollar reporting.
 
Translation adjustments are recorded as other comprehensive income in the condensed consolidated statements of comprehensive income and as a separate component of stockholders equity .

Commencing from July 21, 2005, China adopted a managed floating exchange rate regime based on market demand and supply with reference to a basket of currencies.  Since then, the PBOC administers and regulates the exchange rate of $ against RMB taking into account the demand and supply of RMB, as well as domestic and foreign economic and financial conditions.

(m)          Comprehensive income

The Company’s only component of other comprehensive income is foreign currency translation gains and losses.  Foreign currency translation gains for the three months ended March 31, 2013 and 2012 were $420,000 and $355,000, respectively.  Accumulated other comprehensive income is recorded as a separate component of stockholders’ equity.

(n)          Income taxes

The Company accounts for income taxes under the liability method.  Deferred income taxes are recognized for the estimated tax consequences in future years, as differences between the tax bases of assets and liabilities and their financial reporting amounts at each year-end, based on enacted tax laws and statutory rates applicable to the periods in which the differences are expected to affect taxable income.  Valuation allowances are established to reduce deferred tax assets to the amount expected to be realized when, in management’s opinion, it is more likely than not that some portion of the deferred tax assets will not be realized.  The provision for income taxes represents current taxes payable net of the change during the period in deferred tax assets and liabilities.
    
 
11

 
 
The Company’s income tax returns are subject to examination by the Internal Revenue Service (“IRS”) and other tax authorities in the locations where it operates.  The Company assesses potentially unfavorable outcomes of such examinations based on the criteria of FASB ASC 740-10-25-5 through 740-10-25-7 and 740-10-25-13 .  The interpretation prescribes a more-likely-than-not threshold for financial statement recognition and measurement of a tax position taken (or expected to be taken) in a tax return.  This interpretation also provides guidance on derecognition of income tax assets and liabilities, classification of current and deferred income tax assets and liabilities, accounting for interest and penalties associated with tax positions, accounting for income taxes in interim periods and income tax disclosures.
 
According to the PRC Tax Administration and Collection Law, the statute of limitations is three years if the underpayment of taxes is due to computational or other errors made by the taxpayer or the withholding agent.  The statute of limitations extends to five years under special circumstances.  In the case of transfer pricing issues, the statute of limitations is ten years.  There is no statute of limitations in the case of tax evasion.  Accordingly, the income tax returns of China Dong Rong and Yinglin Jinduren for the years ended December 31, 2010 through 2012 are open to examination by the PRC central and local tax authorities.  The Company records interest and penalties as other expense on the consolidated statements of comprehensive income.  During the three months ended March 31, 2013 and 2012, the Company did not recognize any amount in interest and penalties.
 
(o)          Advertising costs
 
Advertising costs are expensed and reflected in selling expenses on the consolidated statements of comprehensive income in the period in which the advertisements are first run.  Advertising expense for the three months ended March 31, 2013 and 2012 was approximately $1.57 million and $1.54 million, respectively.

(p)           Shipping and handling costs

Shipping and handling costs are expensed as incurred and included in selling expense. Such costs were insignificant for the three months ended March 31, 2013 and 2012.

(q)           Research and development costs

The Company charges all product design and development costs to expense when incurred, and such costs are reflected in general and administrative expenses on the consolidated statements of income and comprehensive income.  Such costs were approximately $0.53 million and $0.59 million for the three months ended March 31, 2013 and 2012, respectively.

(r)            Operating leases

Leases where substantially all the risks and rewards of ownership of assets remain with the lessor are accounted for as operating leases.  Annual rentals applicable to such operating leases are charged to expense on a straight-line basis over the lease terms except where an alternative basis is more representative of the pattern of benefits to be derived from the leased assets.  Lease incentives received are recognized as an integral part of the aggregate net lease payments made.  Contingent rentals are charged to expense in the accounting period in which they are incurred.

(s)           Derivative financial instruments

The Company does not use derivative instruments to hedge exposures to cash flow, market, or foreign currency risks.

The Company reviews the terms of convertible debt or convertible preferred stock that it issues to determine whether there are embedded derivative instruments, including the embedded conversion option, that are required to be bifurcated and accounted for separately as a derivative financial instrument.  Also, in connection with the sale of convertible debt or equity instruments, the Company may issue freestanding warrants that may, depending on their terms, be accounted for as derivative instrument liabilities, rather than as equity.

For derivative financial instruments that are accounted for as liabilities, each such derivative instrument is initially recorded at its fair value and is then re-valued at each reporting date, with changes in the fair value reported as charges or credits to income.  For option-based derivative financial instruments, the Company uses a binomial option pricing model to value the derivative instruments.
 
(t)            Fair value of financial instruments

The carrying amounts of the Company’s financial instruments, which principally include cash and cash equivalents, time deposits, accounts receivable and accounts payable, approximate their fair values due to the relatively short maturity of such instruments.

Warrants that are recorded as derivative instrument liabilities are carried at their fair value, with changes in the fair value reported as charges or credits to income each period.
 
(u)           Earnings per share

Basic net income per share is computed by dividing net income attributable to common shareholders by the weighted average number of shares of common stock outstanding during the period.  Diluted earnings per share is calculated by dividing net income by the weighted-average number of common shares used in the basic earnings per share calculation plus the number of common shares that would be issued assuming exercise or conversion of all potentially dilutive common stock equivalents outstanding.  Equity instruments are excluded from the calculation of diluted earnings per share if the effect of including such instruments is anti-dilutive.
 
 
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(v)           Recent accounting pronouncements
 
In February 2013, the FASB issued ASU No. 2013-02 Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income , which is intended to improve the reporting of reclassifications out of accumulated other comprehensive income. It does not change the current requirements for reporting net income or other comprehensive income in financial statements. However, the standard requires an entity to provide information about the amounts reclassified out of accumulated other comprehensive income by component. For public entities, the amendments are effective prospectively for reporting periods beginning after December 15, 2012, with early adoption permitted. The adoption of the provision in this ASU did not have a material impact on the Company’s consolidated financial statements.
 
Other accounting standards that have been issued or proposed by the FASB or other standards-setting bodies that do not require adoption until a future date are not expected to have a material impact on the Company’s consolidated financial statements upon adoption .
(2)           ACCOUNTS AND OTHER RECEIVABLES

Accounts and other receivables consist of the following (in thousands):

   
March 31,
   
December 31,
 
   
2013
   
2012
 
   
(unaudited)
       
Accounts receivable
 
$
50,683
   
$
43,992
 
Other receivables
   
201
     
396
 
Allowance for doubtful accounts
   
-
     
-
 
                 
   
$
50,884
   
$
44,388
 

All of the Company’s customers are located in the PRC except for one distributor that sells the Company’s products in New York City.  The Company provides credit in the normal course of business.  The Company performs ongoing credit evaluations of its customers and maintains allowances for doubtful accounts based on factors surrounding the credit risk of specific customers, historical trends, and other information.  
 
(3)          INVENTORIES

Inventories consist of the following (in thousands):

   
March 31,
   
December 31,
 
   
2013
   
2012
 
   
(unaudited)
       
Finished goods
 
$
2,531
   
$
1,712
 
(4)          TRADE DEPOSITS

Trade deposits (in thousands):

   
March 31,
   
December 31,
 
   
2013
   
2012
 
   
(unaudited)
       
Trade deposits
 
$
717
   
$
872
 
 
 
13

 
 
Trade deposits consist of deposits made to third-party manufacturers in order for them to manufacture on behalf of the Company.  As of March 31, 2013, 100% of the balance was with the Company’s two top manufacturers. As of December 31, 2012, 100% of the balance was with the top three manufacturers.
   
