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SKY DIGITAL STORES CORP. - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations.
(Edgar Glimpses Via Acquire Media NewsEdge)
The following discussion and analysis of our financial condition and results of
operations should be read in conjunction with our unaudited condensed
consolidated financial statements and the related notes included elsewhere in
this report. This discussion contains forward-looking statements that involve
risks and uncertainties. Actual results and the timing of selected events could
differ materially from those anticipated in these forward-looking statements as
a result of various factors.
This section should be read together with the consolidated financial statements
and related notes thereto in our Annual Report on Form 10-K for the fiscal year
ended December 31, 2011, which was filed on March 30, 2012.
Overview
We are a mobile internet product and application service provider. We have
retail stores targeting the Chinese consumers. We design, manufacture and sell
mobile communication products and accessories under the Donxon/EMI brand, and
operate retail business through our website and retail store chains. We are
developing licensed digital retail stores under our Sky Digital Stores brand,
retailing various smartphones and accessories to end-users.
Business growth for traditional mobile phone sales has been flat for the past
two years. Customer demand for name brand smartphones has increased
significantly. In the second quarter of 2011, we signed up as a reseller for a
top global smartphone supplier. We opened our first concept store under our Sky
Digital Stores brand on July 10, 2011. As of September 30, 2012, we have three
such stores in Guangdong Province and two more in Henan Province. We intend to
seek business opportunities with more global brands in the future and expect
these stores to provide increased revenue sources for our company.
Corporate History
We were incorporated in the state of Nevada on March 23, 2006 under the name
Hoopsoft Development Corp ("Hoopsoft").On January 9, 2007, we entered into an
agreement and plan of merger ("Agreement and Plan of Merger") with Yellowcake
Mining Inc. ("Yellowcake"), a Nevada corporation and wholly-owned subsidiary of
Hoopsoft Development Corp., incorporated for the sole purpose of effecting the
merger. Pursuant to the terms of the Agreement and Plan of Merger, Yellowcake
merged with and into Hoopsoft, with Hoopsoft carrying on as the surviving
corporation under the name "Yellowcake Mining Inc."
On May 5, 2011, SKY Digital Stores, Corp. (the "Company", "we" or "SKYC"), Hong
Kong First Digital Holding Ltd. ("First Digital"), and the shareholders of First
Digital (the "FDH Shareholders") entered into a Share Exchange Agreement
("Exchange Agreement"). The closing of the transaction (the "Closing") took
place on May 5, 2011 (the "Closing Date"). On the Closing Date, pursuant to the
terms of the Exchange Agreement, we acquired all of the outstanding shares (the
"Shares") of First Digital from the FDH Shareholders; and FDH Shareholders
transferred and contributed all of their Shares to us. In exchange, we issued to
the FDH Shareholders, their designees or assigns, an aggregate of 23,716,035
shares (the "Shares Component") or 97.56% of the shares of common stock of the
Company issued and outstanding after the Closing (the "Share Exchange"), at
$0.20 per share. This exchange was based on an acquisition value of First
Digital of $4,743,207. The acquisition of First Digital was treated as a reverse
acquisition, and the business of First Digital became the business of the
Company. After the Closing of the Share Exchange, the Company controlled all the
subsidiaries of First Digital in mainland China through First Digital and the
administration, organization, management teams and operation models of all the
subsidiaries in mainland China remained unchanged from before the Share
Exchange.
First Digital owns (i) 100% of the issued and outstanding capital stock of
Shenzhen Dong Sen Mobile Communication Technology Co., Ltd (also known as
Shenzhen Donxon Mobile Communication Technology Co., Ltd, "Donxon"), a company
organized under the laws of the People's Republic of China ("China" or the
"PRC"); and (ii) 100% of the issued and outstanding capital stock of Shenzhen
Xing Tian Kong Digital Company Limited ("Xingtiankong"), a PRC company.
Xingtiankong is the holder of 100% of the issued and outstanding capital stock
of Shenzhen Da Sheng Communication Technology Company Limited (also known and
doing business as Shenzhen Dasen Communication Technology Company Limited,
"Shenzhen Dasen"), a PRC company. Shenzhen Dasen is the holder of 70% of the
issued and outstanding capital stock of Foshan Da Sheng Communication Chain
Service Company Limited (also known as Foshan Dasen Communication Chain Service
Co. Ltd, "Foshan Dasen"), a company incorporated in PRC on January 19, 2007. Two
PRC individuals own the remaining 30% ownership interest in Foshan Dasen.
