The accompanying notes are an integral part
of the unaudited condensed consolidated financial statements
The accompanying notes are an integral part
of the unaudited condensed consolidated financial statements
The accompanying notes are an integral part
of the unaudited condensed consolidated financial statements
NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS
MARCH 31, 2014 AND DECEMBER 31, 2013
(UNAUDITED)
1.
|
Organization, Recapitalization and Nature of Business
|
China Internet Cafe
Holdings Group, Inc. (“China Internet Cafe”)
China
Internet Cafe Holdings Group, Inc. (formerly known as China Unitech Group, Inc.) (“China Internet Café”, “the
Company”, “we”, “us”, “our”) was incorporated in the State of Nevada on March 14, 2006.
The Company was a development company from incorporation until the quarter ended June 30, 2010. On July 2, 2010, the Company successfully
closed a share exchange transaction with the shareholders of Classic Bond Development Limited, a British Virgin Islands corporation
(" Classic Bond"). The Company will operate through its variable interest entities in China to execute the current business
plan of those affiliates which involves the operation of a chain of China-based internet cafes, the “Business.” On
February 1, 2011, the Company changed its name from China Unitech Group, Inc. to China Internet Cafe Holdings Group, Inc.
Recapitalization
of Classic Bond Development Limited
On
July 2, 2010, the Company entered into a share exchange transaction with Classic Bond Development Limited, a British Virgin Islands
corporation (“Classic Bond”), and the shareholders of Classic Bond. Pursuant to the Share Exchange Agreement, China
Internet Cafe acquired 100% of the issued and outstanding capital stock of Classic Bond in exchange for 19,000,000 newly issued
shares of the Company’s common stock, which represented approximately 94% of the 20,200,000 issued and outstanding shares
of common stock after the transaction and after the coincident cancellation of 4,973,600 shares of common stock held by the Company’s
former majority stockholder. The business, assets and liabilities did not change as a result of the reverse acquisition.
This
share exchange transaction resulted in the shareholders of Classic Bond obtaining a majority voting interest in the Company. Generally
accepted accounting principles require that the Company whose shareholders retain the majority interest in a combined business
be treated as the acquirer for accounting purposes, resulting in a reverse acquisition with Classic Bond as the accounting acquirer
and China Internet Cafe as the acquired party. Accordingly, the share exchange transaction has been accounted for as a recapitalization
of Classic Bond whereby Classic Bond is deemed to be the continuing, surviving entity for accounting purposes, but through reorganization,
has deemed to have adopted the capital structure of China Internet Cafe. The equity section of the accompanying financial statements
has been restated to reflect the recapitalization of the Company due to the reverse acquisition as of the first day of the first
period presented.
Accordingly,
all references to common shares of Classic Bond’s common stock have been restated to reflect the equivalent number of China
Internet Cafe‘s common shares. In other words, the 2,000,000 Classic Bond shares outstanding are restated as 20,200,000 common
shares, as of July 2, 2010. Each share of Classic Bond is restated to 10.10 shares of China Internet Cafe.
The
book value of the net assets that for accounting purposes, were deemed to have been acquired by Classic Bond from China Internet
Cafe, as of the date of acquisition (July 2, 2010) were $3,333.
During
the recapitalization, the Company incurred restructuring expenses of $300,000, related legal and professional fee of $129,033 and
the interest expenses of $6,053 related to the short term loan for paying restructuring expenses. All of these expenses amounting
to $435,086 in total were recorded as reorganizational expenses in statement of income.
Classic Bond Development
Limited (“Classic Bond”)
Classic
Bond Development Limited was incorporated on November 2, 2009 in the British Virgins Islands (“BVI”) with 50,000 authorized
common shares with no par value. On November 2, 2009, 50,000 common shares at $0.129 (HK$1) each were issued for $6,452 (HK$50,000)
cash to several shareholders including Mr. Guo Dishan who is the 65% equity interest shareholder and the sole director of the Company.
On
June 23, 2010, the Company issued 1,950,000 shares of common stock of Classic Bond to 42 individuals for an aggregate of $84,093
(HK$651,721) for 641,046 shares and 1,308,954 shares associated with the reorganization of the Company at a value of $167,519 (HK$1,308,954)
which is reflected as contributed capital by existing shareholders of Junlong and the total amount was $251,612.
As of June
30, 2010, 2,000,000 shares of Common Stock were issued and outstanding.
CHINA INTERNET CAFE HOLDINGS GROUP, INC.
AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS
MARCH 31, 2014 AND DECEMBER 31, 2013
(UNAUDITED)
1.
|
Organization, Recapitalization and Nature of Business (continued)
|
Classic
Bond is in the business of operating internet cafés, throughout the Longang District of Shenzhen in Province of Guangdong
of People's Republic of China ("PRC"). The Company conducts its operations through the following subsidiaries: (a) a
wholly-owned subsidiary of the Company located in the PRC: Shenzhen Zhonghefangda Network Technology Co., Ltd. (“Zhonghefangda”)
and (b) an entity located in the PRC: Shenzhen Junlong Culture Communication Co., Ltd. (“Junlong’), which is controlled
by the Company through contractual arrangements between Zhonghefangda and Junlong, as if Junlong were a wholly-owned subsidiary
of Classic Bond.
Shenzhen Zhonghefangda
Network Technology Co., Ltd. (“Zhonghefangda”)
Zhonghefangda,
Classic Bond’s wholly-owned subsidiary, was incorporated in People’s Republic of China (“PRC”) on June
10, 2010 with registered capital of $129,032 (HK$1 million). Zhonghefangda is engaged in provision of management and consulting
services and Mr. Guo Dishan is the legal representative of Zhonghefangda.
On
June 11, 2010, to protect the Company’s shareholders from possible future foreign ownership restrictions, Zhonghefangda and
Junlong entered into a series of agreements. Under these agreements Zhonghefangda obtained the ability to direct the operations
of Junlong and to receive a majority of the residual returns. Therefore, management determined that Junlong became a variable interest
entity (“VIE”) under the provisions of Financial Accounting Standards Board (“FASB”) ASC 810-10 and Zhonghefangda
was determined to be the primary beneficiary of Junlong. Accordingly, beginning June 11, 2010, Zhonghefangda is able to consolidate
the assets, liabilities, results of operations and cash flows of Junlong in its financial statements. Because the legal representatives
and ultimate major stockholder of Zhonghefangda and Junlong is the same person, Mr. Guo Dishan, Zhonghefangda and Junlong were
deemed, until June 11, 2010, to be under common control.
Exclusive Management
and Consulting Agreement
On
June 11, 2010, Zhonghefangda signed an exclusive management and consulting services agreement with Junlong. Pursuant to the agreement,
Zhonghefangda agreed to provide management and consulting services to Junlong, upon request, in connection with the operation of
the Business. The agreement provides that Junlong will compensate Zhonghefangda by paying an amount equal to the aggregate net
profit of Junlong for a period of twenty (20) years and for succeeding periods of the same duration until the agreement is terminated
by both parties under agreed conditions. Zhonghefangda will reimburse Junlong the full amount of any net losses incurred by Junlong
during the term of this agreement. As a result of entering into the exclusive management and consulting agreement, Zhonghefangda
should be deemed to control Junlong as a Variable Interest Entity and Junlong is consolidated in the accompanying financial statements.
Shenzhen Jun Long
Culture Communication Co., Ltd. (“Junlong”)
Junlong
is a Chinese enterprise organized in the People’s Republic of China (“PRC”) on December 26, 2003 in accordance
with the Laws of the People’s Republic of China with the registered capital of $0.136 million (equivalent to RMB 1 million).