(5)          BUSINESS COMBINATION

In May 2011, the Company entered into an agreement with its then Fujian distributor to acquire the distributor’s retail network of 13 stores for $6,684,000 (RMB 44,100,000) in cash.  The Company completed this acquisition on June 30, 2011 and has reported its operations since July 1, 2011.  This acquisition resulted in a new segment, company stores, as further disclosed in Note 16.
 
The following table summarizes the fair value of the assets acquired and liabilities assumed at the date of acquisition (in thousands):

Total purchase price:
  $
6,684
 
         
Allocation of the purchase price to assets and liabilities at fair value:
       
Inventories
   
151
 
Prepaid rent
   
98
 
Leasehold improvements
   
469
 
Property, plant and equipment
   
17
 
Net assets acquired at fair value
   
735
 
         
Pre-existing distribution agreement
   
919
 
Goodwill
   
5,030
 
Total intangible assets acquired
  $
5,949
 

The pre-existing distribution agreement recognized in conjunction with the acquisition represents the intangible value of the reacquisition of the distribution license that was granted by the Company to its Fujian distributor.  The value assigned to the pre-existing distribution agreement has been fully amortized as of December 31, 2011.

The goodwill recognized in conjunction with the acquisition represents intangible values of the acquired store locations for their future profit potential that do not qualify for separate recognition, or other factors.
(6)          PROPERTY, PLANT AND EQUIPMENT

Property, plant and equipment is summarized as follows (in thousands):

   
March 31,
2013
   
December 31,
2012
 
   
(unaudited)
         
Leasehold improvements
 
2,265
   
2,170
 
Motor vehicles
   
56
     
56
 
Office equipment
   
111
     
105
 
                 
Total property, plant and equipment
   
2,432
     
2,331
 
Less: accumulated depreciation
   
(1,318
   
(1,210
                 
Property, plant and equipment, net
 
$
1,114
   
$
1,121
 

Depreciation expense was $152 and $207 for the three months ended March 31, 2013 and 2012, respectively.
 
During the three months ended March 31, 2013, the Company disposed of leasehold improvements with a collective net book value of $21, for nil, resulting in a loss of $21 .
 
 
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(7)          GOODWILL

Goodwill (see Note 5) consists of the following (in thousands):
 
   
March 31,
2013
   
December 31,
2011
 
   
(unaudited)
       
Beginning of period
 
$
5,260
   
$
5,219
 
Exchange realignment
   
30
     
41
 
                 
End of period
 
$
5,290
   
$
5,260
 
  
(8)            ACCRUED EXPENSES AND OTHER PAYABLES

Accrued expenses and other payables are summarized as follows (in thousands):

   
March 31,
2013
   
December 31, 
2012
 
   
(unaudited)
       
Accrued salaries and wages
 
$
101
   
$
87
 
Accrued liquidated damages (Note 10)
   
987
     
987
 
Accrued expenses
   
342
     
480
 
Advertising subsidies payable
   
205
     
204
 
   
$
1,635
   
$
1,758
 
  
(9)          RELATED PARTY TRANSACTIONS

Related party transactions are summarized as follows (in thousands):

   
March 31,
2013
   
December 31, 
2012
 
   
(unaudited)
       
Qingqing Wu (1)
 
$
760
   
$
664
 
Bennet Tchaikovsky (2)
   
45
     
23
 
Ying Zhang (3)
   
104
     
97
 
Jianwei Shen (3)
   
18
     
12
 
Jianhui Wang (3)
   
20
     
16
 
   
$
947
   
$
812
 

(1)  
The amount due to this director is unsecured, interest-free and repayable on demand.
(2)  
Represents compensation and reimbursable expenses owed.
(3)  
Represents cash compensation owed.

Mr. Qingqing Wu currently has four trademarks registered in his name that were intended to be transferred to Yinglin Jinduren for no consideration prior to the closing of the Share Exchange on February 13, 2009.  As such transfers could not be timely effected, Mr. Wu entered into trademark license contracts with Yinglin Jinduren on February 12, 2009, pursuant to which he perpetually granted Yinglin Jinduren the rights to use these trademarks for no consideration.  Mr. Wu is also in the process of transferring the trademarks to Yinglin Jinduren for no consideration as originally intended, although such transfers have not been completed.  To date, Yinglin Jinduren has not utilized these trademarks, and the Company considers the value of these trademarks to be de minimis.  Upon completion of the transfer to Yinglin Jinduren, the trademarks will be transferred to China Dong Rong.

(10)          SALE OF PREFERRED STOCK, COMMON STOCK AND WARRANTS

On October 27, 2009, the Company issued 1,446,105 shares of the Company’s series A convertible preferred stock (the “Preferred Shares”) to several accredited investors at $2.86 per share, as well as warrants to 96,407 purchase shares of the Company’s common stock.  On November 17, 2009, the Company issued an additional 1,350,616 Preferred Shares to several accredited investors, as well as warrants to purchase 90,041 shares of common stock.  The Company issued the Preferred Shares and warrants pursuant to a securities purchase agreement with the investors, and gross proceeds from both issuances amounted to $8.0 million in the aggregate (the “Preferred Shares Financing”).  The 1,446,105 Preferred Shares issued on October 27, 2009 and the 1,350,616 Preferred Shares issued on November 17, 2009 are convertible into 192,814 common shares and 180,082 common shares, respectively.
 
 
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The designation, rights, preferences and other terms and provisions of the Preferred Shares are set forth in the Certificate of Designation filed with the Nevada Secretary of State on October 23, 2009 (the “Certificate”).  The Preferred Shares are convertible into 0.1333 shares of common stock at $21.45 per share (subject to certain adjustments) at any time at the holder’s option, and will automatically convert when the Company’s common stock is qualified for listing on either the NASDAQ Capital Market or the NYSE Amex Equities.  The Preferred Shares are entitled to participate in any dividends declared and paid on the Company’s common stock on an as-converted basis.  Holders of the Preferred Shares are also entitled to notice of any stockholders’ meeting and vote together with common stock holders on an as-converted basis.  Additionally, as long as any Preferred Shares are outstanding, the Company cannot, without the affirmative vote of the holders of a majority of the then outstanding Preferred Shares, (a) alter or change adversely the powers, preferences, or rights given to the Preferred Shares or alter or amend the Certificate, (b) authorize or create any class of stock ranking as to dividends, redemption or distribution of assets upon a Liquidation (as defined in Section 5 of the Certificate) senior to or otherwise pari passu with the Preferred Shares, (c) amend its charter documents in any manner that adversely affects any rights of the holders of Preferred Shares, (d) increase the number of authorized shares of Preferred Shares, or (e) enter into any agreement with respect to any of the foregoing.  Each Preferred Share also has a liquidation preference of $2.86 per share, plus any accrued but unpaid dividends.  
Each warrant entitles its holder to purchase one share of common stock at an exercise price of $25.725 per share (subject to certain adjustments) for a period of three years.  The Company is also entitled to redeem the warrants for the then applicable exercise price if the volume-weighted average price of the common stock for 20 consecutive days exceeds 200% of the then applicable exercise price.
 
