NOTES TO AUDITED CONSOLIDATED FINANCIAL STATEMENTS
YOU On Demand Holdings, Inc., a Nevada corporation (“YOU On Demand”, “we”, “us”, or “the Company”) (formerly China Broadband, Inc.), operates in the Chinese media segment through our Chinese subsidiaries and variable interest entities (“VIEs”) (1) an integrated value-added service solutions business for the delivery of video on demand (“VOD”) and enhanced premium content for cable providers, Beijing Sino Top Scope Technology Co., Ltd. (“Sinotop Beijing” or “Sinotop”) , (2) a cable broadband business, Jinan Guangdian Jia He Broadband Co. Ltd. ( “Jinan Broadband”), based in the Jinan region of China through which we provide cable and wireless broadband services, principally internet services, Internet Protocol Point wholesale services, related network equipment rental and sales, and fiber network construction and maintenance and (3) a print based media and television programming guide publication, Shandong Lushi Media Co., Ltd. (“Shandong Media”). Effective July 1, 2012, the Company deconsolidated Shandong Media as discussed below in Note 11.
The Company’s Board of Directors authorized a 75:1 reverse stock split on February 9, 2012, which took effect on February 9, 2012. All share and related option information presented in these consolidated financial statements and related notes has been retroactively adjusted to reflect the reduced number of shares resulting from this reverse stock split.
|
2.
|
Summary of Significant Accounting Policies
|
Principles of Consolidation
The audited consolidated financial statements include the accounts of YOU On Demand and (a) its wholly-owned subsidiary China Broadband, Ltd., ("CB Cayman"), (b) two wholly-owned subsidiaries of CB Cayman: Beijing China Broadband Network Technology Co., Ltd. (“WFOE”) and Sinotop Group Limited (“Sinotop Hong Kong”) and (c) six entities located in the PRC: Jinan Zhong Kuan, Jinan Broadband, Shandong Media, Sinotop, Zhong Hai Shi Xun Information Technology Co., Ltd. (“Zhong Hai Video”), and YOU On Demand (Beijing) Technology Co., Ltd. (“YOD WFOE”), which are controlled by the Company through contractual arrangements, as if they are majority owned subsidiaries of the Company. As of July 1, 2012, the Company deconsolidated Shandong Media as discussed below in Note 11. During the third quarter 2011, AdNet was also deconsolidated as a result of the Company’s termination of control as discussed below in Note 10. All material intercompany transactions and balances are eliminated in consolidation.
Investment in Unconsolidated Entities
The Company has two investments in the PRC entities. The consolidated financial statements include our original investment in this entity plus our share of undistributed earnings or losses, in the account “Investment in unconsolidated entities.”
Basis of Presentation
The Company's policy is to use the accrual method of accounting to prepare and present financial statements, which conform to the U.S. generally accepted accounting principles (U.S. GAAP).
Estimates
The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
The most significant estimates relate to goodwill and intangible asset valuations and useful lives, contingent purchase consideration, warrant liabilities, inventory obsolescence, depreciation and allowance for uncollectible accounts receivable. These estimates may be adjusted as more current information becomes available, and any adjustment could be significant.
Cash and cash equivalents
Cash and cash equivalents consist of cash on hand and marketable securities with original maturities of three months or less.
Accounts Receivable
Accounts receivable are recognized and carried at original invoiced amount less an allowance for any uncollectible accounts.
Inventories
Inventories, consisting of cables, fiber, connecting material, power supplies and spare parts are stated at the lower of cost or market value
, including provisions for obsolescence commensurate with known or estimated exposures. Inventories net of a valuation reserve are approximately $384,000 at December 31, 2012, and $414,000 at December 31, 2011. Cost is determined using the weighted average method.
Property and Equipment
Property and equipment are stated at cost less accumulated depreciation. Expenditures for major renewals and betterments, which extend the original estimated economic useful lives or applicable assets, are capitalized. Expenditures for normal repairs and maintenance are charged to expense as incurred. The costs and related accumulated depreciation of assets sold or retired are removed from the accounts and any gain or loss thereon is reflected in operations. Depreciation is provided for on a straight-line basis over the estimated useful lives of the respective assets.
Licensed Content
The Company obtains content through content license agreements and revenue sharing agreements with studios and distributors. The license agreement may or may not be recognized in licensed content.
When the license fee is not known or reasonably determinable for a specific title, the title does not meet the criteria for recognition in licensed content in accordance with Financial Accounting Standards Boards (FASB) Accounting Standards Codification (ASC) Topic 920,
Entertainment – Broadcasters
. In the event, the license fee is not known or reasonably determinable for a specific title in content license agreements that do not specify the license fee per title, we expense as costs of revenues the greater of revenue sharing costs incurred through the end of the reporting period or the proportionate value of total minimum license fees expensed on a straight-line basis over the term of each license agreement. As the Company expenses license fees on a straight-line basis, it may result in deferred or prepaid license fees. Prepaid license fees are classified as an asset on the consolidated balance sheets as licensed content and deferred license fees are classified as a liability on the consolidated balance sheets as deferred license fees. Commitments for license agreements that do not meet the criteria for recognition in licensed content are included in Note 21 to the consolidated financial statements.
Intangible Assets
Intangible assets are stated at acquisition fair value or cost less accumulated amortization. The Company amortizes its intangible assets with definite lives over their estimated useful lives and reviews these assets for impairment. The Company is currently amortizing its intangible assets with definite lives over periods generally ranging between 2.5 to 20 years. The service agreement, publication rights, operating permits and charter/cooperation agreements are amortized over 20 years. Customer relationships, non-compete agreement, and software technology are amortized over 10 years, 2.5 years and 3 years, respectively. Software and licenses are amortized over 3 years and 5 years.
Website development costs
Website development costs are stated at acquisition fair value or cost less accumulated amortization. The Company capitalizes website development costs associated with graphics design and development of the website application and infrastructure. Costs related to planning, content input, and website operations are expensed as incurred. The Company amortizes website development costs over three years and reviews these costs for impairment.
Goodwill
In accordance with U.S. GAAP, the Company tests goodwill for impairment annually as of December 31 and whenever events or circumstances make it more likely than not that impairment may have occurred. The Company reviews goodwill for impairment based on its identified reporting units, which are defined as reportable segments or groupings of businesses one level below the reportable segment level. In September 2011, the FASB issued guidance on testing goodwill for impairment. The guidance provides entities with an option to perform a qualitative assessment to determine whether further quantitative impairment testing is necessary.
In accordance with the guidance, the Company reviews goodwill for impairment by first assessing qualitative factors to determine whether the existence of events or circumstances made it more likely than not that the fair value of a reporting unit is less than its carrying amount. If the Company determines it is more likely than not that the fair value of a reporting unit is less than its carrying amount, goodwill is further tested for impairment by comparing the carrying value to the estimated fair value of its reporting units, determined using externally quoted prices (if available) or a discounted cash flow model and, when deemed necessary, a market approach. Significant assumptions inherent in the valuation methodologies for goodwill are employed and include, but are not limited to, such estimates as projected business results, growth rates, the Company’s weighted-average cost of capital, royalty and discount rates.
Impairment of Long-Lived Assets
Long-lived assets, including property, equipment, intangible assets, website development costs and goodwill, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to the estimated undiscounted future cash flows expected to be generated by the asset. If the carrying amount of an asset exceeds its estimated future cash flows, an impairment charge is recognized for the amount by which the carrying amount of the asset exceeds the fair value of the asset.
Assets to be disposed of are separately presented in the balance sheet and reported at the lower of the carrying amount or fair value less costs to sell, and are no longer depreciated. The assets and liabilities of a disposed group classified as held for sale are presented separately in the appropriate asset and liability sections of the balance sheet.
Warrant Liabilities
We account for derivative instruments and embedded derivative instruments in accordance with the accounting standard for
Accounting for Derivative Instruments and Hedging Activities
, as amended. The amended standard requires an entity to recognize all derivatives as either assets or liabilities in the statement of financial position and measure these instruments at fair value. Fair value is estimated using the Monte Carlo simulation method. We also follow accounting standards for the
Accounting for Derivative Financial Instruments Indexed to and Potentially Settled in, a Company’s Own Stock
, which requires freestanding contracts that are settled in a company’s own stock, including common stock warrants, to be designated as an equity instrument, asset or a liability. Under these provisions a contract designated as an asset or a liability must be carried at fair value, with any changes in fair value recorded in the results of operations. A contract designated as an equity instrument can be included in equity, with no fair value adjustments required. The asset/liability derivatives are valued on a quarterly basis using the Black-Scholes Pricing model. Significant assumptions used in the valuation included exercise dates, fair value for our common stock, volatility of our common stock and a proxy-free interest rate. Gains (losses) on warrants are included in “Changes in fair value of warrant liabilities in our consolidated statement of operations”.
Advertising & Marketing Expense
The Company expenses advertising and marketing costs as incurred, which are included in selling expense. Advertising and marketing costs were approximately $1,024,000 and $752,000 for the years ended December 31, 2012 and 2011, respectively.
Income Taxes
The Company accounts for income taxes in accordance with the asset and liability method. Deferred taxes are recognized for the future tax consequences attributable to temporary differences between the carrying amounts of assets and liabilities for financial statement purposes and income tax purposes using enacted rates expected to be in effect when such amounts are realized or settled. The effect on deferred taxes of a change in tax rates is recognized in income in the period that includes the enactment date. A tax valuation allowance is established, as needed to reduce net deferred tax assets to the amount expected to be realized. The Company also follows applicable guidance for accounting for uncertainty in income taxes.
The evaluation of a tax position is a two-step process. The first step is to determine whether it is more-likely-than-not that a tax position will be sustained upon examination, including the resolution of any related appeals or litigation based on the technical merits of that position. The second step is to measure a tax position that meets the more-likely-than-not threshold to determine the amount of benefit to be recognized in the financial statements. A tax position is measured at the largest amount of benefit that is greater than 50% likely of being realized upon ultimate settlement.
Tax positions that previously failed to meet the more-likely-than-not recognition threshold should be recognized in the first subsequent period in which the threshold is met. Previously recognized tax positions that no longer meet the more-likely-than-not criteria should be de-recognized in the first subsequent financial reporting period in which the threshold is no longer met.
The Company recognizes accrued interest and penalties related to unrecognized tax benefits and audits in the provision for income taxes in our consolidated statements of operation.
Revenue Recognition
Revenue is recorded as services are provided or publications are shipped to customers. The Company generally recognizes all revenues in the period in which the service is rendered or shipment is made, provided that persuasive evidence of an arrangement exists, delivery has occurred, the sales price is fixed or determinable, and collection is reasonably assured. The Company records deferred revenue for payments received from customers for the performance of future services and recognizes the associated revenue in the period that the services are performed.
Net Loss Per Share Attributable to YOU On Demand Shareholders
Basic and Diluted net loss per share attributable to YOU On Demand shareholders have been computed by dividing the net loss by the weighted average number of common shares outstanding. The assumed exercise of dilutive warrants, less the number of treasury shares assumed to be purchased from the proceeds of such exercises using the average market price of the Company’s common stock during each respective period, have been excluded from the calculation of diluted net loss per share as their effect would be antidilutive.