In 2001, the Chinese government imposed higher capital (RMB10 million for regional internet café chain and RMB50 million
for national internet café chain) and facility requirements for the establishment of internet cafes. On August 19, 2004,
Junlong was granted approval from Shenzhen Municipal People’s Government to increase its registered capital by $1,230,500
from $136,722 to $1,367,222 million (increased by RMB 9 million, from RMB 1 million to RMB 10 million) The capital verification
process has been completed. In April and July of 2010, Junlong acquired three internet cafes in Shenzhen.
In
2005, Junlong obtained internet cafe licenses to operate an internet café chain from the Ministry of Culture, and opened
its first internet cafe in April, 2006 and our members can access the internet at our venues. We opened 7 internet cafes in 2006,
5 internet cafes opened in 2007, 11 internet cafes opened in 2008, 5 internet cafes opened in 2009, 16 internet cafes opened in
2010, 15 internet cafes opened in 2011, and 3 internet cafes opened during the year 2012. In total, as of March 31, 2014, we owned
62 internet cafes within Shenzhen, Guangdong.
CHINA INTERNET CAFE HOLDINGS GROUP, INC.
AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS
MARCH 31, 2014 AND DECEMBER 31, 2013
(UNAUDITED)
2.
|
Summary of Significant Accounting Policies
|
|
(a)
|
Basis of presentation
|
The
Company’s accounting policies used in the preparation of the accompanying financial statements conform to accounting principles
generally accepted in the United States of America ("US GAAP") and have been consistently applied.
|
(b)
|
Principle of consolidation
|
The
consolidated financial statements include the accounts of China Internet Cafe Holdings Group, Inc., Classic Bond Development Limited,
Zhonghefangda and the VIE-Junlong. All significant intercompany balances and transactions have been eliminated in the consolidation.
The consolidated financial statements included herein, presented in accordance with United States generally accepted accounting
principles and stated in US dollars, have been prepared by the Company, pursuant to the rules and regulations of the Securities
and Exchange Commission.
In
preparing financial statements in conformity with accounting principles generally accepted in the United States, management makes
estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities
at the dates of the financial statements, as well as the reported amounts of revenues and expenses during the reporting periods.
These accounts and estimates include, but are not limited to, the valuation of receivables due from related parties, inventories
and the estimation of useful lives of plant and machinery and intangibles assets. Actual results could differ from those estimates.
Warrants that could require cash settlement
or have anti-dilution price protection provisions are recorded as liabilities at their estimated fair value at the date of issuance,
with subsequent changes in estimated fair value recorded in other income (expense) in our statement of loss and comprehensive loss
in each subsequent period. In general, warrants with anti-dilution provisions are measured using the binomial valuation model.
The methodology based, in part, upon inputs for which there is little or no observable market data requires the Group to develop
its own assumptions. The assumptions used in calculating the estimated fair value of the warrants represent our best estimates,
however these estimates involve inherent uncertainties and the application of judgment. As a result, if factors change and different
assumptions are used, the warrant liability and the change in estimated fair value could be materially different. Also see Note
16.
Internet
café members purchase prepaid IC cards which include stored value that will be deducted based on time usage of computers
at the internet cafe. Revenues derived from the prepaid IC cards at the internet café are recognized when services are provided.
This is based upon the usage of computer time at the internet cafe. Outstanding customer balances in the IC cards are included
in deferred revenue on the balance sheets. The Company does not charge any service fees that cause a decrease to customer balances.
There is no expiration date for IC cards.
The
Company also records revenue from commissions received from the sale of third parties on-line gaming cards, snacks and drinks.
Commission revenue amounting to 20% of the value of the on-line gaming cards, snacks and drinks is recognized at the time the gaming
cards, etc. are sold to customers. During the three months ended March 31, 2014 and 2013, the commission income was $118,445 and
$113,611, respectively, less than 1% of total revenue.
Cost
of revenue consists primarily of depreciation of each internet café’s computer equipment and hardware and overhead
associated with the internet cafes including rental payments, utilities, value added taxes, and surcharges. Our value added taxes
is 3% on gross revenue generated from selling time of internet surfing in our internet cafes. Our other surcharges are an education
surcharge of 3% of value added tax amount, city development surcharge of 7% of value added tax amount, a culture development surcharge
of 3% of gross revenue, and a snacks and drinks business tax of 5% of gross revenue.
CHINA INTERNET CAFE HOLDINGS GROUP, INC.
AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS
MARCH 31, 2014 AND DECEMBER 31, 2013
(UNAUDITED)
2.
|
Summary of Significant Accounting Policies (continued)
|
The
Company may be exposed to credit risk from its cash at banks. An allowance has been considered for estimated irrecoverable amounts
determined by reference to past default experience and the current economic environment. No allowance is considered necessary for
the period.
|
(g)
|
Cash and cash equivalents
|
Cash
and cash equivalents include cash on hand, cash accounts, interest bearing savings accounts and time certificates of deposit with
a maturity of three months or less when purchased.
Inventory
represents the IC cards we purchased from IC card manufacturers. Inventories are stated at the lower of cost or market value. Cost
is determined using the first-in, first-out (FIFO) method.
|
(i)
|
Fair Value of Financial Instruments
|
The Company applies the provisions of accounting
guidance, FASB Topic ASC 820 that requires all entities to disclose the fair value of financial instruments, both assets and liabilities
recognized and not recognized on the balance sheet, for which it is practicable to estimate fair value, and defines fair value
of a financial instrument as the amount at which the instrument could be exchanged in a current transaction between willing parties.
As of March 31, 2014, the fair value of cash and cash equivalents, accounts payable, short-term loans, and accrued expenses approximated
carrying value due to the short maturity of the instruments, or are based on quoted market prices or interest rates which fluctuate
with market rates except for related party debt or receivables for which it is not practicable to estimate fair value.
The Company adopted the provisions of Accounting
Standards Codification (“ASC”) 820, Fair Value Measurements and Disclosures. ASC 820 clarifies the definition of fair
value, prescribes methods for measuring fair value, and establishes a fair value hierarchy to classify the inputs used in measuring
fair value as follows:
Level 1
– Inputs
are unadjusted quoted prices in active markets for identical assets or liabilities available at the measurement date.
Level 2
– Inputs
are unadjusted quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets
and liabilities in markets that are not active, inputs other then quoted prices that are observable, and inputs derived from or
corroborated by observable market data.
Level 3
– Inputs
are unobservable inputs which reflect the reporting entity’s own assumptions on what assumptions the market participants
would use in pricing the asset or liability based on the best available information.
The availability of inputs observable in
the market varies from instrument to instrument and depends on a variety of factors including the type of instrument, whether the
instrument is actively traded, and other characteristics particular to the transaction. For many financial instruments, pricing
inputs are readily observable in the market, the valuation methodology used is widely accepted by market participants, and the
valuation does not require significant management discretion. For other financial instruments, pricing inputs are less observable
in the market and may require management judgment.
|
(j)
|
Stock-Based Compensation
|
Our
advisor assists the Company for ongoing corporate compliance and development are accounted for under ASC 505-50. ASC 505-50-30-11
(previously EITF 96-18) further provides that an issuer measure the fair value of the equity instruments in these transactions
using the stock price and other measurement assumptions as of the earlier of the following dates, referred to as the measurement
date:
i.
The date at which a commitment for performance by the counterparty to earn the equity instruments is reached (a performance commitment);
and
ii.
The date at which the counterparty’s performance is complete.
CHINA INTERNET CAFE HOLDINGS GROUP, INC.
AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS
MARCH 31, 2014 AND DECEMBER 31, 2013
(UNAUDITED)
2.
|
Summary of Significant Accounting Policies (continued)
|
The
Company prepaid equipment deposits to purchase fire protection systems for its new headquarters in Shenzhen in 2012 and the provider
did not obtain the inspection of the fire protection system as of March 31, 2014.
|
(l)
|
Property, plant and equipment
|
Property,
plant and equipment, comprising computer equipment and hardware, leasehold improvements, office furniture and vehicles are stated
at cost less accumulated depreciation. Depreciation is computed using the straight-line method over the estimated useful lives
listed below.
|
|
Estimated Useful Lives
|
Leasehold improvements
|
|
5 years
|
Cafe computer equipment and hardware
|
|
5 years
|
Cafe furniture and fixtures
|
|
5 years
|
Office furniture, fixtures and equipments
|
|
5 years
|
Motor vehicles
|
|
5 years
|
Leasehold
improvements mainly result from decoration expense. All of the Company’s leases have terms of 5 years and leasehold improvements
are amortized over 5 years, which represents the shorter of useful life and lease term.
Our
intangible assets consist of definite-lived assets subject to amortization such as Business License and Customer Lists. The useful
lives of the Business License are 9 to 15 years and we amortize the customer lists over 5 years. We calculate amortization of definite-lived
intangible assets on a straight-line basis over the useful lives of the intangible assets. Development cost of internal-use software
is insignificant and is recorded as expense in the period such cost occurs.
Deferred
revenue represents unused balances of the prepaid amounts received for IC cards. The Outstanding customer balances are $2,427,347
and $2,293,794 as of March 31, 2014 and December 31, 2013, respectively, and are included in deferred revenue on the balance sheets.
Management has evaluated the deferred revenue balance and has determined any potential revenue from the unused balance to be immaterial
at the quarter ended March 31, 2014.
The
Company follows the FASB’s accounting standard. Comprehensive income is defined as the change in equity of a company during
a period from transactions and other events and circumstances excluding transactions resulting from investments from owners and
distributions to owners. For the Company, comprehensive income for the periods presented includes net income and foreign currency
translation adjustments.
Income
taxes are provided on an asset and liability approach for financial accounting and reporting of income taxes. Current tax is based
on the profit or loss from ordinary activities adjusted for items that are non-assessable or disallowable for income tax purpose
and is calculated using tax rates that have been enacted or substantively enacted at the balance sheet date. Financial Accounting
Standards Board ("FASB") Accounting Standards Codification ("ASC") 740-10-50-2 requires that deferred tax assets
and liabilities be recognized for future tax consequence attributable to differences between the financial statement carrying amounts
of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted
tax rates expected to be applied to taxable income in the years in which those temporary differences are expected to reverse. The
effect on deferred tax assets and liabilities of a change in tax rates is recognized in the statement of income in the period that
includes the enactment date. A valuation allowance is provided for deferred tax assets if it is more likely than not these items
will either expire before the Company is able to realize their benefits, or that future deductibility is uncertain. Losses incurred
by the Company in prior years provide for a net operating loss carry-forward. However, all net operating losses are from the U.S.
shell company and we currently anticipate insufficient income to utilize these losses in the future, so the asset balance has been
fully reserved for.
CHINA INTERNET CAFE HOLDINGS GROUP, INC.
AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS
MARCH 31, 2014 AND DECEMBER 31, 2013
(UNAUDITED)
2.
|
Summary of Significant Accounting Policies (continued)
|
|
(q)
|
Consolidation of Variable Interest Entities
|
According
to the requirements of Statement of Financial Accounting Standards No. 810-10, “Variable interest Entities”, the Company
has evaluated the economic relationships of its wholly owned subsidiary, Shenzhen Zhonghefangda Network Technology Co., Ltd. (“Zhonghefangda”)
with Junlong and has determined that it is required to consolidate Zhonghefangda and Junlong pursuant to the rules of FASB ASC
Topic 810-10. Therefore Junlong is considered to be a VIE, as defined by FASB ASC Topic 810-10 of which Classic Bond is the primary
beneficiary as a result of its wholly owned subsidiary Zhonghefangda. Classic Bond, as mentioned above, will absorb a majority
of the economic risks and rewards of the VIE that are being consolidated in the accompanying financial statements.
The
carrying amount of the VIE’s’ assets and liabilities are as follows:
|
|
March 31,
2014
|
|
|
December 31,
2013
|
|
Current assets and Long term rental deposit
|
|
$
|
44,528,085
|
|
|
$
|
40,805,688
|
|
Property, plant and equipment
|
|
|
8,456,330
|
|
|
|
9,463,574
|
|
Intangible assets
|
|
|
49,943
|
|
|
|
62,008
|
|
Total assets
|
|
|
53,034,358
|
|
|
|
50,331,270
|
|
Total liabilities
|
|
|
(12,190,422
|
)
|
|
|
(11,793,939
|
)
|
Net assets
|
|
$
|
40,843,936
|
|
|
$
|
38,537,331
|
|
|
(r)
|
Foreign currency translation
|
Assets
and liabilities of the Company with a functional currency other than US$ are translated into US$ using period end exchange rates.
Income and expense items are translated at the average exchange rates in effect during the period. Foreign currency translation
differences are included as a component of Accumulated Other Comprehensive Income in Stockholders’ Equity.
The
exchange rates used to translate amounts in RMB into USD for the purposes of preparing the financial statements were as follows:
|
|
March 31, 2014
|
|
|
March 31, 2013
|
|
|
December 31, 2013
|
|
Period-end RMB : USD exchange rate
|
|
|
6.1619
|
|
|
|
-
|
|
|
|
6.1104
|
|
Three months average RMB : USD exchange rate
|
|
|
6.1156
|
|
|
|
6.2769
|
|
|
|
-
|
|
The
RMB is not freely convertible into foreign currency and all foreign exchange transactions must take place through authorized institutions.
No representation is made that the RMB amounts could have been, or could be, converted into USD at the rates used in translation.
|
(s)
|
Post-retirement and post-employment benefits
|
The
Company contributes to a state pension plan in respect of its PRC employees. Other than the above, neither the Company nor its
subsidiary or the consolidated VIE’s provides any other post-retirement or post-employment benefits.
|
(t)
|
Earnings per share (EPS)
|
Earnings
per share is calculated in accordance with ASC 260-10 which requires the Company to calculate net income (loss) per share based
on basic and diluted net income (loss) per share, as defined. Basic EPS excludes dilution and is computed by dividing net income
(loss) by the weighted average number of shares outstanding for the period.
Diluted EPS is similar to basic EPS but presents
the dilutive effect on a per share basis of potential common shares (e.g., convertible securities, preferred stock and warrants)
as if they had been converted at the beginning of the periods presented, or issuance date, if later. Potential common shares that
have an anti-dilutive effect (i.e., those that increase income per share or decrease loss per share) are excluded from the calculation
of diluted EPS.
See Note 15 for details.
|
(u)
|
Retained earnings-appropriated
|
In
accordance with the relevant PRC regulations and Zhonghefangda and Junlong’s articles of association, Zhonghefangda and Junlong
are required to allocate their respective net income to statutory surplus reserve.
CHINA INTERNET CAFE HOLDINGS GROUP, INC.
AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS
MARCH 31, 2014 AND DECEMBER 31, 2013
(UNAUDITED)
2.
|
Summary of Significant Accounting Policies (continued)
|
|
(v)
|
Statutory surplus reserves
|
In
accordance with the relevant laws and regulations of the PRC and the articles of associations of Zhonghefandaand Junlong, each
is required to allocate 10% of its net income reported in the PRC statutory accounts, after offsetting any prior years’ losses,
to the statutory surplus reserve, on an annual basis. When the balance of such reserve reaches 50% of the respective registered
capital of the company, no further allocation is optional.
As
of March 31, 2014 and December 31, 2013, the statutory surplus reserves of Zhonghefanda and Junlong reached 50% of the registered
capital of the subsidiary and the Company was not required to allocate any further amount to it.