The conversion price of the Preferred Shares and the exercise price of the warrants are subject to anti-dilution adjustments in the event that the Company issues additional equity, equity linked securities or securities convertible into common stock at a purchase price less than the then applicable conversion or exercise price (other than shares issued to the Company’s officers, directors, employees or consultants pursuant to any stock or option plan duly adopted by a majority of the Company’s non-employee directors, or issued upon the conversion or exercise of any securities outstanding as of the closing date of the Preferred Shares Financing, or for acquisitions or strategic transactions approved by a majority of the Company’s directors).  The conversion and exercise prices are also subject to customary adjustments for stock dividends, stock splits, reverse stock splits or other similar transactions.
   
In connection with the Purchase Agreement, certain of the Company’s shareholders entered into a lock-up agreement (the “Lock-up Agreement”) whereby they agreed not to offer, sell, or other dispose of (a) 50% of their common stock holdings for nine months from the initial closing of the Preferred Shares Financing, and (b) the remaining 50% of their common stock holdings for twelve months from the initial closing.

In connection with the Preferred Shares Financing, the Company agreed to place $150,000 of its gross proceeds and Warrants to purchase up to 40,000 shares of common stock in an escrow account to be expended for investor relations, pursuant to the terms of an escrow agreement.

Gilford Securities, Incorporated acted as the placement agent in connection with the Preferred Shares Financing. 

On December 1, 2009, the Company issued 87,138 shares of common stock to several accredited investor at $21.45 per share, as well as warrants to purchase 43,569 common shares.  The terms of these warrants are identical to those issued in the Preferred Shares Financing.  The Company issued the common stock and warrants pursuant to a securities purchase agreement with the investors, and gross proceeds from the issuance amounted to $1.87 million (the “Common Shares Financing,” and together with the Preferred Shares Financing, the “Financings”).  
 
In connection with the Financings, the Company timely filed a registration statement registering for resale the issued common shares and those underlying the Preferred Shares and warrants on December 17, 2009.  The registration statement, however, was not declared effective until March 30, 2011, thereby subjecting the Company to liquidated damages of $987,000, or 1% of the gross proceeds from the Financings per month, up to 10%.  As of March 31, 2013 and December 31, 2012, the Company accrued the full amount of the liquidated damages (Note 21).
 
Because the warrants contain provisions that would reduce their exercise price in the event that the Company issues additional equity, equity linked securities or securities convertible into common stock at a purchase price less than the then applicable conversion or exercise price, and because the warrants are denominated in a currency that is different from the Company’s functional currency, they were accounted for as derivative instrument liabilities (see Note 11). The warrants from both Financings expired during the fourth quarter of 2012.

The Preferred Shares are not subject to redemption (except on liquidation), are entitled to participate in any dividends declared and paid on the Company’s common stock on an as-converted basis, and the holders of the Preferred Shares are entitled to vote together with common stock holders on an as-converted basis.  The Preferred Shares, excluding the embedded conversion option, are considered to be an equity instrument and accordingly, the embedded conversion option has not been separated and accounted for as a derivative instrument liability.  However, the Company has recognized a beneficial conversion feature related to the Preferred Shares, to the extent that the conversion feature, based on the proceeds allocated to the Preferred Shares, was in-the-money at the time they were issued.  Such beneficial conversion feature amounted to approximately $1.973 million and $2.030 million related to the initial closing and the final closing of the Preferred Shares Financing, respectively.  Because the Preferred Shares do not have a stated redemption date and may be converted by the holder at any time, the discount recognized by the allocation of proceeds to the beneficial conversion feature has been immediately amortized through retained earnings as a deemed dividend to the holders of the Preferred Shares.

(11)        DERIVATIVE FINANCIAL INSTRUMENTS

Prior to their expiration, the Company used a binomial option pricing model to value the warrants issued in the Financing.  In valuing the warrants at the time they were issued and at March 31, 2012, the Company used the market price of its common stock on the date of valuation, an expected dividend yield of 0% and the remaining period to the expiration date of the warrants.  All warrants could have been exercised by the holder at any time.
 
 
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Because of the relatively limited historical trading period of the Company’s common stock, the expected volatility of its common stock over the then remaining life of the warrants, which was estimated at 77% as of March 31, 2012, was based on a review of the volatility of entities considered by management as comparable.  The risk-free rate of return used for the three months ended March 31, 2012 was 0.16%, based on constant maturity rates published by the U.S. Federal Reserve, applicable to the then remaining life of the warrants.  Dividend was estimated at 0% at March 31, 2012.
 
At March 31, 2013 and December 31, 2012, no derivative liabilities related to common stock warrants were outstanding as all the common stock warrants expired during the fourth quarter of 2012.
 
During the three months ended March 31, 2012, the Company recognized a gain of $318 from the change in fair value of the warrant liability.
  
(12)       COMMON STOCK

All amounts in this note are in thousands except for share data (shares, par value and price per share).  In addition, all common share and per share amounts, and exercise prices of warrants and options in these notes and the accompanying unaudited consolidated financial statements have been retroactively restated to reflect the reverse stock splits described below.
 
The Company is authorized to issue 13,333,334 shares of common stock, $0.00001 par value per share.  At March 31, 2013, 2,603,481 shares of common stock were issued and outstanding.

The Company had 193,923 common shares outstanding prior to the Share Exchange with PXPF, and, as described in Note 1, issued 1,941,334 common shares to the shareholders of PXPF in connection with the Share Exchange.  For accounting purposes, the shares issued to the shareholders of PXPF are assumed to have been outstanding on January 1, 2008, and the 193,923 shares held by the existing shareholders of the Company prior to the Share Exchange on February 13, 2009 are assumed to have been issued on that date in exchange for the net assets of the Company.

On December 1, 2009, the Company sold 87,138 shares of common stock to certain accredited investors (see Note 10).
  
During the year ended December 31, 2010, 1,100 warrants were exercised for, and 1,747,962 Preferred Shares were converted into, 1,100 and 233,062 shares of common stock, respectively.  In addition:

On March 10, 2010, the Company entered into a service agreement with a non-executive director and agreed to issue 1,334 shares of restricted common stock in four quarterly installments for her annual service.  The term of the service agreement was continued on March 10, 2013, with 1,334 shares of restricted common stock to be issued in four quarterly installments accordingly.  The fair value of the granted shares on March 10, 2013 and 2012 was $3.30 and $11.91 per share, respectively, for total values of $4 and $16, respectively.  $3 and $4 were recognized as compensation expense for the three months ended March 31, 2013 and 2012, respectively.

On April 27, 2010, the Company entered into an agreement to issue 2,667 shares of restricted common stock to Worldwide Officers Inc.  (“WOI”) for the services of its chief financial officer for one year, which would vest as follows: 475 shares on June 30, 2010, 672 shares on September 30, 2010, 672 shares on December 31, 2010, 658 shares on March 31, 2011 and 190 shares on April 26, 2011.  The fair value of the granted shares on April 27, 2010 was $37.50 per share for a total value of $100.   $32 was recognized as compensation expense for the year ended December 31, 2011.

During the year ended December 31, 2011, 415,906 Preferred Shares were converted into 55,454 shares of common stock.  In addition:

On September 28, 2011, the Company entered into an agreement to issue 2,648 shares of restricted common stock to WOI for the chief financial officer’s services from April 27, 2011 through September 27, 2011.  The fair value of the granted shares on September 28, 2011 was $9.75 for a total value of $26.  $26 was recognized as compensation expense for the year ended December 31, 2011.