Pursuant to the Exchange Agreement, First Digital became a wholly-owned
subsidiary of the Company, and the Company directly owned 100% of Donxon, 100%
of Xingtiankong, 100% of Dasen and indirectly owned 70% of Foshan Dasen through
First Digital.
First Digital was established on September 30, 2010 in Hong Kong. First Digital
entered into a share exchange agreement with the shareholders of Donxon on
November 3, 2010, and as a result of the transaction, Donxon became a
wholly-owned subsidiary of First Digital. Xingtiankong was established by First
Digital on February 28, 2011 in Shenzhen, PRC. Xingtiankong completed a 100%
ownership acquisition transaction with Shenzhen Dasen on April 7, 2011 and has
an indirect interest ownership of 70% of Foshan Dasen through Shenzhen Dasen.
Shenzhen Dasen was established on November 26, 2007 in Shenzhen, PRC. Foshan
Dasen was established on January 19, 2007 in Foshan, PRC. Shenzhen Dasen
acquired a 70% interest ownership of FDSC on January 7, 2008. On August 1, 2011,
Donxon, a wholly owned subsidiary of the Company incorporated a subsidiary,
Xinyang City Donxon Mobile Communication Technology Company Limited, in Henan
Province ("Xinyang Donxon"). Xinyang Donxon is a logistics center, manufacturing
facility, customer service and training center for the Company.
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On October12, 2011, Donxon entered into an acquisition agreement with Vaslink
Technology Ltd. ("Vaslink") and the sole shareholder of Vaslink to acquire
Vaslink for RMB 7,500,000 (approximately $1,180,675), paid in the Company's
common stock, valued at $1.21 per share. Vaslink is a company incorporated in
China and engaged in the research, development, wholesale and retail of computer
information technology, communications product, hardware and software in
Guangzhou, China. On March 12, 2012, Xingtiankong established Shenzhen Sky
Digital Technology Company Ltd. ("Xingtiankong Digital") with two unrelated
parties. Xingtiankong Digital was established to expand our authorized reseller
network under Sky Digital Stores brand throughout China. Xingtiankong owns 60%
of Xingtiankong Digital.
Economic and Political Risks
Our operations are conducted primarily in the PRC. Accordingly, our business,
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.
Our 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. Our Company's
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.
Critical Accounting Policies and Estimates
In preparing our consolidated financial statements in accordance with US GAAP,
we are required to make judgments, estimates and assumptions that affect: (i)
the reported amounts of our assets and liabilities; (ii) the disclosure of our
contingent assets and liabilities at the end of each reporting period; and (iii)
the reported amounts of revenue and expenses during each reporting period. We
continually evaluate these estimates based on our own historical experience,
knowledge and assessment of current business and other conditions, our
expectations regarding the future based on available information and reasonable
assumptions, which together form our basis for making judgments about matters
that are not readily apparent from other sources. Since the use of estimates is
an integral component of the financial reporting process, our actual results
could differ materially from those estimates.
We believe that any reasonable deviation from those judgments and estimates
would not have a material impact on our financial condition or results of
operations. To the extent that the estimates used differ from actual results,
however, adjustments to the statement of operations and corresponding balance
sheet accounts would be necessary. These adjustments would be made in future
financial statements.
When reading our financial statements, you should consider: (i) our critical
accounting policies; (ii) the judgment and other uncertainties affecting the
application of such policies; and (iii) the sensitivity of reported results to
changes in conditions and assumptions. We have not made any material changes in
the methodology used in our accounting policies which are consistent with those
discussed in our annual report on Form 10-K for the year ended December 31,
2011. We believe the critical accounting policies and related judgments and
estimates are identified in Note 2 to our unaudited consolidated financial
statements accompanying in this report involve the most significant judgment and
estimates used in the preparation of our financial statements.