The
statutory surplus reserves can be used to offset prior years’ losses, if any, and may be converted into registered capital,
provided that the remaining balances of the reserve after such conversion is not less than 25% of registered capital. The statutory
surplus reserve is non-distributable.
Certain reclassifications have been made to the prior year financial
statements to conform to the current year’s presentation.
|
(x)
|
Recent Accounting Pronouncements
|
The
FASB has issued Accounting Standards Update (ASU) No. 2014-07, Applying Variable Interest Entities Guidance to Common Control
Leasing Arrangements. The guidance addresses the consolidation of lessors in certain common control leasing arrangements and is
based on a consensus reached by the Private Company Council (PCC).
Under current U.S. GAAP, a company is required to consolidate an entity in which it has a controlling financial interest. The assessment
of controlling financial interest is performed under either: (a) a voting interest model; or (b) a variable interest entity model.
In a variable interest entity model, the company has a controlling financial interest when it has: (a) the power to direct the
activities that most significantly affect the economic performance of the entity; and (b) the obligation to absorb losses or the
right to receive benefits of the entity that could be potentially significant to the entity.
To determine which model applies, a company preparing financial statements must first determine whether it has a variable interest
in the entity being evaluated for consolidation and whether that entity is a variable interest entity.
The new guidance allows a private company to elect (when certain conditions exist) not to apply the variable interest entity guidance
to a lessor under common control. Instead, the private company would make certain disclosures about the lessor and the leasing
arrangement.
Under the amendments in this ASU, a private company lessee could elect an alternative not to apply variable interest entity guidance
to a lessor when:
(1) The private company lessee and the lessor are under common control;
(2)
The private company lessee has a leasing arrangement with the lessor;
(3)
Substantially all of the activity between the private company lessee and the lessor is related to the leasing activities (including
supporting leasing activities) between those two companies, and
(4)
If the private company lessee explicitly guarantees or provides collateral for any obligation of the lessor related to the asset
leased by the private company, then the principal amount of the obligation at inception does not exceed the value of the asset
leased by the private company from the lessor.
If
elected, the accounting alternative should be applied to all leasing arrangements meeting the above conditions. The alternative
should be applied retrospectively to all periods presented, and is effective for annual periods beginning after December 15, 2014,
and interim periods within annual periods beginning after December 15, 2015. Early application is permitted for all financial statements
that have not yet been made available for issuance.
The
adoption of ASU 2014-07 is not expected to have a material impact on the Company’s financial position or results of operations.
CHINA INTERNET CAFE HOLDINGS GROUP, INC.
AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS
MARCH 31, 2014 AND DECEMBER 31, 2013
(UNAUDITED)
2.
|
Summary of Significant Accounting Policies (continued)
|
The
FASB has issued Accounting Standards Update (ASU) No. 2014-08,
Presentation
of Financial Statements (Topic 205) and Property, Plant, and Equipment (Topic 360): Reporting Discontinued Operations and Disclosures
of Disposals of Components of an Entity. The amendments in the ASU change the criteria for reporting discontinued operations while
enhancing disclosures in this area. It also addresses sources of confusion and inconsistent application related to financial reporting
of discontinued operations guidance in U.S. GAAP.
Under the new guidance, only disposals representing a strategic shift in operations should be presented
as discontinued operations. Those strategic shifts should have a major effect on the organization’s operations and financial
results. Examples include a disposal of a major geographic area, a major line of business, or a major equity method investment.
In addition, the new guidance requires expanded disclosures about discontinued operations that will
provide financial statement users with more information about the assets, liabilities, income, and expenses of discontinued operations.
The new guidance also requires disclosure of the pre-tax income attributable to a disposal of a significant part of an organization
that does not qualify for discontinued operations reporting. This disclosure will provide users with information about the ongoing
trends in a reporting organization’s results from continuing operations.
The amendments in this ASU enhance convergence between U.S. GAAP and International Financial Reporting
Standards (IFRS). Part of the new definition of discontinued operation is based on elements of the definition of discontinued operations
in IFRS 5,
Non-Current Assets Held for Sale and Discontinued Operations.
The amendments in the ASU are effective in the first quarter of 2015 for public organizations with calendar year ends. For most
nonpublic organizations, it is effective for annual financial statements with fiscal years beginning on or after December 15, 2014.
Early adoption is permitted.
The
adoption of ASU 2014-08 is not expected to have a material impact on the Company’s financial position or results of operations.
3.
|
Cash and cash equivalents
|
Cash and cash equivalents are summarized as follows:
|
|
March 31,
|
|
|
December 31,
|
|
|
|
2014
|
|
|
2013
|
|
|
|
|
|
|
|
|
Cash and cash equivalents at bank
|
|
$
|
43,888,083
|
|
|
$
|
40,217,223
|
|
Cash on hand
|
|
|
88,926
|
|
|
|
24,236
|
|
|
|
$
|
43,977,009
|
|
|
$
|
40,241,459
|
|
Financial instruments that potentially
subject the Company to significant concentration of credit risk consist primarily of cash and cash equivalents. As of March 31,
2014 and December 31, 2013, $43,874,908 and $40,204,156 of the Company’s cash and cash equivalents were held by major banks
located in the PRC, which management believes are of high credit quality, and $2,745 and $2,534 of the Company's cash and cash
equivalents were held by Chase Bank, respectively.
CHINA INTERNET CAFE HOLDINGS GROUP, INC.
AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS
MARCH 31, 2014 AND DECEMBER 31, 2013
(UNAUDITED)
4.
Property, Plant and Equipment, net
Property, plant and equipment, net, consist of the following:
|
|
March 31,
|
|
|
December 31,
|
|
|
|
2014
|
|
|
2013
|
|
|
|
|
|
|
|
|
Leasehold improvements
|
|
$
|
4,198,764
|
|
|
$
|
4,234,152
|
|
Cafe computers equipment and hardware
|
|
|
17,162,774
|
|
|
|
17,307,427
|
|
Cafe furniture and fixtures
|
|
|
2,157,962
|
|
|
|
2,176,149
|
|
Office furniture, fixtures and equipment
|
|
|
352,999
|
|
|
|
355,974
|
|
Motor vehicles
|
|
|
482,635
|
|
|
|
486,703
|
|
|
|
$
|
24,355,134
|
|
|
$
|
24,560,405
|
|
Less: Accumulated depreciation
|
|
|
(15,898,804
|
)
|
|
|
(15,096,832
|
)
|
Property, plant and equipment, net
|
|
$
|
8,456,330
|
|
|
$
|
9,463,573
|
|
For the three months ended March 31, 2014, depreciation expense
amounted to $935,176, of which $912,023 and $23,153 were recorded as cost of sales and general and administrative expense, respectively.
5.
Short Term Loan
The short term loan due within one year
as of March 31, 2014 and December 31, 2013 consists of the following:
|
|
|
|
|
Interest
|
|
|
March 31,
|
|
|
December 31,
|
|
Bank
|
|
Loan Period
|
|
|
rate
|
|
|
2014
|
|
|
2013
|
|
China Construction Bank
|
|
|
June 13, 2013 to June 12, 2014
|
|
|
|
9
|
%
|
|
$
|
162,288
|
|
|
$
|
163,655
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
On June 13, 2013,
the Company entered into a loan agreement with China Construction Bank for $162,288 (RMB 1,000,000), which was secured by a director’s
guarantee. The annual interest rate is approximately 9% and is due on June 12, 2014.
For the three months ended March 31, 2014,
the interest expense on this loan was $3,679.