On September 28, 2011, the Company entered into an agreement to grant WOI a restricted stock award of $200 of its common stock for each one-year term of the chief financial officer, $100 of which is calculated based on the closing price of the common stock on the first day of such term, and the other $100 calculated based on the closing price on the first day immediately after the initial 6-month period of such term.  In connection therewith, 10,257 shares were granted to WOI for the initial 6-month period term (the “First Issuance”), and 8,482 shares for the subsequent 6-month term (the “Second Issuance”), calculated based on the closing prices of the Company’s common stock as quoted on the OTC Bulletin Board on September 28, 2011 of $9.75, and on March 28, 2012 of $11.79, respectively.  The term of the agreement was continued on September 28, 2012 with 12,049 shares granted to WOI for the initial 6-month period of the renewal term (the “Third Issuance”) and 22,223 shares for the second 6-month period (the “Fourth Issuance”), calculated based on the closing prices of $8.30 on September 28, 2012, and $4.50 on March 28, 2013, respectively.  The First Issuance vested in two installments of 5,128 shares each on December 27, 2011 and March 27, 2012.  The Second Issuance vested in two installments of 4,241 shares each on June 27 and September 27, 2012.  The Third Issuance vested in two installments of 6,025 shares each on December 27, 2012 and March 27, 2013.  The Fourth Issuance will vest in two installments of 11,111 shares each on June 27 and September 27, 2013.   For the First Issuance and Second Issuance, compensation expense of $0 and $50 was recognized for the three months ended March 31, 2013 and 2012, respectively.  For the Third Issuance, compensation expense of $47 and $0 was recognized for the three months ended March 31, 2013 and 2012, respectively.  For the Fourth Issuance, compensation expense of $2 and $0 was recognized for the three months ended March 31, 2013 and 2012, respectively.
 
 
17

 
 
On December 9, 2011, the Company effected a 1-for-2.5 reverse stock split of its issued and outstanding shares of common stock and a proportional reduction of its authorized shares of common stock.

During the year ended December 31, 2012, 238,375 Preferred Shares were converted into 31,784 shares of common stock.  In addition:

On May 21, 2012, the Company’s Board of Directors (the “Board”) approved a stock plan pursuant to which up to 266,667 shares of common stock may be issued to officers, directors, employees and consultants (the “2012 Stock Plan”).

On May 25, 2012, the Board ratified an agreement with a consultant to provide one year of strategic public relations services from May 4, 2012 to May 3, 2013 in exchange for 22,333 shares of common stock to be issued under the Company’s 2012 Stock Plan.  The fair value of such shares on May 25, 2012 was $10.20, for a total value of $228.  Compensation expense of $228 and $0 was recognized for years ended December 31, 2012 and 2011, respectively.  The shares were issued in July 2012.

On July 25, 2012, the Board ratified an agreement with a consultant to provide the Company with general advice and consulting services from July 20, 2012 to July 19, 2013, regarding the Company’s expansion into the Taiwan, in exchange for 11,667 shares of common stock to be issued under the Company’s 2012 Stock Plan.  The fair value of such shares on July 25, 2012 was $6.15, for a total value of $72.  Compensation expense of $72 and $0 was recognized for the years ended December 31, 2012 and 2011, respectively. The shares were issued in July 2012.

On September 24, 2012, the Company effected a 1-for-3 reverse stock split of its issued and outstanding shares of common stock and a proportional reduction of its authorized shares of common stock.

A summary of the status of the Company’s non-vested shares as of March 31, 2013 and changes during the year ended December 31, 2012, is presented below:

Non-vested shares
 
Shares
   
Weighted-Average Grant Date
Fair Value
 
Non-vested at January 1, 2012
   
5,461
   
$
9.87
 
Granted
   
9,815
     
11.82 
 
Vested
   
(5,722
)
 
$
10.02
 
Forfeited
   
-
     
-
 
Non-vested at March 31, 2012
   
9,554
   
$
11.82
 
Granted
   
46,050
   
$
8.68
 
Vested
   
(49,627
)
 
$
9.30
 
Forfeited
   
-
     
-
 
Non-vested at December 31, 2012
   
5,977
   
$
8.45
 
Granted
   
23,557
     
4.43
 
Vested
   
(6,421
)
 
$
8.16
 
Forfeited
   
-
     
-
 
Non-vested at March 31, 2013
   
23,113
   
$
4.43
 
 
As of March 31, 2013, there was $104 of total unrecognized compensation cost related to non-vested share-based compensation arrangements granted by the Board.  Such cost is expected to be recognized by March 9, 2014.  The total fair value of shares vested during the three months ended March 31, 2013 and 2012 was $53 and $54, respectively.
 
(13)       PREFERRED STOCK

The following amounts are in thousands except for share data (shares, par value and price per share):

The Company is authorized to issue 100,000,000 shares of preferred stock, $0.00001 par value, of which 2,800,000 shares have been designated as series A convertible preferred stock (see Note 10). As of December 31, 2012 and March 31, 2013, 394,478 Preferred Shares were outstanding, with an aggregate liquidation preference of $1.13 million.

No Preferred Shares were converted during the three months ended March 31, 2013.
 
 
18

 

(14)       EARNINGS PER SHARE
 
The following amounts are in thousands except for share data (shares and earnings per share):

(a)            Basic

“Basic earnings per share - common” is calculated by dividing the net income attributable to common shareholders of the Company by the weighted average number of common shares.  Using the two class method pursuant to ASC 260-10-45, the Company allocated its net income to preferred and common shareholders during the three months ended March 31, 2013 and 2012, based on the number of common shares outstanding during the periods shown (taking into account the number of Preferred Shares converted into common shares at the end of such periods on a 1-for-0.1333 common share basis), and participating Preferred Shares outstanding during the periods shown.
  
 
Three Months Ended 
March 31,
 
  
 
2013
(unaudited)
   
2012
(unaudited)
 
Income attributable to common shareholders of the Company
 
$
5,549
   
$
2,412
 
Income attributable to preferred shareholders of the Company
   
112
     
79
 
Net income
   
5,661
     
2,491
 
Weighted average number of common shares outstanding
   
2,603,481
     
2,529,417
 
 
(b)            Diluted
 
Diluted earnings per share is calculated by adjusting the weighted average number of common shares outstanding to assume conversion of all dilutive potential common shares.  The Company has two categories of dilutive potential common shares: the Preferred Shares and the warrants issued in connection with the Financings.  For the three months ended March 31, 2012, the warrants were assumed to have been converted into common shares and the calculation is done to determine the number of shares that could have been acquired at fair value (determined as the average annual market share price of the Company’s common stock) based on the monetary value of the subscription rights attached to outstanding warrants. The warrants expired during the fourth quarter of 2012. The Preferred Shares that were outstanding at the end of the respective periods are assumed to have been converted into common shares on a 1-for-0.1333 basis.  Since the Preferred Shares are included in the diluted calculation, net income (attributable to both common and preferred shareholders) is used.  The number of shares calculated as above is compared with the number of shares that would have been issued assuming the exercise of the warrants for the three months ended March 31, 2012.
 
  
 
Three Months Ended 
March 31,
 
  
 
2013
(unaudited)
   
2012
(unaudited)
 
Net income
 
$
5,661
   
$
2,491
 
Weighted average number of common shares outstanding
   
2,603,481
     
2,529,417
 
                 
Adjustment for: 
               
Preferred stock
   
52,597
     
      83,877
 
     
2,656,078
     
2,613,294
 
 
Warrants were excluded from the calculation of diluted earnings per share for the three months ended March 31, 2013 as all warrants were expired during the fourth quarter of 2012. Warrants were also excluded from such calculation for the three months ended March 31, 2012 as their effects were anti-dilutive .