Foreign Currency Translation
The Company’s subsidiaries and VIEs located in China use its local currency (RMB) as its functional currency. Translation adjustments are reported as gains or losses in other comprehensive income or loss on the statement of comprehensive loss and accumulated as other comprehensive loss in the equity section of the balance sheet. The exchange rates used to translate amounts in functional currencies into USD for the purpose of preparing the consolidated financial statements were as follows:
|
|
|
2012
|
|
|
2011
|
|
|
Period end RMB:USD exchange rate
|
|
|
6.3011
|
|
|
|
6.3588
|
|
|
Average RMB:USD exchange rate
|
|
|
6.3116
|
|
|
|
6.4688
|
|
The RMB is not freely convertible into other foreign currencies, and all foreign exchange transactions must take place through authorized institutions. There is no assurance that the RMB amounts could have been, or could be, converted into USD at the rates used in translation.
Economic and Political Risks
The Company’s current operations are conducted in the PRC. Accordingly, the Company’s consolidated financial condition and results of operations may be influenced by the political, economic and legal environment in the PRC and by the general state of the PRC economy.
The Company’s operations in the PRC are subject to special considerations and significant risks not typically associated with companies in North America and Western Europe. These include risks associated with, among others, the political, economic and legal environment and foreign currency exchange. The Company’s consolidated results may be adversely affected by changes in the political and social conditions in the PRC and by changes in governmental policies with respect to laws and regulations, anti-inflationary measures, currency conversion, remittances abroad and rates and methods of taxation, among other things.
Concentrations of Credit Risk
Financial instruments that potentially subject the Company to concentrations of credit risk consist principally of accounts receivable. The Company generally requires advance payments for internet services. Other concentrations of credit risk are limited due to the large customer base in Jinan, a sub-provincial city of Shandong province in the People’s Republic of China.
Fair value of Financial Instruments
The fair values of accounts receivable, prepaid expenses and accounts payable and accrued expenses are estimated to approximate the carrying values at December 31, 2012 and 2011 due to the short maturities of such instruments.
Stock-Based Compensation
The Company awards stock options and other equity-based instruments to its employees, Directors and consultants (collectively “share-based payments”). Compensation cost related to such awards is measured based on the fair value of the instrument on the grant date and is recognized on a straight-line basis over the requisite service period, which generally equals the vesting period. All of the Company’s stock-based compensation is based on grants of equity instruments and no liability awards have been granted.
Reportable Segment
The Company operates under one reportable business segment, media, for which segment disclosure is consistent with the management decision-making process that determines the allocation of resources and the measuring of performance.
Recent Accounting Pronouncements
Management does not believe that any recently issued, but not yet effective accounting pronouncements, if adopted, would have a material effect on the accompanying financial statements.
|
3.
|
Going Concern and Management’s Plans
|
For the year ended December 31, 2012, we had a net loss of approximately $14,213,000 and we used cash for operations of approximately $10,601,000. We had a working capital deficit of approximately $5,983,000 and accumulated deficit of approximately $59 million, at December 31, 2012. The Company will continue to rely on debt and equity to pay for ongoing operating expenses in order to execute its business plan. We have the ability to raise funds by various methods including utilization of our $50 million shelf registration of which $47.3 million is remaining as well as other means of financing such as debt or private investment. However, financing may not be available to the Company on terms acceptable to us or at all or that such resources will be received in a timely manner. Further we may need approval to seek additional financing from the shareholders from the August 2012 private financing in the event we do a public financing.
These conditions raise substantial doubt about the Company’s ability to continue as a going concern. We anticipate that we will need to raise additional funds to fully implement our business model and related strategies.
The consolidated financial statements have been prepared assuming that the Company will continue as a going concern and, accordingly, do not include any adjustments that might result from the outcome of this uncertainty.
|
4.
|
VIE Structure and Arrangements
|
Management Services Agreement
Pursuant to a Management Services Agreement, dated as of March 9, 2010, between Sinotop Beijing and Sinotop Hong Kong (the “
Management Services Agreement
”), Sinotop Hong Kong has the exclusive right to provide to Sinotop Beijing management, financial and other services related to the operation of Sinotop Beijing’s business, and Sinotop Beijing is required to take all commercially reasonable efforts to permit and facilitate the provision of the services by Sinotop Hong Kong. As compensation for providing the services, Sinotop Hong Kong is entitled to receive a fee from Sinotop Beijing, upon demand, equal to 100% of the annual Net Profits of Sinotop Beijing during the term of the Management Services Agreement (Sinotop Hong Kong may request
ad hoc
quarterly payments of the aggregate fee, which payments will be credited against Sinotop Hong Kong’s future payment obligations).
The Management Services Agreement also provides Sinotop Hong Kong or its designee with a right of first refusal to acquire all or any portion of the equity of Sinotop Beijing upon any proposal by the sole shareholder of Sinotop Beijing to transfer such equity. In addition, at the sole discretion of Sinotop Hong Kong, Sinotop Beijing may be obligated to transfer to Sinotop Hong Kong or its designee any part or all of the business, personnel, assets and operations of Sinotop Beijing which may be lawfully conducted, employed, owned or operated by Sinotop Hong Kong, including:
(a) business opportunities presented to, or available to Sinotop Beijing may be pursued and contracted for in the name of Sinotop Hong Kong rather than Sinotop Beijing, and at its discretion Sinotop Hong Kong may employ the resources of Sinotop Beijing to secure such opportunities;
(b) any tangible or intangible property of Sinotop Beijing, any contractual rights, any personnel, and any other items or things of value held by Sinotop Beijing may be transferred to Sinotop Hong Kong at book value;
(c) real property, personal or intangible property, personnel, services, equipment, supplies and any other items useful for the conduct of the Business may be obtained by Sinotop Hong Kong by acquisition, lease, license or otherwise, and made available to Sinotop Beijing on terms to be determined by agreement between Sinotop Hong Kong and Sinotop Beijing;
(d) contracts entered into in the name of Sinotop Beijing may be transferred to Sinotop Hong Kong, or the work under such contracts may be subcontracted, in whole or in part, to Sinotop Hong Kong, on terms to be determined by agreement between Sinotop Hong Kong and Sinotop Beijing; and
(e) any changes to, or any expansion or contraction of, the Business may be carried out in the exercise of the sole discretion of Sinotop Hong Kong, and in the name of and at the expense of, Sinotop Hong Kong;
provided, however
, that none of the foregoing may cause or have the effect of terminating (without being substantially replaced under the name of Sinotop Hong Kong) or adversely affecting any license, permit or regulatory status of Sinotop Beijing.
The term of the Management Services Agreement is 20 years, and may not be terminated by Sinotop Beijing except with the consent of, or a material breach by, Sinotop Hong Kong.
Equity Pledge Agreement
Pursuant to an Equity Pledge Agreement among Sinotop Hong Kong, Sinotop Beijing and the sole shareholder of Sinotop Beijing (the “
Shareholder
”), dated March 9, 2010, the Shareholder pledged all of its equity interests in Sinotop Beijing (the “
Collateral
”) to Sinotop Hong Kong as security for the performance of the obligations of Sinotop Beijing to make all of the required management fee payments pursuant to the Management Services Agreement. The term of the Equity Pledge Agreement expires two years from Sinotop Beijing’s satisfaction of all obligations under the Management Services Agreement.
Option Agreement
Pursuant to an Option Agreement among Sinotop Hong Kong, Sinotop Beijing and the sole shareholder of Sinotop Beijing (the “
Shareholder
”), dated March 9, 2010, and entered into in connection with the Management Services Agreement, the Shareholder granted an exclusive option to Sinotop Hong Kong or its designee to purchase, at any time and from time to time, to the extent permitted under PRC law, all or any portion of the Shareholder’s equity in Sinotop Beijing. The aggregate purchase price of the option is equal to the paid-in registered capital of the Shareholder. The term of the agreement is until all of the equity interest in Sinotop Beijing held by the Shareholder is transferred to Sinotop Hong Kong or its designee, or until the maximum period allowed by law has run, and may not be terminated by any party to the agreement without the consent of the other parties.
Voting Rights Proxy Agreement
Pursuant to a Voting Rights Proxy Agreement among Sinotop Hong Kong, Sinotop Beijing and the sole shareholder of Sinotop Beijing (the “
Shareholder
”), dated March 9, 2010, the Shareholder granted to Sinotop Hong Kong an irrevocable proxy, for the maximum period of time permitted by law, all of its voting rights as a shareholder of Sinotop Beijing. The Shareholder may not transfer any of its equity interest in Sinotop Beijing to any party other than Sinotop Hong Kong. The Voting Rights Proxy Agreement may not be terminated except upon the written consent of all parties, or unilaterally by Sinotop Hong Kong upon 30 days’ notice.
Jinan Broadband
The corporate structure for our broadband business consists of:
|
|
●
|
a Cooperation Agreement, dated as of December 26, 2006, between CB Cayman and Jinan Parent (the “
December 2006 Cooperation Agreement
”);
|
|
|
|
a Cooperation Agreement dated as of January 2007, between Jinan Broadband and Networks Center (the “
January 2007 Cooperation Agreement
”); and
|
|
|
|
two Exclusive Service Agreements, dated December 2006 and March 2007, between Jinan Broadband, Jinan Parent and Networks Center (collectively, the “
Exclusive Service Agreements
”).
|
Pursuant to the December 2006 Cooperation Agreement, CB Cayman and Jinan Parent set up a joint venture, Jinan Broadband. CB Cayman contributed in cash and owns a 51% controlling interest, and Jinan Parent contributed the assets in exchange of 49% ownership in Jinan broadband. Jinan Broadband is a corporate joint venture with a term of 20 years. Jinan Broadband is considered as a VIE based on ASC 810-10-25-38 due to the fact that CB Cayman has a controlling financial interest in Jinan Broadband and therefore deemed to be the primary beneficiary based on the terms stipulated in the December 2006 Cooperation Agreement below:
|
|
|
CB Cayman appointed 3 directors and Jinan Parent appointed 2 directors;
|
|
|
|
The general manager and financial manager are appointed by CB Cayman; and
|
|
|
|
CB Cayman is entitled to receive 51% of net profit/loss of Jinan Broadband.
|
Pursuant to the January 2007 Cooperation Agreement, Networks Center, the PRC governmental agency which controls Jinan Parent, affirmed the arrangement set forth in the December 2006 Cooperation Agreement which provided that all of the pre-tax revenues of Jinan Broadband would be assigned to our WFOE for 20 years.
Under the terms of the Exclusive Service Agreements, Jinan Broadband is obligated to provide certain technical services needed by Jinan Parent and is entitled to receive 100% of the pre-tax revenue of access services from Jinan Parent as a service charge in exchange.
Shandong Media
Effective July 1, 2012, we deconsolidated Shandong Media due to a decrease in ownership from 50% to 30% (see Note 11 below for additional details related to the deconsolidation).
On March 7, 2008, we entered into the Shandong Cooperation Agreement with the Shandong Newspaper Entities. The Shandong Cooperation Agreement provided for, among other terms, the creation of a joint venture entity in the PRC, Shandong Media, that would own and operate the television program guide, newspaper and magazine publishing businesses previously owned and operated by the Shandong Newspaper Entities pursuant to exclusive licenses. In addition, Shandong Media entered into an exclusive advertising agency agreement and an exclusive consulting services agreement with the Shandong Newspaper Entities and another third party, Music Review Press, which requires that the Shandong Newspaper Entities and Music Review Press shall appoint Shandong Media as their exclusive advertising agent and provider of technical and management support for a fee.