6. Income and Other Taxes Payable
Income and other tax payables consist of the following:
|
|
March 31, 2014
|
|
|
December 31, 2013
|
|
Value added taxes
|
|
$
|
228,054
|
|
|
$
|
218,231
|
|
Income tax
|
|
|
879,184
|
|
|
|
567,419
|
|
Withholding individual income tax payable
|
|
|
4,141
|
|
|
|
4,064
|
|
Other tax payable
|
|
|
238,924
|
|
|
|
222,100
|
|
Total
|
|
$
|
1,350,303
|
|
|
$
|
1,011,814
|
|
7. Due To Related Party
|
|
March 31,
|
|
|
December 31,
|
|
|
|
2014
|
|
|
2013
|
|
Mr. Dishan Guo
|
|
$
|
3,099,902
|
|
|
$
|
3,063,633
|
|
|
|
|
|
|
|
|
|
|
The amount due to Mr. Di Shan Guo is unsecured
with no stated interest and is payable on demand. The amount due as of March 31, 2014, represents amounts accumulated since 2007
used to pay daily operating expenses and professional fees.
CHINA INTERNET CAFE HOLDINGS GROUP, INC.
AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS
MARCH 31, 2014 AND DECEMBER 31, 2013
(UNAUDITED)
8. Income Tax
The Company is subject to U.S. federal
income tax, and the Company’s subsidiary and affiliated entity incorporated in the PRC are subject to enterprise income
taxes in the PRC. The Company’s applicable enterprise income tax rate in PRC is 25% of its net income.
For the three months ended March 31, 2014
and 2013, the Company did not record any uncertain tax benefits.
Aggregate undistributed earnings of approximately
$37.3 million as of March 31, 2014 of the Company’s affiliated entity that are available for distribution to the Company
are considered to be indefinitely reinvested, and, accordingly, no provision has been made for the Chinese dividend withholding
taxes that would be payable upon distribution to the Company. Additionally, the Chinese tax authorities have clarified that distributions
made out of pre-January 1, 2008 retained earnings would not be subject to the withholding tax.
The tax authorities may examine the tax
returns of the Company three years after its fiscal year ended.
9. Employee Benefits
The Company contributes to a state pension
scheme organized by municipal and provincial governments in respect of its employees in PRC. The pension expense related to this
plan is calculated at a range of 8% of the average monthly salary. The pension expense was $3,209 and $2,600 for the three months
ended March 31, 2014 and 2013, respectively.
10. Stockholders’ Equity
Common Stock
On
July 2, 2010, China Internet Cafe entered into a share exchange transaction with Classic Bond and the shareholders of Classic Bond.
Pursuant to the Share Exchange Agreement, China Internet Cafe acquired 100% of the issued and outstanding capital stock of Classic
Bond in exchange for 19,000,000 newly issued shares of the Company’s common stock, which represented approximately 94% of
the 20,200,000 issued and outstanding shares of common stock after the transaction and after the coincident cancellation of 4,973,600
shares of common stock held by the Company’s former majority stockholder The business, assets and liabilities did not change
as a result of the reverse acquisition.
As
of March 31, 2014 and December 31, 2013, there are 25,689,524 shares of Common Stock issued and outstanding respectively.
Series A Preferred Stock
On February 16, 2011, the Company filed
with the Secretary of State of Nevada, as an amendment to its Articles of Incorporation, a Certificate of Designation, Preferences
and Rights for the 5% Series A Convertible Preferred Stock, par value $0.00001 per share (the “Series A Preferred Stock”).
On February 22, 2011, the Company issued 4,274,703 shares of its Series A Preferred Stock.
For each outstanding share of Series A
Preferred Stock, dividends are payable quarterly, at the rate of 5% per annum ($0.675 per share), on or before each date that is
thirty days following the last day of March, June, September, and December of each year, commencing September 30, 2011. Dividends
on the Series A Preferred Stock accrue and are cumulative from and after the date of initial issuance. For the quarter ended September
30 and December 31 of 2012 and from January 1, 2013 to February 22, 2012, dividends have been accrued as dividends payable and
are not paid as of March 31, 2014.
The Series A Preferred Stock was not subject
to mandatory redemption (except on liquidation) but was redeemable in certain circumstances. Because of the possible redemption
conditions, the Series A Preferred Stock was classified as mezzanine equity.
CHINA INTERNET CAFE HOLDINGS GROUP, INC.
AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS
MARCH 31, 2014 AND DECEMBER 31, 2013
(UNAUDITED)
10. Stockholders’ Equity (continued)
Each share of Series A Preferred Stock
may be converted at any time, at the option of the holder, into a number of fully paid and non-assessable shares of Common Stock
equal to the quotient of (i) the Series A Liquidation Preference of $1.35 per share divided by (ii) the conversion price in effect
as of the date of the Conversion Notice. The initial conversion price of the Series A Preferred Stock was $1.35 per share.
In addition to the holder’s right
to convert the Series A Preferred Stock at any time, provided that the Common Stock underlying the Series A Preferred Stock is
registered under an effective registration statement or is available for resale under Rule 144, without limitation, all outstanding
shares of the Series A Preferred Stock automatically convert into shares of Common Stock at the earlier to occur of (i) February
22, 2013, the 24 month anniversary of the Closing Date of the issuance of the Series A Preferred Stock, or (ii) at such time that
the volume-weighted average price of the Company’s Common Stock is equal to or greater than $3.00 (as may be adjusted for
any stock splits or combinations of the Common Stock) for a period of ten consecutive trading days and such Common Stock has an
average daily trading volume, for ten consecutive trading days, equal to or greater than 50,000 shares.
On
February 22, 2013, in accordance with its terms, all 4,274,703 shares of Series A Preferred Stock outstanding automatically converted
into 4,274,703 shares of common stock.
Securities Purchase Agreement
On February 22, 2011 (the “Closing
Date”), the Company completed a private placement (the “Offering”) of 474,967 units at a purchase price of $13.50
per unit, each unit consisting
of:(i) nine shares of the Company’s Series A Preferred
Stock, convertible on a one to one basis into nine shares of the Company’s common stock; (ii) one share of Common Stock;
(iii) two three-year Series A Warrants (the “Series A Warrants”), each exercisable for the purchase of one share of
Common Stock, at an exercise price of $2.00 per share; and (iv) two three-year Series B Warrants (the “Series B Warrants”),
each exercisable for the purchase of one share of Common Stock, at an exercise price of $3.00 per share.
The Company
received aggregate gross proceeds of $6,412,055. The Offering was conducted pursuant to a Securities Purchase Agreement (the “Agreement”)
between the Company and various accredited investors (the “Investors).
Because certain of the instruments issued
in the Offering are derivative instruments which will be initially and continuously carried at fair value, we believe the aggregate
proceeds received should be allocated following the principles implicit in the guidance at ASC 815-15-30-2. The proceeds are first
allocated to those derivative instruments that will initially and continuously be carried at fair value. The remaining proceeds,
if any, are then allocated between the non-derivative host contract and other non-derivative instruments on a relative fair value
basis.
The Company reviewed the features of the
Series A Preferred Stock, other than the conversion feature, and concluded that, on balance, the terms and features of the host
contract should be considered to be more akin to a debt instrument. Accordingly, the embedded conversion option may be required
to be bifurcated and accounted for as a derivative instrument unless it meets the exemption provided by ASC 815-10-15-74a.
The conversion price of the Series A Preferred
Stock is subject to adjustment if the Company subsequently sells Common Stock at a lower price. Also, as described below for the
Warrants, the conversion option is denominated in U.S. dollars, a currency other than the Company’s functional currency.