(15)       INCOME TAXES

The provisions for income tax expense were as follows (in thousands):

 
  
Three Months 
Ended March 31,
  
  
  
2013
(unaudited)
  
  
2012
(unaudited)
  
             
PRC enterprise income tax - current
 
$
1,921
   
$
2,191
 

As of March 31, 2013 and December 31, 2012, the Company did not have any significant temporary differences and carry forwards that may result in deferred tax.

The applicable rate of Hong Kong profits tax for 2013 and 2012 is 16.5%.  No provision for Hong Kong profits tax has been made, however, as the Company does not carry on any business that generates profits chargeable to Hong Kong profits tax.

PXPF is a company incorporated in the BVI and is fully exempt from Domestic Corporate Tax of the BVI.

The Company’s subsidiary and VIE in China are subject to a statutory income tax rate of 25% in the PRC.

The Company has analyzed the tax positions taken or expected to be taken in its tax filings and has concluded it has no material liability related to uncertain tax positions or unrecognized tax benefits as of March 31, 2013.
 
 
19

 

The following table reconciles the theoretical tax expense calculated at the statutory rates to the Company’s effective tax expense for the three months ended March 31, 2013 and 2012 (in thousands):
 
   
For Three Months Ended
March 31,
 
   
2013
(unaudited)
   
2012
(unaudited)
 
             
Theoretical tax expense calculated at PRC statutory enterprise income tax rate of 25%
 
$
1,896
   
$
1,171
 
Tax adjustment for prior year
   
-
     
1,056
 
Tax effect of non-deductible expenses
   
25
     
44
 
Other
   
-
     
(80
Effective tax expense
 
$
1,921
   
$
2,191
 
 
Tax adjustment for prior year represents a change in management's estimate of the prior year income tax provision. Certain expenses that the Company believed were deductible were deemed non-deductible by the relevant tax authority subsequent to the Company's filing of its annual report on Form 10-K on April 12, 2012. Therefore a provision was made for the additional income tax during the three months ended March 31, 2012. Non-deductible expenses for the three months ended March 31, 2013 and 2012 primarily consisted of expenses incurred outside of the PRC which are not deductible in computing the income tax for the PRC.
 
(16)       SEGMENT INFORMATION
 
ASC Topic 280 requires use of the “management approach” model for segment reporting.  Such model is based on the way a company’s management organizes segments within the company for making operating decisions and assessing performance.  Reportable segments are based on products and services, geography, legal structure, management structure, or any other manner in which management disaggregates a company.  During the three months ended March 31, 2013 and 2012, the Company operated in two reportable business segments: (1) sales to its distributors, and (2) retail sales at company stores.  These reportable segments represent the two ways that the Company sells its products: (1) to its distributors who then sell the products to consumers, and (2) directly to consumers (via company stores).  These segments share certain costs that are allocated on the basis of revenues: advertising within the PRC and research and development.  Company stores, however, require different types of management focus and as such are managed separately.  As of March 31, 2013 the Company’s distributors operated 404 points of sale, and the Company operated 17 company stores.
 
Condensed information with respect to the two reportable business segments for the three months ended March 31, 2013 and 2012 is as follows (in thousands):
   
Three Months Ended
March 31,
 
   
2013
(unaudited)
   
2012
(unaudited)
 
             
Net sales:
               
Distributor
 
25,502
   
$
 14,111
 
Company stores
   
1,108
     
1,053
 
   
$
26,610
   
$
15,164
 
                 
Cost of sales:
               
Distributor
 
$
14,681
   
$
 7,003
 
Company stores
   
391
     
384
 
   
$
15,072
   
$
7,387
 
                 
Selling expense:
               
Distributor
 
2,328
   
$
1,632
 
Company stores
   
520
     
800
 
   
$
2,848
   
$
2,432
 
                 
General and administrative expense:
               
Distributor
 
$
503
   
$
 552
 
Company stores
   
22
     
41
 
Other
   
583
     
405
 
   
$
1,108
   
$
998
 
                 
Income (loss) before provision for income taxes
               
Distributor
 
$
7,990
   
$
4,924
 
Company stores
   
175
     
( 172
Other (a)
   
(583
   
( 70
)
   
$
7,582
   
$
4,682
 

(a)  
The Company does not allocate its general and administrative expenses from its activities in the United States, or the fair value changes of its derivative liabilities, to its reportable segments, as they are managed at the corporate level. 
    
 
20

 
   
March 31,
2013
   
December 31,
2012
 
    (unaudited)    
 
 
Identifiable long lived assets at March 31, 2013 and December 31, 2012 (net of depreciation and amortization):
           
Corporate
 
$
69
   
$
71
 
Distributor
   
-
     
-
 
Company stores
   
6,335
     
6,310
 
   
$
6,404
   
$
6,381
 

(17)       STATUTORY RESERVES

Under PRC regulations, Yinglin Jinduren and China Dong Rong may each pay dividends only out of its accumulated profits, if any, determined in accordance with generally acceptable accounting principles in China (“PRC GAAP”).  In addition, each company is required to set aside at least 10% of its after-tax net profits each year, if any, to fund the statutory reserves until the balance of the reserves reaches 50% of its registered capital.  The funds in the statutory reserves can only be used for certain purposes, such as to increase registered capital or to eliminate future losses or make up prior year losses as determined under PRC GAAP, and are not distributable as cash dividends to the Company.  As of March 31, 2013, the statutory reserves of both companies have been fully funded.

(18)      LEASE COMMITMENTS

Company leases (in thousands)

For its administrative operations, the Company leases certain premises under long-term, non-cancelable leases and year-to-year leases.  These leases are accounted for as operating leases.  Rent expense for such leases amounted to $47 and $38 for the three months ended March 31, 2013 and 2012, respectively.
 
Store leases (in thousands)
 
Of the leases for the 17 company stores that the Company operated as of March 31, 2013, 5 require fixed rent payments.  The remaining 12 have rental payments based on store revenue with no minimum rental payment, and are thus not listed below.  Instead, rent expense for such leases is recorded as sales are made.  Rent expense for the fixed-rent leases amounted to $110 and $109 for the three months ended March 31, 2013 and 2012, respectively.  Rent expense for the revenue-based leases was $197 and $152 for the three months ended March 31, 2013 and 2012, respectively.
 
Future minimum payments under long-term, non-cancelable leases as of March 31, 2013, are as follows (in thousands):
 
   
Future
minimum
payments -
Corporate
   
Future
minimum
payments-
Stores
   
Total
future
minimum
payments
 
Nine months ending December 31,
                 
2013
 
$
147
   
$
290
   
$
437
 
Year ending December 31,
                       
2014
   
203
     
230
     
433
 
2015
   
213
     
113
     
326
 
2016
   
163
     
113
     
276
 
2017
   
-
     
28
     
28
 
                         
   
$
726
   
$
774
   
$
1,500
 

(19)       BUSINESS AND CREDIT CONCENTRATIONS
 
The Company operates in the fashion apparel industry and generates all of its sales in the PRC except for one distributor that sells the Company’s products in New York City.  Products are sold to that distributor in China, who exports them to the United States.  The fashion apparel industry is impacted by the general economy.  Changes in the marketplace would significantly affect management’s estimates and the Company’s performance.
 