Under the terms of the Shandong Cooperation Agreement and related pledge and trust documents, the Shandong Newspaper Entities contributed their entire Shandong newspaper business and transferred certain employees to Shandong Media in exchange for a 50% stake in Shandong Media, with the other 50% of Shandong Media to be owned directly by Jinan Zhong Kuan and indirectly by our WFOE in the PRC in the second quarter of 2008, with the joint venture becoming operational in July of 2008. In exchange, therefore, the Shandong Cooperation Agreement provided for total initial consideration from us of approximately $1.5 million (approximately 10 million RMB). As part of the transaction, and to facilitate our subsidiary’s ownership and control over Shandong Newspaper under PRC law, through our WFOE in the PRC, this acquisition was completed in accordance with a pledge and loan agreement, pursuant to which all of the shares of Shandong Media which we acquired are held in trust on our behalf by a nominee holder, as security for a loan to Shandong Media’s parent seller.
On January 19, 2012, through Jinan Zhong Kuan, we entered into a Memorandum of Understanding with the Shandong Newspaper Entities pursuant to which we expressed the intention to amend the terms of the Shandong Cooperation Agreement to transfer an aggregate of 20% of our ownership interest in Shandong Media to the Shandong Newspaper Entities. Shandong Media received notice of approval by the PRC State Administration for Industry & Commerce to effect the changes made in the Articles of Association and complete the transaction. The equity transfer ownership was effective as of July 1, 2012, and we have deconsolidated Shandong Media and recorded our 30% ownership under the equity method of accounting.
We are entitled to 100% of the pre-tax income of Jinan Zhong Kuan, in two ways which are discussed below. First, there are two individual owners of Jinan Zhong Kuan which hold all of the equity in that company in trust for the benefit of CB Cayman, pursuant to trustee arrangements entered into with them in 2008. The trustee arrangements relieve the individual shareholders from any responsibilities for the day-to-day operations of the company and any liability arising from their role as equity holders. All actions taken by them as shareholders will be in accordance with instructions provided by CB Cayman. The trustee arrangements provide that, in consideration for an up-front fee paid by CB Cayman, and monthly cash payments thereafter, the equity holders of Jinan Zhong Kuan will hold the equity of Jinan Zhong Kuan in trust for, and only for the benefit of, CB Cayman. We believe CB Cayman’s right to receive 100% of the dividends paid on the equity held in trust for it by the two individuals is appropriate under PRC transfer pricing rules, which are found in Arts. 41-48 of the PRC Enterprise Income Tax Law and Arts. 109-123 of the Implementing Regulations thereunder, and complies with the “arm’s length principle” mandated by Art. 41 of the Enterprise Income Tax Law, because those individuals have no responsibilities and take no risk in connection with their role as trustee shareholders other than to vote when requested and as directed by CB Cayman.
As a practical matter, however, there are not likely to be any dividends paid on the equity of Jinan Zhong Kuan, because all of its pre-tax income is required to be paid over to the WFOE under the terms of an exclusive services agreement entered into in January 2008. Under the terms of the exclusive services agreement, the WFOE is obligated to provide all management, technical and support services needed by Jinan Zhong Kuan and is entitled to receive 100% of the pre-tax income of Jinan Zhong Kuan in exchange. Jinan Zhong Kuan has no income other than profit distributions from Shandong Media. Jinan Zhong Kuan and our WFOE are related parties, and all of the risk and burden of the operations of Jinan Zhong Kuan is shifted to the WFOE under the exclusive services agreement, and therefore all of the economic benefit is shifted to the WFOE, as well. If the PRC tax authorities were to disagree with our position regarding the pricing under the exclusive services agreement between Jinan Zhong Kuan and the WFOE, there is no potential for past-due tax liability with respect to Jinan Zhong Kuan because, as noted above, Jinan Zhong Kuan has never recognized any profits.
The Company, through CB Cayman, is the sole owner of the WFOE, and exercises the overall voting power over the WFOE. In addition, through the various contractual agreements between CB Cayman, the trustees, the WFOE and Jinan Zhong Kuan, as discussed above, Jinan Zhong Kuan is considered a VIE. As the Company bears all risks and is entitled to all benefits relating to the investment in Jinan Zhong Kuan, the Company is a primary beneficiary of Jinan Zhong Kuan and is required to consolidate Jinan Zhong Kuan under the variable interest model. With respect to Shandong Media, it cannot finance its own activities without the cash contribution from Jinan Zhong Kuan. In addition, apart from its equity interest in Shandong Media, Jinan Zhong Kuan has the obligation to bear expected losses and receive expected returns through the exclusive services agreement, which entitles Jinan Zhong Kuan to all net profits of Shandong Media.
The Company obtains content through content license agreements and revenue sharing agreements with studios and distributors. The license agreement may or may not be recognized in licensed content.
When the license fee is not known or reasonably determinable for a specific title, the title does not meet the criteria for recognition in licensed content in accordance with ASC 920-350-25-2. We expense as costs of revenues the greater of revenue sharing costs incurred through the end of the reporting period or the proportionate value of total minimum license fees expensed on a straight-line basis over the term of each license agreement. As the Company expenses license fees on a straight-line basis, it may result in deferred or prepaid license fees. Prepaid license fees are classified as an asset on the consolidated balance sheets as licensed content and deferred license fees are classified as a liability on the consolidated balance sheets as deferred license fees. Commitments for license agreements that do not meet the criteria for recognition in licensed content are discussed in Note 21 to the consolidated financial statements.
|
6.
|
Warner Bros. License Agreement
|
On July 1, 2011, the Company, through its Chinese joint venture Zhong Hai Video entered into a Transactional Video on Demand and Pay-Per-View License Agreement (the “WB Agreement”) with CAV Warner Home Entertainment Co., Ltd. (“CAVW”), Warner Bros. Home Entertainment Group’s joint venture in China. Pursuant to the WB Agreement, Zhong Hai Video was granted a license under copyright for a total term of fifty-four months beginning on July 1, 2011. The contract is subject to annual minimum payments.
In connection with the WB Agreement, the Company issued 200,000 warrants to Warner Bros. Entertainment Inc. exercisable at a price per share of $6.60 for a term of five years beginning on May 12, 2011. These warrants are subject to a right of redemption exercisable by the Company in the event the closing price of the Company's common stock shall equal or exceed $13.20 per share for twenty consecutive trading days. In accordance with ASC 505-50,
Equity-based Payments to Non-employees
, the fair value of equity instruments issued in the acquisition of goods or services should be recognized in the same manner as if an enterprise had paid cash. As such, the Company estimated the fair value of the warrants granted using the Black-Scholes Merton model at $676,462 and capitalized the amount as licensed content. The Black-Scholes Merton model incorporated the following assumptions: risk-free interest rate of 1.89%, expected volatility of 60.0%, expected life of 5.0 years and expected dividend yield of 0%. The Company began amortizing this asset during the third quarter of 2011 and recognized approximately $150,000 and $75,000 (which is included in cost of revenue) during the years ended December 31, 2012 and 2011, respectively.
|
7.
|
Property and Equipment
|
During 2012, we reviewed the equipment assets at our Jinan Broadband subsidiary and determined that an additional impairment should be recorded based on the estimated realizable values. We initially reserved a portion of these assets in 2010. During 2012, we recorded an additional estimated impairment of $840,000 related to the facilities and machinery assets. The assets being impaired are considered to have no salvageable value.
|
|
|
December 31,
|
|
|
December 31,
|
|
|
|
|
2012
|
|
|
2011
|
|
|
|
|
|
|
|
|
|
|
Furniture and office equipment
|
|
$
|
3,202,000
|
|
|
$
|
2,088,000
|
|
|
Facilities and machinery
|
|
|
15,779,000
|
|
|
|
16,724,000
|
|
|
Leasehold improvements
|
|
|
178,000
|
|
|
|
310,000
|
|
|
Vehicles
|
|
|
54,000
|
|
|
|
30,000
|
|
|
Total property and equipment
|
|
|
19,213,000
|
|
|
|
19,152,000
|
|
|
Less: accumulated depreciation
|
|
|
(15,114,000
|
)
|
|
|
(14,053,000
|
)
|
|
Net carrying value
|
|
$
|
4,099,000
|
|
|
$
|
5,099,000
|
|
We recorded depreciation expense of approximately $2,052,000 and $2,505,000 for the years ended December 31, 2012 and 2011, respectively.
|
8.
|
Goodwill and Intangible Assets
|
The Company has intangible assets primarily relating to the acquisitions of Jinan Broadband and Sinotop Hong Kong. The Company amortizes its intangible assets that have finite lives. As discussed in Note 10, the Company determined during 2011 that AdNet’s remaining assets would no longer be used. As such, the Company recognized an impairment loss related to AdNet’s software technology in the amount of $189,241 during the quarter ended June 30, 2011. For Jinan Broadband, we reclassified $159,132 from fixed assets to software and licenses during the quarter ended June 30, 2012.
A roll forward of our intangible assets activity from December 31, 2011 to December 31, 2012 is as follows:
|
|
|
Balance at
|
|
|
|
|
|
|
|
|
Deconsolidation
|
|
|
Foreign
|
|
|
Balance at
|
|
|
|
|
December 31,
|
|
|
|
|
|
Amortization
|
|
|
of Shandong
|
|
|
Currency
|
|
|
December 31,
|
|
|
|
|
2011
|
|
|
Additions
|
|
|
Expense
|
|
|
Media
|
|
|
Transl Adj
|
|
|
2012
|
|
|
Amortized intangible assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Service agreement
|
|
$
|
1,310,892
|
|
|
$
|
-
|
|
|
$
|
(85,960
|
)
|
|
$
|
-
|
|
|
$
|
291,231
|
(1)
|
|
$
|
1,516,163
|
|
|
Publication rights
|
|
|
400,953
|
|
|
|
-
|
|
|
|
(12,150
|
)
|
|
|
(388,803
|
)
|
|
|
-
|
|
|
|
-
|
|
|
Customer relationships
|
|
|
76,579
|
|
|
|
-
|
|
|
|
(5,890
|
)
|
|
|
(70,689
|
)
|
|
|
-
|
|
|
|
-
|
|
|
Operating permits
|
|
|
600,147
|
|
|
|
-
|
|
|
|
(18,186
|
)
|
|
|
(581,961
|
)
|
|
|
-
|
|
|
|
-
|
|
|
Charter / Cooperation agreements
|
|
|
2,560,616
|
|
|
|
-
|
|
|
|
(137,792
|
)
|
|
|
-
|
|
|
|
-
|
|
|
|
2,422,824
|
|
|
Noncompete agreement
|
|
|
1,576,256
|
|
|
|
-
|
|
|
|
(1,455,004
|
)
|
|
|
-
|
|
|
|
-
|
|
|
|
121,252
|
|
|
Software and licenses
|
|
|
240,015
|
|
|
|
586,733
|
|
|
|
(191,212
|
)
|
|
|
(4,066
|
)
|
|
|
(789
|
)
|
|
|
630,681
|
|
|
Website development
|
|
|
250,000
|
|
|
|
100,000
|
|
|
|
(116,989
|
)
|
|
|
-
|
|
|
|
967
|
|
|
|
233,978
|
|
|
Total amortized intangible assets
|
|
$
|
7,015,458
|
|
|
$
|
686,733
|
|
|
$
|
(2,023,183
|
)
|
|
$
|
(1,045,519
|
)
|
|
$
|
291,499
|
|
|
$
|
4,924,898
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Unamortized intangible assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Website name
|
|
|
134,290
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
134,290
|
|
|
Goodwill
|
|
|
6,105,478
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
6,105,478
|
|
|
Total unamortized intangible assets
|
|
$
|
6,239,768
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
6,239,768
|
|
|
|
(1)
|
Cumulative foreign currency translation adjustment related to our Jinan Service Agreement
|
In accordance with ASC 250, we recorded amortization expense related to our intangible assets of approximately $2,030,000 and $1,919,000 during 2012 and 2011, respectively.