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Results of operations
Recent Developments
In the third quarter of 2012, we entered into licensing agreements with nine
additional retail stores nationwide and granted these retail stores
non-exclusive licenses to use our "Sky Digital Stores" brand name and store
images and sell our digital products, including our Donxon brand products and
other digital products, including Apple products. As of September 30, 2012, we
have total 57 licensed stores. We supply the products to be sold in these
stores. In the meantime, we opened two Company stores under the "Sky Digital
Stores" brand; one is operating in Shenzhen city, Guangdong province, and the
other one is in Xinyang city, Henan province. We believe that these newly
licensed and company stores will help to expand our market coverage and generate
more sales revenue in the near future.
Results of operation for the three months ended September 30, 2012 compared with
the three months ended September 30, 2011 (Unaudited)
The following tables set forth key components of our results of operations and
key components of our revenue for the period indicated.
For three months ended September 30,
2012 % of Revenue 2011 % of Revenue Change ($) Change (%)
Sales $ 23,704,674 100.00 % $ 15,844,644 100.00 % $ 7,860,030 49.61 %
Cost of goods sold (23,119,444 ) -97.53 % (14,823,183 ) -93.55 % (8,296,261 ) 55.97 %
Gross profit 585,230 2.47 % 1,021,461 6.45 % (436,231 ) -42.71 %
Income from commission
and licensing stores 117,940 0.50 % 55,084 0.35 % 62,856 114.11 %
Operating expenses
Selling expenses (159,680 ) -0.67 % (935,676 ) -5.91 % 775,996 -82.93 %
General and
administrative expenses (1,079,894 ) -4.56 % (68,575 ) -0.43 % (1,011,319 ) 1,474.76 %
Total operating
expenses (1,239,574 ) -5.23 % (1,004,251 ) -6.34 % (235,323 ) 23.43 %
Income (loss) from
operations (536,404 ) -2.26 % 72,294 0.46 % (608,698 ) -841.98 %
Total other expenses (169,752 ) -0.72 % (45,114 ) -0.28 % (124,638 ) 276.27 %
Income (loss) before
provision for income
taxes (706,156 ) -2.98 % 27,180 0.17 % (733,336 ) -2,698.07 %
Provision for income
taxes (9,056 ) -0.04 % (69,213 ) -0.44 % 60,157 -86.92 %
Net loss $ (715,212 ) -3.02 % $ (42,033 ) -0.27 % $ (673,179 ) 1,601.55 %
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Net Sales / Revenue:
We have two types of revenue streams from our two lines of businesses, namely
(i) design, manufacturing and sale of mobile phones and digital products
(Donxon) and (ii) retail stores (Shenzhen Dasen).
For the three months ended September 30, 2012, net sales increased by 49.61% to
$23.70 million from $15.84 million as compared to the three months ended
September 30, 2011. The increase in our sales was primarily due to the following
factors:
(1) The addition of the retail store business line opened a new window for us to
sell mobile communication products to customers. As an authorized Apple
product retailer, we rapidly expanded our sales and market coverage by
retailing Apple products and other top smartphone brands in our retail
stores and in our licensed stores in Guangdong Province and nearby areas,
which in turn led to increased sales of our own Donxon brand products as
customers were exposed to our products while shopping for Apple products.
(2) The increase in sales was also affected by higher product selling prices for
the period indicated. For the three months ended September 30, 2012, a
significant portion of our sales were related to Apple iPhone, iPad, other
high-end branded smartphones and digital communication accessories in our
retail stores. The selling prices of such products are much higher than our
own Donxon brand products. As a result of the increased quantity sold and
higher selling price, our sales revenue increased accordingly.
(3) The rebranding and sale of third-party products under our Donxon brand also
increased for the three months ended September 30, 2012 as compared to the
three months ended September 30, 2011, primarily due to increased product
variety and increased quantity sold to target a broader range of customers.
(4) Sales of our Donxon brand products decreased for the three months ended
September 30, 2012 as compared to the three months ended September 30, 2011,
because our factory moved from Shenzhen to Henan Xinyang. During the factory
shift process, we reduced the manufacturing our own Donxon brand mobile and
digital products.
The overall increase in our sales revenue for the three months ended September
30, 2012 reflected the above combined factors.