 
21

 

The Company had distribution agreements in effect with 13 distributors at March 31, 2013, and with 11 distributors at March 31, 2012.             
 
Four distributors accounted for 14.9%, 12.3%, 10.9% and 10.2% of the Company’s revenue for the three months ended March 31, 2013, respectively.  Four distributors accounted for 20.9%, 15.9%, 14.6% and 14.2% of the Company’s revenue for the three months ended March 31, 2012, respectively.  No other customer accounted for 10% or more of the Company’s revenue for the three months ended March 31, 2013 or 2012.
 
Four distributors accounted for 23.9%, 18.9%, 17.5% and 12.9% of the Company’s total accounts receivable as of March 31, 2013, respectively.  Four distributors accounted for 24.4%, 19.3%, 18.0% and 13.6% of the Company’s total accounts receivable as of December 31, 2012, respectively.  No other customer accounted for 10% or more of the Company’s accounts receivable as of March 31, 2013 or December 31, 2012.
 
Five vendors accounted for 23.0%, 18.7%, 18.0%, 12.8% and 12.5% of the Company’s purchases for the three months ended March 31, 2013, respectively.  Three vendors accounted for 33.7%, 28.8%, and 15.0% of the Company’s purchases for the three months ended March 31, 2012, respectively.  No other vendor accounted for 10% or more of the Company’s purchases for the three months ended March 31, 2013 or 2012.
 
Four vendors accounted for 24.1%, 21.2%, 17.9% and 15.7% of the Company’s total accounts payable as of March 31, 2013, respectively.  Four vendors accounted for 39.8%, 17.7%, 16.4% and 10.8% of the Company’s total accounts payable as of December 31, 2012, respectively.  No other vendor accounted for 10% or more of the Company’s accounts payable as of March 31, 2013 or December 31, 2012.
 
The above concentrations make the Company vulnerable to a near-term severe impact should its relationships with such distributors and/or vendors terminate.
 
(20)       BENEFIT PLAN
 
Pursuant to the relevant regulations of the PRC government, China Dong Rong participates in a local municipal government retirement benefits scheme, whereby it is required to contribute a certain percentage of the basic salaries of its employees to the Scheme to fund their retirement benefits.  Contributions under such scheme are charged to the income statement as incurred and amounted to $28,000 and $25,000 for the quarter ended March 31, 2013 and 2012, respectively.
   
(21)           SUBSEQUENT EVENTS
 
On April 19, 2013, a complaint was served on the Company’s agent for service of process in Nevada.  The complaint was filed in the District Court for Clark County, Nevada, by ARC China Semper, LLC.  The plaintiff purports to be an assignee of ARC Semper China Investments, Ltd. and ARC China Investment Funds, of their purported rights and obligations under the securities purchase agreement that the Company entered into in connection with the Preferred Shares Financing (the “SPA”).  The complaint alleges that the Company breached the SPA by failing to timely (i) file a registration statement, (ii) have such registration statement declared effective and (iii) appoint a bilingual chief financial officer.  The complaint seeks monetary damages, specific performance to appoint a bilingual chief financial officer, and reimbursement of costs and fees. Although the Company is unable to predict the final outcome of this litigation, the Company does not believe that such outcome will have a material effect on its consolidated financial condition, results of operations, or cash flows. As of March 31, 2013, the Company already made a provision of $987 for liquidated damages in connection with the Financings (Note 10).
 
 
22

 

ITEM 2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

The following management’s discussion and analysis should be read in conjunction with our consolidated financial statements and the notes thereto that are included elsewhere in this report.  In addition to historical information, the following discussion contains certain forward-looking statements within the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995.  These statements relate to our future plans, objectives, expectations and intentions.  These statements may be identified by the use of words such as “may, “will,” “could,” “expect,, “anticipate,” “intend,” “believe, “estimate,” “plan,” “predict” and similar terms or terminology, or the negative of such terms or other comparable terminology.  Although we believe the expectations expressed in these forward-looking statements are based on reasonable assumptions within the bound of our knowledge of our business, our actual results could differ materially from those discussed in these statements.  Factors that could contribute to such differences include, but are not limited to, those discussed in the “Risk Factors” section of our annual report on Form 10-K for the year ended December 31, 2012 and filed with the SEC on April 16, 2013.  We undertake no obligation to update publicly any forward-looking statements for any reason even if new information becomes available or other events occur in the future.

Our financial statements are prepared in U.S.  Dollars and in accordance with accounting principles generally accepted in the United States.  See “Foreign Currency Translation” below for information concerning the exchanges rates at which Renminbi were translated into U.S. Dollars at various pertinent dates and for pertinent periods.

Overview

We design, market and distribute apparel and related products targeted at 20-45 years old men under the “VLOV” brand.  We currently carry two product lines: (1) Esquire and (2) Richard Wu.
 
We primarily sell our products to our independent distributors, each of whom is granted rights to market and sell our products in a defined market or territory.  Our distributors sell our products at points of sale, or POS, that they establish within their territories and operate either directly or through third-party retail operators, including counters, concessions, store-in-stores and stand-alone stores.  To better showcase our brand, however, we acquired the retail network of our Fujian distributor in June 2011 to operate the stores on our own.  As of March 31, 2013, our products were sold at 421 POS, including 403 that our distributors operate in China, 17 that we operate directly (“company stores”), and one that a distributor operates in the United States.
 
Prior to 2011, all of our business operations were carried out by Yinglin Jinduren, which we control through contractual arrangements between Yinglin Jinduren and our wholly-owned subsidiary HK Dong Rong.  We completed the transfer of all sales contracts and design, marketing, sales and purchasing-related assets from Yinglin Jinduren to our wholly-owned subsidiary China Dong Rong in the first quarter of 2011, and all of our business activities are currently conducted by China Dong Rong.
 
As Yinglin Jinduren has had no operations since early 2011, we may dissolve it, and exit from the contractual arrangements sometime in the future.  Until then, we will continue to operate our business through China Dong Rong (as we currently do) while continuing to control Yinglin Jinduren through the contractual arrangements.

Critical Accounting Policies

Our management’s discussion and analysis of our financial condition and results of operations are based on our unaudited condnesed consolidated financial statements included with this report that have been prepared in accordance with accounting principles generally accepted in the United States.  The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements as well as the reported net sales and expenses during the reporting periods.  On an ongoing basis, we evaluate our estimates and assumptions.  We base our estimates on historical experience and on various other factors that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources.  Actual results may differ from these estimates under different assumptions or conditions.

Our significant accounting policies are described in Note 1 to our unaudited condensed consolidated financial statements accompanying this report.  Our critical accounting policies are those where we have made the most difficult, subjective or complex judgments in making estimates, and/or where these estimates can significantly impact our financial results under different assumptions and conditions.  Our critical accounting policies are :

Basis of presentation and consolidation
 
As discussed above and in Note 1 to our unaudited condensed consolidated financial statements accompanying this report, we transferred our operations from Yinglin Jinduren to China Dong Rong during the first quarter of 2011.  Previously, our operations were conducted by Yinglin Jinduren, the equity interests in which are held by our CEO and his brother.  Through contractual arrangements, we control the daily operations of Yinglin Jinduren, as well as all matters requiring shareholder approval.  We received a fee equal to Yinglin Jinduren’s net income and, in the event it were to incur losses, would be expected to absorb those losses through our inability to collect the accumulated net income due to us.  As a result, we are considered to be the primary beneficiary of Yinglin Jinduren’s operations and accordingly consolidated its assets, liabilities and results of operations in our condensed consolidated financial statements.  All of our operations are now conducted by China Dong Rong .
 