The following table outlines the amortization expense for the next five years and thereafter:
|
|
|
Jinan
|
|
|
Sinotop
|
|
|
|
|
|
|
|
|
Years ending December 31,
|
|
Broadband
|
|
|
Hong Kong
|
|
|
Sinotop
|
|
|
Total
|
|
|
2013
|
|
$
|
155,284
|
|
|
$
|
259,041
|
|
|
$
|
277,062
|
|
|
$
|
691,387
|
|
|
2014
|
|
|
148,779
|
|
|
|
137,791
|
|
|
|
241,604
|
|
|
|
528,174
|
|
|
2015
|
|
|
133,745
|
|
|
|
137,791
|
|
|
|
97,700
|
|
|
|
369,236
|
|
|
2016
|
|
|
113,952
|
|
|
|
137,791
|
|
|
|
95,298
|
|
|
|
347,041
|
|
|
2017
|
|
|
106,398
|
|
|
|
137,791
|
|
|
|
26,830
|
|
|
|
271,019
|
|
|
Thereafter
|
|
|
984,170
|
|
|
|
1,733,871
|
|
|
|
-
|
|
|
|
2,718,041
|
|
|
Total amortization to be recognized
|
|
$
|
1,642,328
|
|
|
$
|
2,544,076
|
|
|
$
|
738,494
|
|
|
$
|
4,924,898
|
|
|
9.
|
Equity Method Investments
|
The Company’s investments in companies that are accounted for on the equity method of accounting consist of the following: (1) 30% interest in Shandong Media, a print based media business; and (2) 39% interest in Hua Cheng, a company established to provide integrated value-added service solutions for the delivery of VOD and enhanced premium content for cable providers.
|
|
|
2012
|
|
|
2011
|
|
|
Condensed income statement information:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net sales
|
|
$
|
1,862,223
|
|
|
$
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross margin
|
|
$
|
419,696
|
|
|
$
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss
|
|
$
|
(258,450
|
)
|
|
$
|
(36,849
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Company's equity in net income (loss)
|
|
$
|
67,675
|
|
|
$
|
(14,371
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Condensed balance sheet information:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Current assets
|
|
$
|
3,018,413
|
|
|
$
|
1,364,720
|
|
|
Noncurrent assets
|
|
$
|
577,291
|
|
|
$
|
177,960
|
|
|
Total assets
|
|
$
|
3,595,704
|
|
|
$
|
1,542,680
|
|
|
|
|
|
|
|
|
|
|
|
|
Current liabilities
|
|
$
|
1,578,030
|
|
|
$
|
10
|
|
|
Noncurrent liabilities
|
|
$
|
182,151
|
|
|
$
|
-
|
|
|
Equity
|
|
$
|
1,835,523
|
|
|
$
|
1,542,670
|
|
|
Total liabilities and equity
|
|
$
|
3,595,704
|
|
|
$
|
1,542,680
|
|
|
10.
|
Deconsolidation of AdNet
|
We acquired AdNet during the first half of 2009. Due to the shift of our business model to the VOD business, as of December 31, 2009 we permanently suspended day-to-day operations of AdNet. Subsequently, we continued to maintain the technology and assets of AdNet, which we planned to use in our VOD business.
Due to recent continuing advancements in other advertising technologies, the Company determined that AdNet’s remaining assets would no longer be used to support the VOD business. As such, on August 3, 2011, the Company provided a thirty-day notice of its termination of the VIE arrangement with AdNet, which served to relinquish the Company’s control and any right to economic benefit, as well as release the Company of any future liability, upon effectiveness of such termination on September 2, 2011.
Accordingly, as of June 30, 2011, the Company recognized a loss on the impairment of AdNet’s remaining assets in the amount of $212,180. Upon the effectiveness of termination during the third quarter of 2011, the Company deconsolidated AdNet’s liabilities and recognized a gain of $470,041 in accordance with ASC 810-10-40,
Deconsolidation of a Subsidiary
.
|
11.
|
Deconsolidation of Shandong Media Joint Venture
|
In connection with the Shandong Newspaper Cooperation Agreement, based on certain financial performance thresholds we were required to make an additional payment of RMB 5,000,000 (approximately US $791,900) to Shandong Media. In January 2012, the Company, through Jinan Zhong Kuan, signed a Memorandum of Understanding (“MOU”) with Shandong Broadcast and Modern Movie, our partners in our Shandong Media joint venture company, whereby upon execution of a formal agreement, the Company was relieved of its obligation to make the additional payment of RMB 5,000,000 (approximately US $791,900) described above in exchange for payment of RMB 1,000,000 (approximately US$158,300) to Shandong Media and the transfer of 20% of the Company’s 50% ownership interest in Shandong Media to Shandong Broadcast and Modern Movie. In April 2012, Jinan Zhong Kuan made payment of RMB 1,000,000 to Shandong Broadcast in connection with the signed MOU.
Shandong Media has received notice of approval by the PRC State Administration for Industry & Commerce (“AIC”) to effect the changes made in the Articles of Association (“AOA”) and complete the transaction. The equity transfer ownership is effective as of July 1, 2012 and we have deconsolidated Shandong Media and recorded our 30% ownership under the equity method of accounting in accordance with ASC 810-10-40,
Deconsolidation of a Subsidiary
. We valued the 30% investment in Shandong Media at fair value based on historical and forecasted performance utilizing discounted cash flow methodology. Due to current performance and risks associated with future cash flow we valued Shandong Media at $0.00 as of the date of deconsolidation. As part of the deconsolidation we have removed the net assets associated with Shandong and recognized a gain of $141,814 on such deconsolidation.
Also in accordance with ASC 810-10-40, Deconsolidation of a Subsidiary, we will maintain a balance for our 30% investment in Shandong Median not to go below $0.00. Based on our valuation for our 30% ownership and the net loss from Q3 our balance is currently negative and as such is recorded as a $0.00 balance on our financial statements.
|
12.
|
Fair Value Measurements
|
Accounting standards require the categorization of financial assets and liabilities, based on the inputs to the valuation technique, into a three-level fair value hierarchy. The various levels of the fair value hierarchy are described as follows:
|
|
●
|
Level 1 — Financial assets and liabilities whose values are based on unadjusted quoted market prices for identical assets and liabilities in an active market that we have the ability to access.
|
|
|
|
Level 2 — Financial assets and liabilities whose values are based on quoted prices in markets that are not active or model inputs that are observable for substantially the full term of the asset or liability.
|
|
|
|
Level 3 — Financial assets and liabilities whose values are based on prices or valuation techniques that require inputs that are both unobservable and significant to the overall fair value measurement.
|
Accounting standards require the use of observable market data, when available, in making fair value measurements. When inputs used to measure fair value fall within different levels of the hierarchy, the level within which the fair value measurement is categorized is based on the lowest level input that is significant to the fair value measurement.
Common stock is valued at closing price reported on the active market on which the individual securities are traded.
Annually we review the valuation techniques used and determine if the fair value measurements are still appropriate and evaluate and adjust the unobservable inputs used in the fair value measurements based on current market conditions and third party information. There were no changes in the valuations techniques during the current year.
The fair value of the warrant liabilities at December 31, 2012 was valued using the Monte Carlo Simulation method which incorporated the following assumptions: risk-free rate of interest .777%, expected volatility of 75%, expected life of 4.67 years and expected dividend yield of 0%.
The fair value of the option portion of our contingent purchase consideration liabilities at December 31, 2012 was valued using the Black-Scholes Merton model and at December 31, 2011 it was valued using the Monte Carlo simulation method, which is based on valuation theories underlying the Black-Scholes Merton model. Estimated probabilities related to achieving the earn-out milestones were incorporated into our December 31, 2011 valuation. In addition, our valuation incorporates the following assumptions:
|
|
|
December 31,
|
|
|
December 31,
|
|
|
|
|
2012
|
|
|
2011
|
|
|
|
|
(Black-Scholes)
|
|
|
(Monte Carlo)
|
|
|
Risk-free interest rate
|
|
|
0.45
|
%
|
|
|
0.41
|
%
|
|
Expected volatility
|
|
|
75
|
%
|
|
|
75
|
%
|
|
Expected life
|
|
3.5 years
|
|
|
4 years
|
|
|
Expected dividend yield
|
|
|
0
|
%
|
|
|
0
|
%
|
The following tables present the fair value hierarchy for those assets and liabilities measured at fair value on a recurring basis at December 31, 2012 and 2011, respectively:
|
|
|
December 31, 2012
|
|
|
|
|
|
|
|
Fair Value Measurements
|
|
|
|
|
|
|
|
Level 1
|
|
|
Level 2
|
|
|
Level 3
|
|
|
Total Fair Value
|
|
|
Assets
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Available-for-sale securities
|
|
$
|
2,229
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
2,229
|
|
|
Investment in unconsolidated entities (Shandong Media)
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Warrant liabilities
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
878,380
|
|
|
$
|
878,380
|
|
|
Contingent purchase price consideration, current (see Note 13)
|
|
|
-
|
|
|
|
-
|
|
|
|
368,628
|
|
|
|
368,628
|
|
|
Contingent purchase price consideration, noncurrent (see Note 13)
|
|
|
-
|
|
|
|
-
|
|
|
|
368,628
|
|
|
|
368,628
|
|
|
|
|
December 31, 2011
|
|
|
|
|
|
|
|
Fair Value Measurements
|
|
|
|
|
|
|
|
Level 1
|
|
|
Level 2
|
|
|
Level 3
|
|
|
Total Fair Value
|
|
|
Assets
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Available-for-sale securities
|
|
$
|
2,229
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
2,229
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Contingent purchase price consideration, current (see Note 13)
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
1,091,571
|
|
|
$
|
1,091,571
|
|
|
Contingent purchase price consideration, noncurrent (see Note 13)
|
|
|
-
|
|
|
|
-
|
|
|
|
2,267,518
|
|
|
|
2,267,518
|
|
|
|
|
Level 3 Assets and Liabilities
|
|
|
|
|
For the Years Ended December 31, 2011 and 2012
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1/1/2011
|
|
|
Unrealized
(gain) / loss
|
|
|
12/31/2011
|
|
|
Purchases, sales
and issuances
and settlements
|
|
|
Unrealized
(gain) / loss
|
|
|
12/31/2012
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Warrant Liability
|
|
$
|
-
|
|
|
|
-
|
|
|
$
|
-
|
|
|
|
1,525,682
|
|
|
|
(647,302
|
)
|
|
$
|
878,380
|
|
|
Contingent purchase price consideration
|
|
$
|
3,362,105
|
|
|
|
(3,016
|
)
|
|
$
|
3,359,089
|
|
|
|
(1,308,390
|
)
|
|
|
(1,313,443
|
)
|
|
$
|
737,256
|
|
|
Quantitative Information about Level 3 Fair Value Measurements
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair Value at
|
|
Valuation
|
Unobservable
|
|
|
|
|
|
|
12/31/2012
|
|
Techniques
|
Inputs
|
|
Input
|
|
|
|
|
|
|
|
|
|
|
|
|
Warrant Liability
|
|
$
|
878,380
|
|
Monte Carlo Simulation Method
|
Risk Free rate of interest
|
|
|
0.777
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Expected volatility
|
|
|
75
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Expected life (years)
|
|
|
4.67
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Expected dividend yield
|
|
|
0
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Contingent consideration
|
|
$
|
737,256
|
|
Black-Scholes Merton Model
|
Risk Free rate of interest
|
|
|
0.540
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Expected volatility
|
|
|
75
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Expected life (years)
|
|
|
3.5
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Expected dividend yield
|
|
|
0
|
%
|
The significant unobservable inputs used in the fair value measurement of the Company’s warrant liability and contingent consideration includes the risk free interest rate, expected volatility, expected life and expected dividend yield. Significant increases or decreases in any of those inputs in isolation would result in a significantly different fair value measurement
With the adoption of ASU 2011-04, there were no changes in valuation technique and related inputs resulting from the adoption of the new requirements.