Accordingly, the embedded conversion option is not considered to be indexed only to the Company’s common stock. In addition,
the Company may be required to redeem the Series A Preferred Stock for cash if, on receipt of a conversion request, it is unable
to issue shares registered for resale for any reason. In addition, the conversion price of the Series A Preferred Stock is subject
to adjustment if the Company subsequently sells Common Stock at a lower price but there is no explicit limit on the number of shares
that the Company may be required to issue. As a result of the foregoing, the exemption provided by ASC 815-10-15-74a is not available
and the embedded conversion option has been bifurcated and accounted for as a derivative liability. Because the embedded conversion
option has been bifurcated and accounted for as a derivative liability, no beneficial conversion option was required to be recognized.
CHINA INTERNET CAFE HOLDINGS GROUP, INC.
AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS
MARCH 31, 2014 AND DECEMBER 31, 2013
(UNAUDITED)
10. Stockholders’ Equity (continued)
Warrants
The Series A and Series B Warrants are
exercisable at any time and from time to time at an exercise price of $2.00 and $3.00 per share, respectively, and expired on
February 22, 2014. The holder may elect a cashless exercise of the Warrants beginning 12 months after the issuance date but only
if the shares underlying the Warrants are not registered for sale.
The Warrants contain standard anti-dilution
adjustments for stock splits and similar events but the exercise price is not otherwise subject to adjustment.
The Company may call the Series A and Series
B Warrants for redemption at a redemption price of $0.01 per Warrant share if the shares underlying the Warrants are registered
for sale and the volume-weighted average price of the Company’s Common Stock is equal to or greater than $6.00 per share
or $9.00 per share, respectively, for a period of ten consecutive trading days and such Common Stock has an average daily trading
volume, for ten consecutive trading days, equal to or greater than 75,000 shares per day.
The Warrants are free-standing derivative
instruments. Although the Company is a U.S. entity, the Company has no U.S. operations and all of its operations are conducted,
through its subsidiaries, in the People’s Republic of China. Accordingly, because the Company is fully invested in China
and those operations in China represent the Company’s only source of future revenues or income, the Company concluded that
its functional currency should be considered to be the RMB. As a result, because the Warrants are denominated in U.S. dollars,
they are denominated in a currency different from the Company’s functional currency and therefore, in accordance with the
guidance at ASC 815-40-15-7I, the Warrants are not considered to be indexed only to the Company’s common stock. As a result,
the exemption provided by ASC 815-10-15-74a is not available and the Warrants are recorded as a derivative liability.
Registration Rights Agreement
In connection with the Offering, the Company
entered into a Registration Rights Agreement with the Investors, in which the Company agreed to file a registration statement to
register for resale the Common Stock and the Common Stock issuable upon conversion of the Series A Preferred Stock and exercise
of the Series A and Series B Warrants, within 45 calendar days of the Closing Date, and to have the registration statement declared
effective within 150 calendar days of the Closing Date or within 180 calendar days of the Closing Date in the event of a full review
of the registration statement by the Securities and Exchange Commission. If the Company does not comply with the foregoing obligations
under the Registration Rights Agreement, the Company will be required to pay cash liquidated damages to each Investor, at the rate
of 1% of the applicable subscription amount for each 30 day period or part thereof in which we are not in compliance; provided,
that such liquidated damages will be capped at 10% of the subscription amount of each Investor and will not apply to any securities
that may be sold pursuant to Rule 144 under the Securities Act, or which are subject to an SEC restriction with respect to Rule
415 under the Securities Act.
The required registration statement was
filed by the required due date. However, the Company did not meet the deadline to render its S-1 registration statement effective.
At March 31, 2014, the Company has accrued $641,200 for the estimated liquidated damages it expects to pay.
Placement Agent Fees
In connection with the Offering, the Company
paid its placement agents (i) a cash fee of 7% of the gross proceeds from sale of the Units, (ii) a cash management fee of 1% and
(iii) a 0.5% non-accountable expense allowance. In addition to these placement agent cash fees aggregating $545,025, the Company
paid $181,415 in legal fees and other expenses related to the Offering. After payment of the placement agent cash fees and legal
and other expenses, the Company received net proceeds of $5,675,614.
In addition, the placement agents received
warrants to purchase such number of securities as is equal to 9% of the aggregate number of shares of common stock issuable in
connection with the Units (the “Placement Agent Warrants”). The Placement Agent Warrants expire after three years and
are exercisable at the following prices: (i) 427,740 Warrants - $1.35 per share (ii) 85,494 Series A Warrants - $2.00 per share
and (iii) 85,494 Series B Warrants - $3.00 per share. The terms of the Warrants, including anti-dilution protection for stock splits
and similar events, are similar to the Warrants issued to the Investors, except that the 427,740 Warrants do not permit the Company
to call the Warrants.
CHINA INTERNET CAFE HOLDINGS GROUP, INC.
AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS
MARCH 31, 2014 AND DECEMBER 31, 2013
(UNAUDITED)
10. Stockholders’ Equity (continued)
Securities Escrow Agreement
In connection with the Offering, we also
entered into a Securities Escrow Agreement with the Investors and Mr. Dishan Guo (the “Stockholder”), the Company’s
chairman and principal stockholder, pursuant to which the Stockholder placed in escrow one share of our Common Stock for each $10
of Units sold to the Investors, equal to 641,205 shares of Common Stock (the “Escrow Shares”). The escrow agreement
establishes a performance threshold for the Company based on net income (as defined and subject to certain non-cash adjustments)
for the year ending December 31, 2011 of $10,000,000. If the Company achieves 95% or more of the performance threshold, the shares
will be returned to the Stockholder. If the Company’s net income is less than $9,500,000, then the shares will be delivered
to the Investors in the amount of 10% of the escrow shares for each full percentage point by which such performance threshold was
not achieved, up to a maximum of the 641,205 shares placed in escrow.
The Stockholder’s agreement to place
the shares in escrow was undertaken in his capacity as a major stockholder of the Company. In accordance with the guidance at ASC
718-10-S99-2, the Company does not believe the potential return of the shares to the Stockholder is compensatory because such return
is not contingent on his continued employment with the Company. The Investors who may receive shares under the escrow arrangement
have no relationship with the Company other than in their capacity as shareholders.
The shares are outstanding and are included
in the weighted average shares outstanding for purposes of computing basic earnings per share.
Lock-up Agreement
On the Closing Date, the Company entered
into a lock-up agreement (the “Lock-Up Agreement”) with the Stockholder whereby the Stockholder is prohibited from
selling our securities that he directly or indirectly owns (the “Lock-Up Shares”) until nine months after the Registration
Statement is declared effective (the “Lock-Up Period”). In addition, the Stockholder further agreed that during the
12 months immediately following the Lock-Up Period, the Stockholder will not offer, sell, contract to sell, assign or transfer
more than 0.833% of the Lock-Up Shares during each calendar month following the Lock-Up Period, other than engaging in a transfer
in a private sale of the Lock-Up Shares if the transferee agrees in writing to be bound by and subject to the terms of the Lock-Up
Agreement.
Accounting for Derivative Instruments
The Warrants and Placement Agent Warrants
are derivative instruments as defined in ASC 815-10-15-83. ASC 815-10-15-74 provides that a contract that would otherwise meet
the definition of a derivative instrument but that is both (a) indexed to a company’s own stock and (b) classified in stockholders’
equity in the statement of financial position would not be considered a derivative financial instrument. FASB ASC 815-40-15 and
815-40-25 provide guidance for determining whether those two criteria are met. For purposes of this evaluation, the Company has
concluded that the Company’s functional currency is the Renminbi. Because the Warrants are denominated in U.S. Dollars, FASB
ASC 815-40-15-7I provides that they are not considered to be indexed only to the Company’s Common Stock. Accordingly, the
exemption in FASB ASC 815-10-15-74 is not available and the Warrants are classified as a derivative instrument liability.
CHINA INTERNET CAFE HOLDINGS GROUP, INC.
AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS
MARCH 31, 2014 AND DECEMBER 31, 2013
(UNAUDITED)
10. Stockholders’ Equity (continued)
The Series A Preferred Stock is a hybrid
financial instrument that embodies the risks and rewards typically associated with both equity and debt instruments. Accordingly,
we are required to evaluate the features of this contract to determine its nature as either an equity-type contract or a debt-type
contract. We determined that the Series A Preferred Stock is generally more akin to a debt-type contract, principally due to its
potential redemption requirements, its fixed rate quarterly dividend requirement and its lack of voting rights. This determination
is subjective. However, in complying with the guidance provided in FASB ASC 815, we concluded, based upon the preponderance and
weight of all terms, conditions and features of the host contract, that the Series A Preferred Stock was more akin to a debt instrument
for purposes of considering the clear and close relationship of the embedded derivative features to the host contract. ASC 815
requires bifurcation when the embedded derivative features and the host contract have risks that are not clearly and closely related.
Certain exemptions to this rule, such as that for conventional convertible instruments that are convertible into a fixed number
of shares, were not available to us because the conversion price of the Series A Preferred Stock is not fixed and will be adjusted
if the Company sells shares of Common Stock at a price lower than the conversion price. Also, because the conversion price of the
Series A Preferred Stock is denominated in U.S. Dollars, as for the warrants discussed above, the embedded conversion option is
not considered to be indexed only to the Company’s Common Stock. In addition, the Company may be required to redeem the Series
A Preferred Stock if it is unable to deliver registered shares on conversion. Accordingly, the exemption in FASB ASC 815-10-15-74
is not available and the embedded conversion option, along with certain other features of the Series A Preferred Stock that have
risks of equity, required bifurcation and classification in liabilities as a compound embedded derivative financial instrument.
Derivative financial instruments are initially measured at their
fair value and are then re-valued at each reporting date, with changes in the fair value reported as charges or credits to income.
Valuation of Derivative Instruments
The Warrants and the Placement Agent Warrants
were initially valued, using a binomial model, at $649,821 and $262,966, respectively, based on the quoted market price of the
Common Stock of $1.00 per share, a term equal to the remaining life of the Warrants, an expected dividend yield of 0%, a risk-free
interest rate of 1.32% based on constant maturity rates published by the U.S. Federal Reserve applicable to the remaining life
of the Warrants and estimated volatility of 85%, based on a review of the historical volatility of publicly-traded companies considered
by management to be comparable to the Company.
The compound embedded derivative financial
instrument related to the Series A Preferred Stock, consisting primarily of the embedded conversion option, was initially valued,
using a binomial model, at $1,604,794, based on the quoted market price of the Common Stock of $1.00, a term equal to the expected
life of the conversion option, an expected dividend yield of 0%, a risk-free interest rate of 0.78% based on constant maturity
rates published by the U.S. Federal Reserve applicable to the expected life and estimated volatility of 85%.
After allocating a portion of the proceeds
received to the fair value of the Warrants and the embedded derivative instrument in the Series A Preferred Stock, the remaining
proceeds were allocated to the Common Stock component of the Units and the carrying value of the Series A Preferred Stock host
contract.
On February 22, 2013, all outstanding shares
of the Series A Preferred Stock were converted to common stock. As of that date, the conversion feature of the Series A Preferred
Stock was out-of-the-money and accordingly had no value. The aggregate change in the fair value of the embedded derivative instrument
related to the Series A Preferred Stock between December 31, 2012 and February 22, 2013 of $64,280 has been credited to income.
At December 31, 2013, the Warrants, the
Placement Agent Warrants and the embedded derivative instrument related to the Series A Preferred Stock were re-valued at $-0-,
$-0- and $-0-, respectively, because of their short remaining life with expiration date on February 14, 2014 and the recent low
volatility of the stock price. The aggregate change in the fair value of the derivative liabilities between December 31, 2012 and
December 31, 2013 of $393,534 has been credited to income.
On February 14, 2014, the Warrants, the
Placement Agent Warrants and the embedded derivative instrument related to the Series A Preferred Stock expired.
CHINA INTERNET CAFE HOLDINGS GROUP, INC.
AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS
MARCH 31, 2014 AND DECEMBER 31, 2013
(UNAUDITED)
10. Stockholders’ Equity (continued)
Accounting for Series A Preferred Stock
$3,682,473 of the proceeds received was
allocated to the carrying value of the Series A Preferred Stock host contract. The 4,274,703 shares of Series A Preferred Stock
have a liquidation value of $5,770,849. Because the Series A Preferred Stock has conditions for its redemption that are outside
our control, it is classified outside of Stockholders’ Equity, in the mezzanine section of our balance sheet, in accordance
with ASC 480-10-S99-3A. Because the Series A Preferred Stock is not currently redeemable and the Company currently believes that
it is not probable that it will become redeemable, no adjustment of the carrying value of the Series A Preferred Stock has been
recognized. If it becomes probable that the Series A Preferred Stock will be redeemed, it will be adjusted to its redemption value.
Placement Agent Fees
The placement agent cash fees of $545,025,
other expenses related to the sale of the Units of $181,415 and the initial fair value of the Placement Agent Warrants of $262,966,
aggregating $989,406, have been charged to additional paid-in capital.
Advisory Fees
On November 22, 2010, the Company entered
into a 12 month Advisory Agreement with an affiliate of its placement agent, under which the affiliate agreed to render on-going
financial advisory and investment banking services to the Company. As compensation for its services, the Company agreed to pay
a monthly fee of $10,000, payable on the first day of each month after the completion of a Transaction, as defined in the agreement
between the Company and its placement agent. Payment of these fees commenced on March 1, 2011, following completion of the sale
of the Units.
The Company also agreed to place in escrow
for issuance to the affiliate a total of 400,000 shares of Common Stock, with 200,000 shares to be released following the completion
of a Transaction, 100,000 shares to be released six months after the completion of a Transaction and 100,000 shares to be released
12 months after the completion of a Transaction. In accordance with ASC 505-50-25-7, the Company concluded that the value of the
shares should be measured at the date the Transaction was completed because the shares are effectively fully vested as of that
date and non-forfeitable and the agreement does not provide for any further specific performance criteria to be met. The Company
valued the shares issued at $1.00 per share (based on the quoted market price), resulting in compensation expense for the services
rendered and to be rendered of $400,000. The expense related to the services provided and to be provided was recognized over the
period from November 22, 2010, the date from which services commenced under the agreement, to the one year anniversary, when the
agreement expired. At December 31, 2011, the expense has been fully recognized.
In addition to the above fees, the Company
issued 50,000 shares to its legal counsel, in consideration for their introducing the Company to the placement agent. The cost
of these shares, which were valued at $1.00 per share (determined as described above) were expensed during the year ended December
31, 2011.
Fair Value Considerations
As required by FASB ASC 820, assets and
liabilities measured at fair value are classified in their entirety based on the lowest level of input that is significant to their
fair value measurement. Our derivative financial instruments that are measured at fair value on a recurring basis under FASB ASC
815 are all measured at fair value using Level 3 inputs. Level 3 inputs are unobservable inputs that are supported by little or
no market activity and that are significant to the fair value of the assets or liabilities.
Estimating fair values of derivative financial
instruments requires the development of significant and subjective estimates that may, and are likely to, change over the duration
of the instrument with related changes in internal and external market factors. In addition, valuation techniques are sensitive
to changes in the estimated fair value of our common stock and our estimates of its volatility. Because derivative financial instruments
are initially and subsequently carried at fair values, our income will reflect the volatility in these estimate and assumption
changes.
CHINA INTERNET CAFE HOLDINGS GROUP, INC.
AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS
MARCH 31, 2014 AND DECEMBER 31, 2013
(UNAUDITED)
10. Stockholders’ Equity (continued)
Options
On
February 27, 2014, the Board approved the Company’s 2014 Incentive Stock Plan (the “2014” Plan). The 2014 Plan
provides for grant of incentive stock options, non-statutory stock options,
restricted stock, restricted stock purchase offers and other types of stock-based awards to the Company’s employees, officers,
directors and consultants. Up to 2,568,952 shares of common stock are issuable pursuant to awards the 2014 Plan. Unless terminated
earlier by the Board, the 2014 Plan shall terminate at the close of business on February 26, 2024. As of the date of this report,
no shares have been issued under the 2014 Plan.
12.
Commitments
and Contingencies
Operating Leases
In
the normal course of business, the Company leases office space and internet cafes under operating leases agreements, which expire
through 2017. The Company rents internet cafe venues and office space, primarily for regional sales administration offices that
are conducive to administrative operations. The operating lease agreements generally contain renewal options that may be exercised
in the Company's discretion after the completion of the base rental terms. In addition, many of the leases provide for regular
increases to the base rental rate at specified intervals, which usually occur on an annual basis.
As
of March 31, 2014, the Company was obligated under operating leases requiring minimum rentals as follows:
Fiscal year
|
|
|
|
|
Remainder of 2014
|
|
$
|
2,008,039
|
|
2015
|
|
|
1,520,957
|
|
2016
|
|
|
338,029
|
|
2017
|
|
|
4,869
|
|
|
|
$
|
3,871,894
|
|
During the three months ended March 31,
2014 and 2013, rent expenses amounted to $656,800 and $853,718, respectively, of which $863,596 and $840,559 were recorded as cost
of sales, respectively.
13.
Concentrations
The Company did not have any customer constituting
greater than 10% of net sales for the three months ended March 31, 2014 and 2013.
At March 31, 2014 and December 31, 2013,
there was one supplier of consignment snacks and drinks in the amount of $210,561 and $227,981, respectively, which accounted for
100% and 100% of the Company’s accounts payable.
CHINA INTERNET CAFE HOLDINGS GROUP, INC.
AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS
MARCH 31, 2014 AND DECEMBER 31, 2013
(UNAUDITED)
14.
Operating Risk and Uncertainties
Interest
rate risk
The
interest rates and terms of repayment of bank and other borrowings are disclosed in Note 5. Other financial assets and liabilities
do not have material interest rate risk.
Foreign
currency risk
Most
of the transactions of the Company were settled in Renminbi. In the opinion of the directors, the Company does not have significant
foreign currency risk exposure.
Company’s
operations are substantially in foreign countries
Substantially
all of the Company’s services are provided in China. The Company’s operations are subject to various political, economic,
and other risks and uncertainties inherent in China. Among other risks, the Company’s operations are subject to the risks
of restrictions on transfer of funds; export duties, quotas, and embargoes; domestic and international customs and tariffs; changing
taxation policies; foreign exchange restrictions; and political conditions and governmental regulations.
The
Chinese government began tightening its regulation of internet cafes in 2001. In particular, a large number of unlicensed internet
cafes have been closed. In addition, the Chinese government has imposed higher capital (RMB10,000,000 is required for a regional
internet café chain and RMB50,000,000 is required for a national internet café chain) and facility requirements for
the establishment of internet cafes. Furthermore, the Chinese government’s policy, which encourages the development of a
limited number of national and regional internet cafe chains and discourages the establishment of independent internet cafes, may
slow down the growth of internet cafes. Recently, the Ministry of Culture, together with other government authorities, issued a
joint notice suspending the issuance of new internet cafe chain licenses. Any intensified government regulation of internet cafes
could restrict our ability to maintain and expand our internet cafes.
Currently,
the Company uses only one internet service provider. However, there are other internet service providers available to the Company.
The management of the Company believes that the risk of loss of internet services is not that high because other service providers
are available to the Company.
CHINA INTERNET CAFE HOLDINGS GROUP, INC.
AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS
MARCH 31, 2014 AND DECEMBER 31, 2013
(UNAUDITED)
Basic
earnings per share is computed by dividing net income attributable to common shareholders by the weighted average number of common
shares outstanding during the period. Diluted earnings per share reflects the potential dilution of securities by including other
potential common stock, including convertible preferred stock, stock options and warrants, in the weighted average number of common
shares outstanding for the period, if dilutive. The numerators and denominators used in the computations of basic and dilutive
earnings per share are presented in the following table:
|
|
For Three Months Ended March 31,
|
|
|
|
2014
|
|
|
2013
|
|
BASIC
|
|
|
|
|
|
|
|
|
Numerator for basic earnings per share attributable to the Company’s common stockholders:
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
2,609,766
|
|
|
$
|
2,435,241
|
|
Dividend on preferred stock
|
|
|
-
|
|
|
|
(113,836
|
)
|
Net income used in computing basic earnings per share
|
|
$
|
2,609,766
|
|
|
$
|
2,321,405
|
|
|
|
|
|
|
|
|
|
|
Basic weighted average shares outstanding
|
|
|
25,689,524
|
|
|
|
23,219,696
|
|
Basic earnings per share
|
|
$
|
0.10
|
|
|
$
|
0.10
|
|
|
|
For Three Months Ended March 31,
|
|
|
|
2014
|
|
|
2013
|
|
DILUTED
|
|
|
|
|
|
|
|
|
Numerator for diluted earnings per share attributable to the Company’s common stockholders:
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
2,609,766
|
|
|
$
|
2,321,405
|
|
Dividend on preferred stock
|
|
|
-
|
|
|
|
113,836
|
|
Net income used in computing diluted earnings per share
|
|
$
|
2,609,766
|
|
|
$
|
2,435,241
|
|
|
|
|
|
|
|
|
|
|
Weighted average outstanding shares of common stock
|
|
|
25,689,524
|
|
|
|
23,219,696
|
|
Weighted average preferred stock
|
|
|
-
|
|
|
|
2,469,828
|
|
Diluted weighted average shares outstanding
|
|
|
25,689,524
|
|
|
|
25,689,524
|
|
Diluted earnings per share
|
|
$
|
0.10
|
|
|
$
|
0.09
|
|
|
|
|
|
|
|
|
|
|
Potential common shares outstanding as of March 31:
|
|
|
|
|
|
|
|
|
Warrants
|
|
|
-
|
|
|
|
2,498,326
|
|
|
|
|
-
|
|
|
|
2,498,326
|
|
The Company applies the provisions of
ASC 280, "Disclosures about Segments of an Enterprise and Related Information". The Company views its operations and
manages its business as one segment: the operation of internet cafe chains. Factors used to identify the Company's single operating
segment include the organizational structure of the Company and the financial information available for evaluation by the chief
operating decision-maker in making decisions about how to allocate resources and assess performance. The Company operates in one
geographical area, the PRC.
CHINA INTERNET CAFE HOLDINGS GROUP, INC.
AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS
MARCH 31, 2014 AND DECEMBER 31, 2013
(UNAUDITED)
17. Subsequent Events
On April 25, 2014, the Company filed
a Certificate of Change with the Office of the Secretary of State of Nevada in connection with a one (1)-for-five (5) reverse
stock split of its authorized and outstanding shares of common stock, which is to become effective to a date to be determined
by the Company subject to FINRA approval. As a result of the reverse stock split, the number of its authorized shares
of common stock will be reduced from 100 million to 20 million, and the number of outstanding shares of common stock will
be reduced from 25,689,524 to approximately 5,138,001. The Company will not issue fractional shares resulting from the
reverse stock split or settle fractional shares by payment in cash; however fractional shares will be rounded up to the
nearest whole share. The Company has notified FINRA of the reverse stock split.
As of the date of this report, the Company
has evaluated subsequent events for potential recognition and disclosure through the date of the financial statement issuance.