 
23

 

Revenue Recognition
 
Sales of goods - distributors

Products for our distributors are manufactured based on their orders.  We are responsible for product design, product specification, pricing to the customer, the choice of OEM manufacturers, product quality and credit risk associated with the customer receivable.  As such, we act as a principal, not as an agent, and record revenues on a gross basis.
 
We recognize revenue when (a) the price to the customer is fixed or determinable, (b) persuasive evidence of an arrangement exists, (c) delivery has occurred and (d) collectability of the resulting receivable is reasonably assured.  Revenue from the sales of goods is recognized on the transfer of significant risks and rewards of ownership, which generally coincides with the time when the goods are delivered and title has passed to the customer.  Revenue excludes value-added tax and is stated after deduction of trade discounts and allowances.
 
We only accept returns within three days of purchase and for quality reasons.  We have not yet had the experience to estimate and provide for such returns at the time of sale, and returns have been minimal to date.

In addition, we do not have any obsolete stock arrangements with our distributors. Therefore, we do not have any arrangements with distributors to accept returns of out-of season stock.

Sales of goods - retail
 
In July 2011, we began operating company stores selling our products.  Revenue from retail sales is recognized at each point of sale.  During the three months ended March 31, 2013 and 2012, such sales accounted for 4.2% and 6.9% of our total revenue, respectively.
 
Our retail revenue is net of value-added tax (“VAT”) collected on behalf of PRC tax authorities in respect of the sale of merchandise.  VAT collected from customers, net of VAT paid for purchases, is recorded as a liability in the accompanying consolidated balance sheets until it is paid to the relevant PRC tax authorities.

Retail sales returns within seven days of purchase are accepted only for quality reasons.  We have not yet had the experience to estimate and provide for such returns at the time of sale, and returns have been minimal to date.
 
Accounts receivable

Accounts receivable, which are unsecured, are stated at the amount we expect to collect.  We continuously monitor collections and payments from our customers (our distributors) and maintain a provision for estimated credit losses based upon historical experience and any specific customer collection issues that have been identified.  Historically, our credit losses have not been significant and within our expectations.  However, we cannot guarantee that we will continue to experience the same credit loss rates that have been experienced in the past.

Our accounts receivable aging was as follows for the periods below (amounts in thousands):

   
March 31,
2013
   
December 31,
2012
 
From date of invoice to customer
 
(unaudited)
       
0-30 days
   
11,846
     
10,974
 
31-60 days
   
13,687
     
9,304
 
61-90 days
   
7,119
     
11,617
 
91 – 120 days
   
5,935
     
4,104
 
121 days and above
   
12,096
     
7,993
 
Allowance for doubtful accounts
   
-
     
-
 
Total accounts receivable
 
$
50,683
   
$
43,992
 
 
On average, we collect our receivables within 150 days.  Our ability to collect is attributed to the steps that we take prior to extending credit to our distributors as discussed above.  If we are having difficulty collecting from a distributor, we take the following steps: cease existing shipments to the distributor, visit the distributor to request payment on past due invoice, and if necessary, take legal recourse.  If all of these steps are unsuccessful, management would then determine whether or not the receivable should be reserved or written off.  Of $50,683 in receivables as of March 31, 2013, $20,033 was collected as of May 13, 2013.  As of May 13, 2013, there was $5,106 in accounts receivable aged over 120 days at March 31, 2013 that had not been collected.  As of March 31, 2013 and December 31, 2012, there was no allowance for uncollectible accounts receivable.
 
Goodwill

As a result of acquiring the retail stores of our Fujian distributor in June 2011, we began operating company stores selling our products.  As our purchase price exceeded the net of the amounts assigned to assets acquired and liabilities assumed, the excess value was recognized as goodwill.
 
 
24

 

In September 2011, the Financial Accounting Standards Board issued an authoritative pronouncement related to testing goodwill for impairment. The guidance permits us to first assess qualitative factors to determine whether it is “more likely than not” that the fair value of a reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two-step goodwill impairment test.  We adopted this pronouncement as of the first quarter of 2012.  If it is more likely than not that the fair value of a reporting unit is less than its carrying amount, goodwill is then tested following a two-step process.  The first step compares the fair value of each reporting unit to its carrying amount, including goodwill.  If the fair value of each reporting unit exceeds its carrying amount, goodwill is not considered to be impaired and the second step will not be required.  If the carrying amount of a reporting unit exceeds its fair value, the second step compares the implied fair value of goodwill to the carrying value of a reporting unit’s goodwill.  The implied fair value of goodwill is determined in a manner similar to accounting for a business combination with the allocation of the assessed fair value determined in the first step to the assets and liabilities of the reporting unit.  The excess of the fair value of the reporting unit over the amounts assigned to the assets and liabilities is the implied fair value of goodwill.  An impairment loss is recognized for any excess in the carrying value of goodwill over the implied fair value of goodwill.

We have performed an assessment and determined that there was no indication of impairment to goodwill during the three months ended March 31, 2013 and 2012.

Income Taxes

We are subject to income taxes, primarily in the PRC.  We believe we have adequately provided for all taxes due but amounts asserted by tax authorities could be greater or less than the amounts we have accrued.  We are not aware of any PRC corporate income tax matters through March 31, 2013 and do not anticipate adjustments as a result of any tax audits within the next twelve months.

Derivative instruments

In connection with the sale of debt or equity instruments, we may sell warrants to purchase our common stock.  In certain circumstances, these warrants may be classified as derivative liabilities, rather than as equity.  Additionally, the debt or equity instruments may contain embedded derivative instruments, such as conversion options, which in certain circumstances may be required to be bifurcated from the associated host instrument and accounted for separately as a derivative instrument liability.

The identification of, and accounting for, derivative instruments is not only complex, but can, along with the assumptions used to value them, significantly affect our financial statements.  Our derivative instrument liabilities are re-valued at the end of each reporting period, with changes in the fair value of the derivative liability recorded as charges or credits to income in the period in which the changes occur.  
 
At March 31, 2013, the warrants that we issued in connection with the private placements of our series A convertible preferred stock and common stock in 2009 (collectively the “2009 Financings”) had expired during the fourth quarter of 2012 and were therefore no longer carried as a derivative liability.  Prior to their expiration, we had determined the fair value of these instruments using a binomial option pricing model.  The model requires the use of a number of assumptions, including our expected dividend yield and the expected volatility of our common stock price over the life of the instruments.  Because of the limited trading history for our common stock, we had estimated the future volatility of our common stock price based on the historical experience of other entities deemed comparable to us.  
 
Foreign Currency Translation

Our functional currency is the Chinese Renminbi (“RMB”), which we translate into U.S. Dollars (“$”) in our financial statements.  Accordingly, all assets and liabilities are translated at the exchange rates prevailing at the balance sheet dates, all income and expenditure items are translated at the average rates for each of the periods and equity accounts, except for retained earnings, are translated at the rate at the transaction date.  Retained earnings reflect the cumulative net income (loss) translated at the average rates for the respective periods since inception, less dividends translated at the rate at the transaction date.
 