In accordance with our deconsolidation of Shandong Media, we recorded the fair value of our 30% equity investment. Utilizing forecasts based on recent historical performance we computed a discounted cash flow valuation of $0.00.
|
13.
|
Sinotop Contingent Consideration
|
In connection with the acquisition of Sinotop Hong Kong on July 30, 2010, if specified performance milestones are achieved, Weicheng Liu (“Mr. Liu” or “the Seller”) will be entitled to earn up to (i) an additional 403,820 shares of common stock of the Company, (ii) three-year warrants to purchase 571,275 shares of the Company’s common stock, equivalent to 5.0% of the total number of shares of the Company’s common stock underlying all outstanding warrants as of immediately following the closing of the July 2010 financing and (iii) a four-year option to purchase 80,000 shares of the Company’s common stock which was equal to 5% of the total number of shares of the Company’s common stock underlying all outstanding options of the Company granted to individuals employed by the Company as of September 1, 2010 (collectively, the securities referred to in clauses (i), (ii) and (iii) are referred to herein as the “Earn-Out Securities”). The milestones are as follows: Sinotop Hong Kong will ensure that (i) at the end of the first earn-out year (July 1, 2012), at least 3 million homes will have access to the Company’s VOD services, (ii) at the end of the second earn-out year (July 1, 2013), at least 11 million homes will have access to the Company’s VOD services, and (iii) at the end of the third earn-out year (July 1, 2014), at least 30 million homes will have access to the Company’s VOD services.
Subsequent to the acquisition of Sinotop, the Company underwent a warrant exchange that converted the three-year warrants to be potentially earned under clause (ii) above to 332,002 shares of common stock. As such, the Earn-Out Securities subject to the achievement of the specified performance milestones were 735,822 shares of common stock and a four-year option to purchase 80,000 shares of common stock.
The Company recorded a contingent consideration obligation related to the Earn-Out Securities at the time of acquisition which totaled $2,750,966, representing the fair value of the estimated payment of the full earn-out. The contingent consideration is classified as a liability because the earn-out securities do not meet the fixed-for-fixed criteria under ASC 815-40-15 for equity classification. Further ASC 815-40-15 requires us to re-measure the contingent consideration obligation at the end of every reporting period with the change in value reported in the consolidated statements of operations and, accordingly, we reported a gain of $1,313,443 and $3,016, for the years ended December 31, 2012 and 2011, respectively.
At the end of the first earn-out year (July 1, 2012), the first milestone was achieved with over 3 million homes having access to our VOD services. As such, we issued 245,274 shares of our common stock and 26,667 options to Mr. Liu.
The following is a summary of the earned purchase price consideration and the estimated fair value of the contingent consideration obligation for the acquisition of Sinotop Hong Kong at December 31, 2012 and 2011, respectively.
|
|
|
January 1,
|
|
|
|
|
|
|
|
|
December 31,
|
|
|
|
|
2012
|
|
|
Earned
|
|
|
Change in
|
|
|
2012
|
|
|
Class of consideration
|
|
Fair Value
|
|
|
Fair Value
|
|
|
Fair Value
|
|
|
Fair Value
|
|
|
Common shares
|
|
$
|
3,147,109
|
|
|
$
|
(1,226,369
|
)
|
|
$
|
(1,209,446
|
)
|
|
$
|
711,294
|
|
|
Stock options
|
|
|
211,980
|
|
|
|
(82,021
|
)
|
|
|
(103,997
|
)
|
|
|
25,962
|
|
|
Total earned and contingent consideration
|
|
$
|
3,359,089
|
|
|
$
|
(1,308,390
|
)
|
|
$
|
(1,313,443
|
)
|
|
$
|
737,256
|
|
|
|
|
January 1,
|
|
|
|
|
|
|
|
|
December 31,
|
|
|
|
|
2011
|
|
|
Earned
|
|
|
Change in
|
|
|
2011
|
|
|
Class of consideration
|
|
Fair Value
|
|
|
Fair Value
|
|
|
Fair Value
|
|
|
Fair Value
|
|
|
Common shares
|
|
$
|
3,175,902
|
|
|
$
|
-
|
|
|
$
|
(28,793
|
)
|
|
$
|
3,147,109
|
|
|
Stock options
|
|
|
186,203
|
|
|
|
-
|
|
|
|
25,777
|
|
|
|
211,980
|
|
|
Total earned and contingent consideration
|
|
$
|
3,362,105
|
|
|
$
|
-
|
|
|
$
|
(3,016
|
)
|
|
$
|
3,359,089
|
|
The following table represents the estimated fair value of the current and the noncurrent portion of the consideration liability for the acquisition of Sinotop Hong Kong at December 31, 2012.
|
|
|
As of December 31, 2012
|
|
|
|
|
Number of
|
|
|
Current
|
|
|
Noncurrent
|
|
|
Total
|
|
|
|
|
Instruments
|
|
|
Liability
|
|
|
Liability
|
|
|
Liability
|
|
|
Shares July 2013
|
|
|
245,274
|
|
|
$
|
355,647
|
|
|
$
|
-
|
|
|
$
|
355,647
|
|
|
Shares July 2014
|
|
|
245,274
|
|
|
|
-
|
|
|
|
355,647
|
|
|
|
355,647
|
|
|
Total Common Shares
|
|
|
490,548
|
|
|
$
|
355,647
|
|
|
$
|
355,647
|
|
|
$
|
711,294
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options July 2013
|
|
|
26,667
|
|
|
$
|
12,981
|
|
|
$
|
-
|
|
|
$
|
12,981
|
|
|
Options July 2014
|
|
|
26,666
|
|
|
|
-
|
|
|
|
12,981
|
|
|
|
12,981
|
|
|
Total Options
|
|
|
53,333
|
|
|
$
|
12,981
|
|
|
$
|
12,981
|
|
|
$
|
25,962
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Shares and Options
|
|
|
543,881
|
|
|
$
|
368,628
|
|
|
$
|
368,628
|
|
|
$
|
737,256
|
|
|
|
|
As of December 31, 2011
|
|
|
|
|
Number of
|
|
|
Current
|
|
|
Noncurrent
|
|
|
Total
|
|
|
|
|
Instruments
|
|
|
Liability
|
|
|
Liability
|
|
|
Liability
|
|
|
Shares July 2012
|
|
|
245,274
|
|
|
$
|
1,027,391
|
|
|
$
|
-
|
|
|
$
|
1,027,391
|
|
|
Shares July 2013
|
|
|
245,274
|
|
|
|
-
|
|
|
|
1,066,573
|
|
|
|
1,066,573
|
|
|
Shares July 2014
|
|
|
245,274
|
|
|
|
-
|
|
|
|
1,053,145
|
|
|
|
1,053,145
|
|
|
Total Common Shares
|
|
|
735,822
|
|
|
$
|
1,027,391
|
|
|
$
|
2,119,718
|
|
|
$
|
3,147,109
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options July 2012
|
|
|
26,667
|
|
|
$
|
64,180
|
|
|
$
|
-
|
|
|
$
|
64,180
|
|
|
Options July 2013
|
|
|
26,667
|
|
|
|
-
|
|
|
|
71,620
|
|
|
|
71,620
|
|
|
Options July 2014
|
|
|
26,666
|
|
|
|
-
|
|
|
|
76,180
|
|
|
|
76,180
|
|
|
Total Options
|
|
|
80,000
|
|
|
$
|
64,180
|
|
|
$
|
147,800
|
|
|
$
|
211,980
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Shares and Options
|
|
|
815,822
|
|
|
$
|
1,091,571
|
|
|
$
|
2,267,518
|
|
|
$
|
3,359,089
|
|
|
14.
|
Related Party Transactions
|
Jinan Broadband
Payable to Jinan Parent
As of December 31, 2012, our payable to Jinan Guangdian Jiahe Digital Television Co., Ltd. (“Jinan Parent”) increased approximately $1,000, due to currency fluctuations. At December 31, 2012 and December 31, 2011, approximately $144,000 and $143,000, respectively, remained due to Jinan Parent. This amount represents the remaining balance due from the initial acquisition which is unsecured, interest free and has no fixed repayment terms.
Revenue
During the years ended December 31, 2012 and 2011, Jinan Broadband generated $147,000 and $158,000, respectively, of value-added service revenue from an affiliate, Jinan Radio and Television Networks Center (“Networks Center”). Networks Center is the owner of Jinan Parent who has a 49% ownership interest in Jinan Broadband.
Cost of Revenue
During the years ended December 31, 2012 and 2011, Jinan Broadband incurred service fees to Networks Center of approximately $35,000 and $47,000, respectively. To minimize administrative fees and maintain a low headcount at Jinan Broadband, Networks Center collects customer payments on behalf of Jinan Broadband and then remits the funds to Jinan Broadband. Networks Center charges Jinan Broadband a 2% service fee on the payments collected.
General and Administrative Expense
During the years ended December 31, 2012 and 2011, Jinan Broadband paid sales agency fees of approximately $69,000 and $31,000, respectively, to Networks Center for revenue collection on behalf of Jinan Broadband and network maintenance.
Accounts Payable
As of December 31, 2012 and 2011, respectively, Jinan Broadband had accounts payable to Networks Center of approximately $270,000 and $268,000, respectively, relating to maintenance, network leasing and facility rental fees. Jinan Broadband’s operation is located in a building that is owned by Networks Center. As such, Jinan Broadband shares the cable network usage with Networks Center. Additionally, Jinan Broadband utilizes Networks Center’s staff to provide cable network maintenance support to their customers. As such, Network Center charges Jinan Broadband fees for these services and usage of their facility.
Accrued Expense
Jinan Broadband had accrued network maintenance fees and network leasing fees to Networks Center of approximately $1,087,000 and $47,000 as of December 31, 2012 and 2011, respectively.
Sinotop
Amount due from Non-controlling Interest
Subsequent to our acquisition of Sinotop Hong Kong in July 2010, Sinotop and Hua Cheng entered into a variable interest entity agreement to form and operate Zhong Hai Video with equity ownership interests of 80% and 20%, respectively, of total registered capital of RMB 50 million. Sinotop contributed RMB 10 million and had a commitment to fund the remaining RMB 30 million. At December 31, 2011, Hua Cheng had not made its capital contribution of RMB 10 million. Accordingly, we recorded an amount due from non-controlling interest in the amount of $1,572,699.
During the third quarter of 2012, Zhong Hai Video reduced the total registered capital from RMB 50 million (USD 7,903,000) to RMB 12.5 million (USD 1,871,000). Following the registered capital reduction, Hua Cheng contributed a software management system valued at RMB 2,519,700 (USD 398,000) and Sinotop no longer had a commitment to fund the remaining RMB 30 million as noted above. As of December 31, 2012 there is no amount due from our non-controlling interest.
Cost of Revenue
During the year ended December 31, 2012 Zhong Hai Video paid licensed content fees to Hua Cheng Film and Television Digital Program Co., Ltd., a related party, of RMB 1,000,000 (USD 159,000).
|
15.
|
Retail Financing, December 2012
|
On December 14, 2012, we entered into an underwriting agreement with Chardan Capital Markets LLC, as representative of several underwriters, and National Securities Corporation, as qualified independent underwriter (collectively, the “Underwriters”) in connection with the offer and sale by the Company of 1,800,000 shares of the Company’s common stock, par value $0.001 per share, at a price to the public of $1.50 per share. The Company received net proceeds from this offering of $2,193,738, after deducting underwriting discounts and commissions. The shares were offered and sold under a prospectus supplement and related prospectus filed with the U.S. Securities and Exchange Commission pursuant to the Company’s shelf registration statement on Form S-3 (File No. 333-183689). The offering closed on December 19, 2012.
|
16.
|
Private Financing, August 2012
|
On August 30, 2012, we entered into a Securities Purchase Agreement with certain accredited investors, pursuant to which the Company offered the Investors the option to purchase either (i) Class A Units, with each Class A Unit consisting of one share of the Company’s common stock, par value $0.001 per share and (b) a common stock purchase warrant (each a “Warrant,” and, collectively, the “
Warrants
”) to purchase one share of Common Stock at an exercise price of $4.25 per share, or (ii) Class B Units, with each Class B Unit consisting of one share of the Company’s Series C Preferred Stock, par value $0.001 per share, and a Warrant. The per unit price for each of the Class A Units and the Class B Units was $4.00.
On August 30, 2012, the Company closed the transactions contemplated by the Purchase Agreement and issued and sold to Investors (i) an aggregate of 646,250 Class A Units (consisting of an aggregate of 646,250 shares of Common Stock and Warrants to purchase 646,250 shares of Common Stock), and (ii) an aggregate of 250,000 Class B Units (consisting of an aggregate of 250,000 shares of Series C Preferred Stock and Warrants to purchase 250,000 shares of Common Stock). The Company received aggregate gross proceeds of $3,585,000.
The proceeds from the sale were allocated to Common Stock, Series C Convertible, Preferred Stock, warrants and beneficial conversion features based on the relative fair value of the securities in accordance with ASC 470-20-30. The value of the Common Stock and Series C Preferred stock was based on the closing price paid by investors. The fair value of the warrants was calculated using the Black-Scholes model with the following assumptions: expected life of 5 years, expected dividend rate of 0%, volatility of 75% and an interest rate of .66%. The exercise price of the warrants is $4.25.
The Company recognized a beneficial conversion feature discount on Series C Convertible Preferred Stock at its intrinsic value, which was the fair value of the common stock at the commitment date for Series C Convertible Preferred Stock investment, less the effective conversion price. The Company recognized approximately $342,000 of beneficial conversion feature as an increase in additional paid in capital in the accompanying consolidated balance sheet on the date of issuance of Series C Convertible Preferred Stocks since these shares were convertible at the issuance date. The Series C Preferred Stock have been classified as temporary equity as of December 31, 2012, based on their conversion characteristics. The Series C Preferred Stock is not deemed to be an embedded derivative instrument to be bifurcated since it’s indexed to its own stock.
In accordance with FASB ASC 815-40-15-5, “Determining Whether an Instrument (or Embedded Feature) is Indexed to an Entity’s Own Stock”, the warrants have been characterized as derivative liabilities to be re-measured at the end of every reporting period with the change in value reported in the consolidated statement of operations. On August 30, 2012, such warrants were valued at $1,525,000 utilizing a valuation model and were initially recorded as a liability. As of December 31, 2012, the warrant liability was re-valued using a Monte Carlo valuation as disclosed in Note 12, Fair Value Measurement, and was adjusted to its new fair value of approximately $878,000 as determined by the Company, resulting in a gain of approximately $647,000.
As a result of the Negative Clawback provisions included in the warrant agreement we have reset the exercise price from $4.25 per share to $1.50 per share. The fair value calculation on our warrant liability includes this reset.
The Purchase Agreement contains customary representations, warranties and covenants. In addition, the Company agreed to a negative clawback provision. Under the Negative Clawback, if at any time after the closing the Company consummates an underwritten public offering with respect to the purchase and sale of Common Stock or preferred stock (collectively, “
Additional Securities
”) of the Company resulting in a price per share of such Additional Securities (after giving effect to the conversion of any preferred stock to be issued in the Subsequent Public Financing) of less than $4.00, then, simultaneously with the closing of such Subsequent Public Financing, the Company shall be obligated to issue to each Investor of Class A Units only, for no additional consideration, that number of Common Shares as is equal to (i) the number of Common Shares that would have been issuable to such Class A Investor at closing if the Per Unit Purchase Price were equal to the greater of (A) the Public Financing Price and (B) $2.50, minus (ii) the number of Common Shares issued to the Class A Investor at the closing. As a result of our December 2012 retail financing the Company adjusted the number of shares in accordance with the negative clawback provisions and has recorded a charge to operations of $659,000 for the issuance of additional shares. As of December 31, 2012, the Company has accrued such charge which is included in other current liabilities since it’s subject to shareholders’ approval which is expected in 2013.
The holder of shares of Series C Preferred Stock will not have the right to vote and will not have full voting rights and powers equal to the voting rights and powers of holders of the Company’s Common Stock. In addition, the holders of Series C Preferred Stock will not be entitled to convert any shares of Series C Preferred Stock into shares of the Common Stock if, after giving effect to the conversion, such holder would hold in excess of 9.99% of the Company’s outstanding Common Stock. Each share of Series C Preferred Stock is convertible, at any time at the option of the holder, into such number of shares of common stock equal to the product of (i) the number of shares of Series C Preferred Stock to be converted, multiplied by (ii) $4.00 divided by (iii) the conversion price, which is equal to the lesser of (x) $4.00 and (y) the price per share paid by investors in a Subsequent Public Financing;
provided
,
however
, that the conversion price shall not, in any event, be less than $2.50. Notwithstanding the foregoing, the conversion price shall equal $4.00, and there shall be no adjustment to the conversion price resulting from the price per share paid by investors in a Subsequent Public Financing, until the provisions of the Certificate regarding the adjustment to the conversion price are approved by shareholders holding a majority of the outstanding voting securities of the Company. As a result of our December 2012 retail financing, we have adjusted the conversion price of the Preferred C Shares to the floor of $2.50 and as such have reflected the additional value amounting to $924,000 as a deemed dividend in the consolidated statement of operations.
Lastly, the Company paid issuance costs of approximately $119,000 and issued shares and warrants valued at approximately $515,000 to the placement agent related to the August 2012 financings.
|
17.
|
Private Financings, June 2011
|
On June 3, 2011, we completed a private placement transaction with FIL Investment Management (Hong Kong) Limited (“Fidelity”), professional fiduciary for various accounts from time to time. Pursuant to a securities purchase agreement between us and Fidelity, we issued to funds managed by Fidelity and its affiliates an aggregate of 979,213 shares of our common stock at a per share price of $6.60, resulting in aggregate gross proceeds to the Company of $6,462,806. Pursuant to the securities purchase agreement with Fidelity, we could not, during the six month period following the closing, without the prior written consent of Fidelity, issue any shares of our common stock, including securities that were exercisable or convertible into common stock except for (i) up to 1,958,426 shares of our common stock at a per share price equal to or greater than $6.60, (ii) shares of our common stock upon the exercise, exchange or conversion of our securities which were outstanding prior to the closing, (iii) shares of our common stock upon the exercise, exchange or conversion of callable warrants to purchase up to 666,667 shares of our common stock, with a per share exercise price equal to or greater than $6.60, and (iv) pursuant to our Stock Incentive Plan, options to purchase up to an aggregate of 440,000 shares of our common stock to new and existing employees in the normal course of business.
In connection with the private placement transaction with Fidelity, we entered into a registration rights agreement with Fidelity pursuant to which we were obligated to file a registration statement with the U.S. Securities and Exchange Commission within thirty days following the closing to register the shares of common stock issued to Fidelity. The registration statement was filed on June 29, 2011 and declared effective on July 8, 2011.
On June 7, 2011, we completed a private placement transaction with a group of twenty-seven accredited investors. Pursuant to a securities purchase agreement between us and the investors, we issued to the investors an aggregate of 675,000 shares of our common stock at a per share price of $6.60, resulting in aggregate gross proceeds of $4,455,000. The offer and sale of the shares to the accredited investors was made in compliance with the securities purchase agreement with Fidelity.
The Company paid issuance costs of $822,167 related to the June 2011 financings.
Stock Purchase Right
In connection with the June 3, 2011 private placement, we granted to Fidelity a right of first refusal during the six month period following the closing to purchase up to ten percent of the number of shares of common stock offered to other investors, as permitted in the securities purchase agreement, at a per share price of $6.60 and on identical terms as set forth in the securities purchase agreement.
In connection with the June 7, 2011 private placement, Fidelity had the right to purchase up to 75,000 shares of our common stock, or up to ten percent of the number of shares sold to the accredited investors, at a per share price of $6.60. On June 7, 2011, we agreed to modify the right with Fidelity to extend the right to purchase these shares until December 3, 2011 at a price of $6.60 per share. We valued this right at approximately $155,000 based on the Black-Scholes Merton model and recorded it as a right to purchase shares expense in connection with the placement. On December 4, 2011, we granted Fidelity an extension of this right to purchase for an additional six months and valued this right at approximately $39,000 and in June 2012, we granted another six month extension and valued this right at approximately $44,000. Both valuations were based on the Black-Scholes Merton model and were recorded as a right to purchase shares expense in connection with the placement. As of December 31, 2012, this right of first refusal has expired.
|
18.
|
Net Loss Per Common Share
|
Basic net loss per common share attributable to YOU On Demand shareholders is calculated by dividing the net loss attributable to YOU On Demand shareholders by the weighted average number of outstanding common shares during the period. Diluted net loss per common share includes the weighted average dilutive effect of stock options, warrants and series preferred stocks.
For the years ended December 31, 2012 and 2011, the number of securities convertible into common shares not included in diluted EPS because the effect would have been anti-dilutive consists of the following:
|
|
|
2012
|
|
|
2011
|
|
|
Warrants
|
|
|
1,348,975
|
|
|
|
358,579
|
|
|
Stock purchase right
|
|
|
-
|
|
|
|
75,000
|
|
|
Options
|
|
|
1,585,401
|
|
|
|
1,383,567
|
|
|
Series A Preferred Stock
|
|
|
933,333
|
|
|
|
933,333
|
|
|
Series B Preferred Stock
|
|
|
1,048,907
|
|
|
|
1,368,907
|
|
|
Series C Preferred Stock
|
|
|
250,000
|
|
|
|
-
|
|
|
Total
|
|
|
5,166,616
|
|
|
|
4,119,386
|
|
At December 31, 2012 and 2011, the Company has reserved 8,330,529 and 7,551,641 shares of its authorized but unissued common stock for possible future issuance in connection with the following:
|
|
|
2012
|
|
|
2011
|
|
|
Exercise of stock warrants
|
|
|
1,348,975
|
|
|
|
358,579
|
|
|
Exercise of stock purchase right
|
|
|
-
|
|
|
|
75,000
|
|
|
Exercise and future grants of stock options
|
|
|
4,051,986
|
|
|
|
4,080,000
|
|
|
Exercise of preferred stock
|
|
|
2,382,240
|
|
|
|
2,302,240
|
|
|
Issuance of restricted stock grants
|
|
|
56,780
|
|
|
|
-
|
|
|
Contingent issuable shares in connection with Sinotop acquisition
|
|
|
490,548
|
|
|
|
735,822
|
|
|
Total
|
|
|
8,330,529
|
|
|
|
7,551,641
|
|
Stock Options
As of December 31, 2012, the Company has 1,585,401 options and 1,348,975 warrants outstanding to purchase shares of our common stock.