RMB is not a fully convertible currency.  All foreign exchange transactions involving RMB must take place either through the People's Bank of China (the “PBOC”) or other institutions authorized to buy and sell foreign exchange.  The exchange rates adopted for the foreign exchange transactions are the rates of exchange quoted by www.oanda.com, which are determined largely by supply and demand.  The rates of exchange quoted by www.oanda.com on March 31, 2013 and December 31, 2012 were $1.00 to RMB 6.27 and RMB 6.31, respectively.  The average translation rates of $1.00 to RMB 6.28 and RMB 6.31 were applied to the income statement accounts for the three months ended March 31, 2013 and 2012, respectively.

Translation adjustments are recorded as other comprehensive income in the consolidated statement of stockholders equity and comprehensive income and as a separate component of stockholders equity.

Commencing from July 21, 2005, China adopted a managed floating exchange rate regime based on market demand and supply with reference to a basket of currencies.  Since then, the PBOC administers and regulates the exchange rate of $ against RMB taking into account the demand and supply of RMB, as well as domestic and foreign economic and financial conditions.
 
 
25

 

Results of Operations

Comparison of Three Months ended March 31, 2013 and 2012
 
   
Three Months ended 
March 31,
 
  
 
2013
 
2012
 
   
Amount
   
% of 
net sales
   
Amount
   
% of 
 net sales
 
   
(Amounts in thousands, in $, except for percentages)
 
Net sales
 
$
26,610
     
100.0
%
 
$
15,164
     
100.0
%
Cost of Sales
 
$
15,072
     
56.6
%
 
$
7,387
     
48.7
%
Gross profit
 
$
11,538
     
43.4
%
 
$
7,777
     
51.3
%
Operating expense
 
$
3,956
     
14.9
%
 
$
3,430
     
22.6
%
Income from operations
 
$
7,582
     
28.5
%
 
$
4,347
     
28.7
%
Other expenses /(income), net
 
$
-
     
-
%
 
$
(335
)
   
(2.2)
%
Income tax expenses
 
$
1,921
     
7.2
%
 
$
2,191
     
14.4
%
Net income
 
$
5,661
     
21.3
%
 
$
2,491
     
16.4
%

Net Sales (amounts in thousands, in $, except for percentages)
 
Net sales for the three months ended March 31, 2013 increased by 75.5% from the same period in 2012. Net sales for both periods were primarily generated from sales to our distributors, who retailed them at their POS primarily throughout northern, central and southern China. The increased net sales was primarily attributable to sales increases by our Shaanxi, Liaoning, and Beijing distributors as well as sales from our Shanghai distributor that was established in the third quarter of 2012.
 
We strive to continue creating more upscale products and educating and working closely with our distributors to best showcase our products, such as through higher-end stand-alone stores and store-in-stores which we believe strengthen the image and exclusivity of our brand among our target demographic.  Additionally, we believe that having our clothing sold in New York by a new distributor can enhance our global brand image which can further strengthen our brand within China.
 
Cost of Sales and Gross Profit Margin (amounts in thousands, in $ except for percentages)
 
Total cost of sales for the three months ended March 31, 2013 increased by 104.0% from a year ago primarily due to the period’s significantly higher sales. Our cost of sales as a percentage of net sales was 56.6% and 48.7% for the three months ended March 31, 2013 and 2012, respectively. Consequently, gross margin as a percentage of net sales decreased from 51.3% to 43.4% period over period. Gross margin decreased due to our decision to lower prices to our distributors during the quarter.
 
The following table sets forth the geographical breakdown of our total sales revenue for the periods indicated:
 
   
Three Months ended 
March 31,
 
  
 
2013
   
2012
       
  
 
Amount
   
% of net sales
   
Amount
   
% of net sales
   
Growth (decline) 
in 2013
compared
with 2012
 
   
(Amounts in thousands, in $, except for percentages)
Zhejiang
 
$
3,964
     
14.9
 
$
3,174
     
20.9
   
24.9
%
Beijing
 
$
3,262
     
12.3
 
$
2,409
     
15.9
   
35.4
%
Shandong
 
$
2,893
     
10.9
 
$
2,153
     
14.2
   
34.4
%
Hubei
 
$
2,722
     
10.2
 
$
2,222
     
14.7
   
22.5
%
Liaoning
 
$
2,475
     
9.3
 
$
961
     
6.3
   
157.5
%
Shanghai
 
$
2,282
     
8.6
%
 
$
-
     
-
     
N/A
 
Sichuan
 
$
1,497
     
5.6
%
 
$
762
     
5.0
%
   
96.5
%
Shaanxi
 
$
1,370
     
5.2
 
$
250
     
1.7
   
448.0
%
Henan
 
$
1,333
     
5.0
 
$
530
     
3.5
   
151.5
%
Jiangxi
 
$
1,308
     
4.9
 
$
694
     
4.6
   
88.5
%
Guangxi
 
$
1,180
     
4.4
 
$
591
     
3.9
   
99.7
%
Yunnan
 
$
1,138
     
4.3
 
$
365
     
2.4
   
211.8
%
United States of America
 
$
78
     
0.2
 
$
-
     
-
     
N/A
 
Total Net Sales-  Distributors
 
$
25,502
     
95.8
%
   
14,111
     
93.1
%
   
80.7
%
Fujian (Company stores)
 
$
1,108
     
4.2
%
 
$
1,053
     
6.9
%
   
5.2
%
Total Net Sales
 
$
26,610
     
100.0
 
$
15,164
     
100.00
   
75.5
%
 
 
26

 
 
The following tables set forth our total net sales, cost of sales, gross profit and gross margin of the geographic market segments for the periods indicated.
 
  
  
Three Months ended March 31,
  
  
  
2013
  
  
2012
  
  
  
Net Sales
  
  
Cost of
sales
  
  
Gross
profit
  
  
Gross
profit %
  
  
Net Sales
  
  
Cost of
sales
  
  
Gross
profit
  
  
Gross
profit %
  
  
 
(Amounts in thousands, in $, except for percentages)
  
Zhejiang
 
$
3,964
   
$
2,282
   
$
1,682
     
42.5
%
 
$
3,174
   
$
1,594
   
$
1,580
     
49.8
%
Beijing
 
$
3,262
   
$
1,849
   
$
1,413
     
43.3
%
 
$
2,409
   
$
1,190
   
$
1,219
     
50.6
%
Shandong
 
$
2,893
   
$
1,657
   
$
1,236
     
42.7
%
 
$
2,153
   
$
1,056
   
$
1,097
     
51.0
%
Hubei
 
$
2,722
   
$
1,588
   
$
1,134
     
41.7
%
 
$
2,222
   
$
1,123
   
$
1,099
     
49.5
%
Liaoning
 
$
2,475
   
$
1,430
   
$
1,045
     
42.2
%
 
$
961
   
$
478
   
$
483
     
50.3
%
Shanghai
 
$
2,282
   
$
1,354
   
$
928
     
40.7
%
 
$
-
   
$
-
   
$
-
     
-
%
Sichuan
 
$
1,497
   
$
845
   
$
652
     
43.5
%
 
$
762
   
$
385
   
$
377
     
49.5
%
Shanxi
 
$
1,370
   
$
779
   
$
591
     
43.2
%
 
$
250
   
$
123
   
$
127
     
50.8
%
Henan
 
$
1,333
   
$
761
   
$
572
     
42.9
%
 
$
530
   
$
269
   
$
261
     
49.3
%
Jiangxi
 
$
1,308
   
$
755
   
$
553
     
42.3
%