The following table provides the details of the approximate total share based payments expense during the years ended December 31, 2012 and 2011:
|
|
|
2012
|
|
|
2011
|
|
|
|
Stock option amortization
|
|
$
|
766,000
|
|
|
$
|
599,000
|
|
(a)
|
|
Stock issued for services
|
|
|
572,000
|
|
|
|
10,000
|
|
(b)
|
|
Stock warrants issued for services
|
|
|
39,000
|
|
|
|
25,000
|
|
|
|
Right to purchase shares
|
|
|
44,000
|
|
|
|
194,000
|
|
(see note 17)
|
|
|
|
$
|
1,421,000
|
|
|
$
|
828,000
|
|
|
|
(a)
|
The Company accounts for its stock option awards pursuant to the provisions of ASC 718,
Stock Compensation
. The fair value of each option award is estimated on the date of grant using the Black-Scholes Merton valuation model. The Company recognizes the fair value of each option as compensation expense ratably using the straight-line attribution method over the service period, which is generally the vesting period. The Black-Scholes Merton model incorporated the following assumptions for the options granted in 2012 and 2011: risk-free interest rate of 1.73% to 3.43%, expected volatility of 60% and 75%, expected life of 10.0 years and expected dividend yield of 0%.
|
|
(b)
|
In the second quarter of 2012, the Company appointed two new “independent” (as defined under the NASDAQ listing requirements) members to the Board of Directors. In connection with the appointment we granted each of our three “independent” directors 10,000 restricted shares to be vested quarterly over one year.
|
During 2012, the Company granted 196,620 shares to certain consultants and Directors for services. As of December 31, 2012, there were 181,620 shares vested. We recorded the common shares at the closing price on the issue date and expensed to consulting, marketing and technology services $294,000 during the year ended December 31, 2012. We recorded $278,000 to prepaid expense to be recognized for services provided in 2013. During the year ended December 31, 2011, we recorded $10,000 for other consulting services.
Effective as of December 3, 2010, our Board of Directors approved the YOU On Demand Holdings, Inc. 2010 Stock Incentive Plan (“the Plan”) pursuant to which options or other similar securities may be granted. The maximum aggregate number of shares of our common stock that may be issued under the Plan is 4,000,000 shares.
Stock option activity from commencement of plan through December 31, 2012 is summarized as follows:
|
|
|
Options
|
|
|
Weighted Average
|
|
|
|
|
Outstanding
|
|
|
Exercise Price
|
|
|
Approved plan
|
|
|
4,000,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding at December 31, 2010
|
|
|
1,285,567
|
|
|
$
|
3.00
|
|
|
Granted
|
|
|
111,333
|
|
|
|
4.91
|
|
|
Exercised
|
|
|
-
|
|
|
|
-
|
|
|
Canceled
|
|
|
(13,333
|
)
|
|
|
3.00
|
|
|
Outstanding at December 31, 2011
|
|
|
1,383,567
|
|
|
|
|
|
|
Granted
|
|
|
227,567
|
|
|
|
4.48
|
|
|
Exercised
|
|
|
(1,347
|
)
|
|
|
3.80
|
|
|
Canceled
|
|
|
(24,386
|
)
|
|
|
5.38
|
|
|
Outstanding at December 31, 2012
|
|
|
1,585,401
|
|
|
$
|
3.54
|
|
|
|
|
|
|
|
|
|
|
|
|
Options exercisable as of December 31, 2012 (vested)
|
|
|
1,067,404
|
|
|
$
|
3.32
|
|
|
|
|
|
|
|
|
|
|
|
|
Options available for issuance at December 31, 2012
|
|
|
2,414,599
|
|
|
|
|
|
As of December 31, 2012, there was no aggregate intrinsic value of shares outstanding and exercisable since our closing stock price was below all of the exercise prices.
The following table summarizes information concerning outstanding and exercisable options as of December 31, 2012:
|
|
|
|
|
|
|
Weighted Average
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Remaining
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Number
|
|
|
Contractual Life
|
|
|
Weighted Average
|
|
|
Number
|
|
|
Weighted Average
|
|
|
Range of Exercise Prices
|
|
|
Outstanding
|
|
|
(Years)
|
|
|
Exercise Price
|
|
|
Exerciseable
|
|
|
Exercise Price
|
|
|
$3 - $4
|
|
|
|
1,338,000
|
|
|
|
8.17
|
|
|
$
|
3.04
|
|
|
|
1,000,570
|
|
|
$
|
3.03
|
|
|
$4 - $8
|
|
|
|
243,168
|
|
|
|
8.95
|
|
|
|
6.43
|
|
|
|
62,601
|
|
|
|
6.63
|
|
|
$8 - $33
|
|
|
|
0
|
|
|
|
0
|
|
|
|
0.00
|
|
|
|
0
|
|
|
|
0
|
|
|
$33 - $34
|
|
|
|
2,000
|
|
|
|
0.46
|
|
|
|
33.75
|
|
|
|
2,000
|
|
|
|
33.75
|
|
|
$34 - $45
|
|
|
|
900
|
|
|
|
0.20
|
|
|
|
45.00
|
|
|
|
900
|
|
|
|
45.00
|
|
|
$45 - $75
|
|
|
|
1,333
|
|
|
|
5.20
|
|
|
|
75.00
|
|
|
|
1,333
|
|
|
|
75.00
|
|
|
|
|
|
|
1,585,401
|
|
|
|
8.09
|
|
|
$
|
3.43
|
|
|
|
1,067,404
|
|
|
$
|
3.32
|
|
As of December 31, 2012, there were 1,585,401 options outstanding with 1,067,404 options exercisable.
The following table summarizes the status of options which contain vesting provisions:
|
|
|
|
|
|
Weighted
|
|
|
|
|
|
|
|
Average
|
|
|
|
|
|
|
|
Grant Date
|
|
|
|
|
Options
|
|
|
Fair Value
|
|
|
Non-vested at January 1, 2012
|
|
|
675,209
|
|
|
$
|
3.33
|
|
|
Granted
|
|
|
200,900
|
|
|
|
4.58
|
|
|
Vested
|
|
|
(336,837
|
)
|
|
|
3.46
|
|
|
Canceled
|
|
|
(20,219
|
)
|
|
|
5.30
|
|
|
Non-vested at December 31, 2012
|
|
|
519,053
|
|
|
$
|
3.66
|
|
As of December 31, 2012 the Company had total unrecognized compensation expense related to options granted of approximately $1,407,000 which will be recognized over a remaining service period of 4.0 years.
Warrants
In connection with the Company’s Share Exchange, capital raising efforts in 2007, the Company’s January 2008 Financing of Convertible Notes and Class A Warrants, the April 2010 Convertible Note, the July 2010, June 2011, August 2012 and December 2012 financings, the WB Agreement and a service agreement, the Company issued warrants to investors and service providers to purchase common stock of the Company. As of December 31, 2012, the weighted average exercise price was $14.42 and the weighted average remaining life was 3.92 years. The following table outlines the warrants outstanding as of December 31, 2012 and December 31, 2011:
|
|
|
2012
|
|
|
2011
|
|
|
|
|
|
|
|
|
|
Number of
|
|
|
Number of
|
|
|
|
|
|
|
|
|
|
Warrants
|
|
|
Warrants
|
|
|
Exercise
|
|
Expiration
|
|
|
Warants Outstanding
|
|
Outstanding
|
|
|
Outstanding
|
|
|
Price
|
|
Date
|
|
|
Share Exchange Consulting Warrants ($45.00 exercise price)
|
|
|
59,664
|
|
|
|
59,664
|
|
|
$
|
45.00
|
|
1/11/2013
|
|
|
2007 Private Placement Broker Warrants ($45.00 exercise price)
|
|
|
8,533
|
|
|
|
8,533
|
|
|
$
|
45.00
|
|
1/11/2013
|
|
|
2007 Private Placement Investor Warrants ($150.00 exercise price)
|
|
|
53,333
|
|
|
|
53,333
|
|
|
$
|
150.00
|
|
1/11/2013
|
|
|
July 2010 Sinotop Acquisition Warrants ($45.00 exercise price)
|
|
|
17,049
|
|
|
|
17,049
|
|
|
$
|
45.00
|
|
1/11/2013
|
|
|
July 2010 Sinotop Acquisition Warrants ($150.00 exercise price)
|
|
|
13,333
|
|
|
|
13,333
|
|
|
$
|
150.00
|
|
1/11/2013
|
|
|
May 2011 Warner Brothers Warrants ($6.60 excercise price)
|
|
|
200,000
|
|
|
|
200,000
|
|
|
$
|
6.60
|
|
5/11/2016
|
|
|
June 2011 Fidelity Right to Purchase ($6.60 exercise price)
|
|
|
-
|
|
|
|
75,000
|
|
|
$
|
6.60
|
|
12/3/2012
|
|
|
2011 Service Agreement Warrants ($7.20 exercise price)
|
|
|
20,000
|
|
|
|
6,667
|
|
|
$
|
7.20
|
|
6/15/2016
|
|
|
2012 August Financing Warrants ($4.25 exercise price)
|
|
|
977,063
|
|
|
|
-
|
|
|
$
|
4.25
|
|
8/30/2017
|
(1)
|
|
|
|
|
1,348,975
|
|
|
|
433,579
|
|
|
|
|
|
|
|
|
|
(1)
|
As a result of the negative clawback provisions included in our warrant agreements associated with our August 2012 private financings, the exercise price of $4.25 per share is expected to be reset to $1.50 per share after shareholder approval.
|
|
|
(A)
|
Corporate Income Tax (“CIT”)
|
YOD was incorporated in Nevada and is subject to U.S. federal and state income tax.
CB Cayman was incorporated in Cayman Islands as an exempted company and is not subject to income tax under the current laws of Cayman Islands.
Sinotop Hong Kong was incorporated in HK as a holding company. The statutory income tax rate in HK is 16.5%.
All of the Company’s income is generated in the PRC. WFOE, YOD WFOE, Sinotop Beijing, Zhong Hai Video, Jinan Zhongkuan, Jinan Broadband are PRC entities. The income tax provision of these entities is calculated at the applicable tax rates on the taxable income for the periods based on existing legislation, interpretations and practices in the PRC.
In accordance with the Corporate Income Tax Law of the PRC (“CIT Law”), effective beginning on January 1, 2008, enterprises established under the laws of foreign countries or regions and whose “place of effective management” is located within the PRC territory are considered PRC resident enterprises and subject to the PRC income tax at the rate of 25% on worldwide income. The definition of “place of effective management” refers to an establishment that exercises, in substance, and among other items, overall management and control over the production and business, personnel, accounting, and properties of an enterprise. If the Company’s non-PRC incorporated entities are deemed PRC tax residents, such entities would be subject to PRC tax under the CIT Law. Since our non-PRC entities have accumulated loss, the application of this tax rule will not result in any PRC tax liability.
The CIT Law imposes a 10% withholding income tax, subject to reduction based on tax treaty where applicable, for dividends distributed by a foreign invested enterprise to its immediate holding company outside China. Under the PRC-HK tax treaty, the withholding tax on dividends is 5% provided that a HK holding company qualifies as a HK tax resident as defined in the tax treaty. No provision has been made for U.S income taxes on the earnings generated by the Company’s foreign subsidiaries since the Company plans to permanently reinvest all such earnings outside the U.S.
The provision for income tax expense (benefit) consists of the following components:
|
|
|
2012
|
|
|
2011
|
|
|
Income (loss) before tax
|
|
$
|
(16,640,490
|
)
|
|
$
|
(13,011,772
|
)
|
|
Current tax expense (benefit)
|
|
|
|
|
|
|
|
|
|
United States
|
|
$
|
(21,875
|
)
|
|
$
|
1,620
|
|
|
PRC/Hong Kong
|
|
|
-
|
|
|
|
|
|
|
|
|
|
(21,875
|
)
|
|
|
1,620
|
|
|
|
|
|
|
|
|
|
|
|
|
Deferred tax (benefit) expense other than the benefit of net operating losses
|
|
|
|
|
|
|
|
|
|
United States
|
|
|
-
|
|
|
|
-
|
|
|
PRC/Hong Kong
|
|
|
(270,830
|
)
|
|
|
(193,781
|
)
|
|
|
|
|
(270,830
|
)
|
|
|
(193,781
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Deferred tax (benefit) of net operating losses
|
|
|
|
|
|
|
|
|
|
United States
|
|
|
-
|
|
|
|
|
|
|
PRC/Hong Kong
|
|
|
(60,380
|
)
|
|
|
(177,546
|
)
|
|
|
|
|
(60,380
|
)
|
|
|
(177,546
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Total income tax (benefit) expense
|
|
$
|
(353,085
|
)
|
|
$
|
(369,707
|
)
|
A reconciliation of the expected income tax derived by the application of the 34% U.S. corporate income tax rate to the Company's loss before income tax benefit is as follows:
|
|
|
2012
|
|
|
2011
|
|
|
|
|
|
|
|
|
|
|
Net loss before income taxes
|
|
$
|
(16,640,490
|
)
|
|
$
|
(13,011,772
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Expected income tax benefit at 34%
|
|
|
(5,657,767
|
)
|
|
|
(4,424,002
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Nondeductible expenses
|
|
|
480,620
|
|
|
|
379,915
|
|
|
Non-taxable gain on deconsolidation of Shandong Media
|
|
|
(25,536
|
)
|
|
|
-
|
|
|
Non-taxable gain on AdNet
|
|
|
-
|
|
|
|
(563,319
|
)
|
|
Non-taxable change in warrant liabilities
|
|
|
(220,083
|
)
|
|
|
-
|
|
|
Non-taxable (gain) loss on contingent consideration
|
|
|
(446,571
|
)
|
|
|
-
|
|
|
Rate-differential on foreign income invested indefinitely
|
|
|
1,228,607
|
|
|
|
1,180,646
|
|
|
Increase in valuation allowance
|
|
|
4,286,768
|
|
|
|
2,960,535
|
|
|
Change in estimates - offset by changes in valuation allowance above
|
|
|
22,752
|
|
|
|
-
|
|
|
Removal of deferred tax assets relating to pre-merger NOLs
|
|
|
2,280,194
|
|
|
|
-
|
|
|
Change in valuation allowance related to pre-merger NOLs
|
|
|
(2,280,194
|
)
|
|
|
-
|
|
|
Other changes in estimates
|
|
|
-
|
|
|
|
94,898
|
|
|
Unrecognized tax benefits
|
|
|
(21,875
|
)
|
|
|
1,620
|
|
|
|
|
|
|
|
|
|
|
|
|
Income tax expense (benefit)
|
|
$
|
(353,085
|
)
|
|
$
|
(369,707
|
)
|
Deferred income taxes are recognized for future tax consequences attributable to temporary differences between the carrying amounts of assets and liabilities for financial statement purposes and income tax purposes using enacted rates expected to be in effect when such amounts are realized or settled. Significant components of the Company’s deferred tax assets and liabilities at December 31, 2012 and 2011 are as follows:
|
|
|
2012
|
|
|
2011
|
|
|
Deferred tax assets
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S. NOL - pre-stock exchange transaction
|
|
$
|
-
|
|
|
$
|
2,280,194
|
|
|
U.S. NOL - subsequent to stock exchange transaction
|
|
|
5,134,195
|
|
|
|
3,365,208
|
|
|
Foreign NOL
|
|
|
2,105,960
|
|
|
|
1,064,145
|
|
|
Deferred revenue
|
|
|
429,346
|
|
|
|
439,521
|
|
|
Reserve for returns
|
|
|
-
|
|
|
|
21,502
|
|
|
Fixed assets cost basis
|
|
|
1,604,393
|
|
|
|
1,468,092
|
|
|
Costs capitalized for tax
|
|
|
10,452
|
|
|
|
-
|
|
|
Accrued payroll
|
|
|
21,675
|
|
|
|
8,500
|
|
|
Accrued expenses
|
|
|
905,265
|
|
|
|
-
|
|
|
Deferred rent
|
|
|
390
|
|
|
|
-
|
|
|
Expenses prepaid for tax
|
|
|
6,902
|
|
|
|
-
|
|
|
Inventory reserves
|
|
|
160,000
|
|
|
|
150,927
|
|
|
Allowance for doubtful accounts
|
|
|
1,587
|
|
|
|
34,090
|
|
|
Equity method investee
|
|
|
-
|
|
|
|
4,927
|
|
|
Investment in and advance to cost method investee
|
|
|
33,724
|
|
|
|
-
|
|
|
Nonqualified options
|
|
|
207,443
|
|
|
|
109,214
|
|
|
Marketable securities
|
|
|
100,795
|
|
|
|
100,795
|
|
|
AMT credits
|
|
|
-
|
|
|
|
17,952
|
|
|
Charitable contribution carryover
|
|
|
757
|
|
|
|
680
|
|
|
Capital loss carryover
|
|
|
482,898
|
|
|
|
482,898
|
|
|
Total deferred tax assets
|
|
|
11,205,782
|
|
|
|
9,548,645
|
|
|
|
|
|
|
|
|
|
|
|
|
Less: valuation allowance
|
|
|
(10,699,560
|
)
|
|
|
(9,057,657
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Deferred tax liabilities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basis in equity method investee
|
|
|
(13,256
|
)
|
|
|
-
|
|
|
Intangible assets
|
|
|
(798,815
|
)
|
|
|
(1,279,729
|
)
|
|
Total deferred tax liabilities
|
|
|
(812,071
|
)
|
|
|
(1,279,729
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Net deferred tax liability
|
|
$
|
(305,849
|
)
|
|
$
|
(788,741
|
)
|
As of December 31, 2012, the Company had approximately $15.2 million of the U.S domestic cumulative tax loss carryforwards (which excludes the NOL carryforwards of approximately $1.7 million because of the uncertainty of the position being sustained) and approximately $8.7 million of the foreign cumulative tax loss carryforwards, which may be available to reduce future income tax liabilities in certain jurisdictions. These U.S. and foreign tax loss carryforwards will expire beginning year 2027 through 2032 and year 2013 to year 2017, respectively. The non-recognition of the tax benefits, while reducing the net operating loss carryovers, gives rise to a capital loss carryover of $1,420,289. Utilization of net operating losses may be subject to an annual limitation due to ownership change limitations provided in the Internal Revenue Code and similar state and foreign provisions. This annual limitation may result in the expiration of net operating losses before utilization.
Realization of the Company’s net deferred tax assets is dependent upon the Company’s ability to generate future taxable income in appropriate tax jurisdictions to obtain benefit from the reversal of temporary differences and net operating loss carryforwards. The valuation allowance increased by $641,903 (net of approximately $396,000 valuation allowance eliminated with the deconsolidation of Shandong Media) and $2,962,985 during the year ended December 31, 2012 and 2011, respectively. The increase was primarily related to increases in net operating loss carryovers, which the Company does not expect to realize.
|
|
(B)
|
Uncertain Tax Positions
|
Accounting guidance for recognizing and measuring uncertain tax positions prescribes a threshold condition that a tax position must meet for any of the benefit of uncertain tax position to be recognized in the financial statements. The following is a reconciliation of the beginning and ending amounts of unrecognized tax benefits for the years ended December 31, 2012 and 2011:
|
|
|
2012
|
|
|
2011
|
|
|
Balance, beginning of year
|
|
$
|
21,875
|
|
|
$
|
20,255
|
|
|
Increase from prior year's tax positions
|
|
|
884
|
|
|
|
1,620
|
|
|
Reduction resulting from the lapse of the statute of limitations
|
|
|
(22,759
|
)
|
|
|
-
|
|
|
Balance, end of year
|
|
$
|
-
|
|
|
$
|
21,875
|
|
As of December 31, 2012 and 2011, the Company did not accrue any material interest and penalties.
The Company's United States income tax returns are subject to examination by the Internal Revenue Service for at least 2009 and later years. Because of the uncertainty regarding the filing of tax returns for years before 2007, it is possible that the Company is subject to examination by the IRS for earlier years. All of the Chinese tax returns for the Chinese operating companies are subject to examination by the Chinese tax authorities for all periods from the companies' inceptions in 2007 through 2012 as applicable.
|
21.
|
Commitments and Contingencies
|
The Company has employment agreements with certain employees that provide severance payments upon termination of employment under certain circumstances, as defined in the applicable agreements. As of December 31, 2012, the Company's potential minimum cash obligation to these employees was approximately $867,000.
The Company is committed to paying leased property costs related to our China offices through 2014 as follows:
|
|
|
Leased
|
|
|
|
|
Property
|
|
|
Years ending December 31,
|
|
Costs
|
|
|
2013
|
|
$
|
317,000
|
|
|
2014
|
|
|
17,000
|
|
|
Total
|
|
$
|
334,000
|
|
The Company is committed to paying content costs through 2016 as follows:
|
|
|
Content
|
|
|
Years ending December 31,
|
|
Costs
|
|
|
2013
|
|
$
|
1,860,000
|
|
|
2014
|
|
|
2,161,000
|
|
|
2015
|
|
|
2,292,000
|
|
|
2016
|
|
|
1,031,000
|
|
|
Total
|
|
$
|
7,344,000
|
|
The Company is committed to paying service fees to certain consultants of $85,000 through 2013.
From time to time, we may become involved in various lawsuits and legal proceedings which arise in the ordinary course of business. However, litigation is subject to inherent uncertainties, and an adverse result in these or other matters may arise from time to time that may harm our business. We are currently not aware of any such legal proceedings or claims that we believe will have a material adverse effect on our business, financial condition or operating results.
|
22.
|
Defined Contribution Plan
|
During 2011, the Company began sponsoring a 401(k) defined contribution plan ("401(k) Plan") that provides for a 100% employer matching contribution of the first 3% and a 50% employer matching contribution of each additional percent contributed by an employee up to 5% of each employee’s pay. Employees become fully vested in employer matching contributions after six months of employment. Company 401(k) matching contributions were approximately $62,000 and $46,000 for the years ended December 31, 2012 and 2011, respectively.
In January 2013, 7,866,800 Series B Preferred Shares were converted to 1,048,907 shares of common stock. Also, in the first quarter of 2013, as discussed in Note 18 and pursuant to our vesting arrangements, we issued 28,390 shares to our independent board members and to certain consultants for services.