The following table sets forth the breakdown of our sales and gross profit for
our two business lines for the three months ended September 30, 2012 and 2011:
Three Months Ended September 30, 2012 Three Months Ended September 30, 2011
Mobile phone Mobile phone
manufacturing Retail store Total manufacturing Retail store Total
Sales $ 12,074,060 $ 11,630,614 $ 23,704,674 $ 11,938,568 $ 3,906,076 $ 15,844,644
Cost of goods (11,438,485 ) (11,680,959 ) (23,119,444 ) (11,263,824 ) (3,559,359 ) (14,823,183 )
Gross profit 635,575 (50,345 ) 585,230 674,744 346,717 1,021,461
Gross profit margin 5.26 % -0.43 % 2.47 % 5.65 % 8.88 % 6.45 %
Cost of goods sold:
Cost of goods sold increased $8.30 million or 55.97% when comparing the three
months ended September 30, 2012 to the three months ended September 30, 2011.
The increase in our cost of goods sold was in line with our increased sales. The
overall increase in our cost of goods sold for the three months ended September
30, 2012 as compared to the prior comparative period were attributable to the
following factors.
(1) Due to the addition of the retail store business line into our operation,
our sales volume increased and we incurred more cost to sell top brand
products in our retail stores, such as iPhones, other smartphones and
digital products which were purchased from other manufacturers and put into
our retail store chain for resale.
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(2) The purchase prices for these products were higher than our self-produced
Donxon brand products. The increase in our cost of goods sold was largely
attributable to the increased purchase cost incurred.
(3) Due to the general inflation and increase in market price for raw materials
and labor costs, the production costs incurred in our Donxon brand products
also increased as compared to the comparable period a year ago, which led to
the increased costs to be allocated to products sold.
Gross profit and Gross margin:
Gross profit decreased by 42.71% to $0.59 million for the three months ended
September 30, 2012, as compared with the same period in 2011. The decrease in
our gross profit was primarily due to decreased gross margin of retail business.
Our gross margin for the three months ended September 30, 2012 was 2.47%,
decreased from 6.45% for the three months ended September 30, 2011. The decrease
in gross margin was due to higher purchase costs and lower gross margin from
retail of Apple products and re-branded products during the quarter ended
September 30, 2012.
Operating Expenses:
Total operating expenses increased from $1.00 million for the three months ended
September 30, 2011 to $1.24 million for the three months ended September 30,
2012, representing a 23.43% increase. The increase in our total operating
expense was primarily due to increased general and administrative expenses as
discussed below:
(1) For the three months ended September 30, 2012, we incurred increased travel,
office, salary and other administration expenses in connection with managing
our newly formed Xinyang factory.
(2) For the three months ended September 30, 2012, we opened two new Company
stores in Henan province. In order to promote sales from these newly opened
Company stores, we incurred more advertising and promotion expenses than we
did in the same period of 2011.
(3) For the three months ended September 30, 2012, we had more subsidiaries and
company stores than in the same period of 2011. We also increased employee
hiring, leased more office and retail store space, incurred more
administrative and office expenses, accrued more stock-based compensation
expense, and faced increased audit, legal and consulting fees as a public
company. Accordingly, our operating expenses for the three months ended
September 30, 2012 were higher than the prior comparative period.
We expect that our operating expenses will increase as we expand our business
and operations. The Company will need to devote additional resources to increase
our corporate governance and internal controls and to develop experience in
complying with the laws, rules and regulations applicable to us as a U.S. public
company that conducts business in China. We believe that we will need to hire
more personnel as our business continues to grow, and we believe that we will
need to incur additional general and administrative costs in the near future to
support our business.
Net Income/Loss:
Net loss for the three months ended September 30, 2012 was $0.72 million,
compared with net loss of $0.04 million for the three months ended September 30,
2011. The increase in our net loss for the three months ended September 30, 2012
was primarily due to (i) the increase in our cost of goods sold, which reduced
our gross margin and (ii) the increase in our operating expenses as discussed
above. We expect to see a positive net income trend in the last quarter of 2012
and beyond because we have designed more new products which will be put into
production and attract more customers. In addition, we will expand our retail
store business line by opening more retail stores and grant licenses to third
parties to operate more retail stores in expanded geographic areas.
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Results of operation for the nine months ended September 30, 2012 compared with
the nine months ended September 30, 2011 (Unaudited)
The following tables set forth key components of our results of operations and
key components of our revenue for the period indicated.
For nine months ended September 30,
2012 % of Revenue 2011 % of Revenue Change ($) Change (%)
Sales $ 72,776,405 100.00% $ 38,066,707 100.00% $ 34,709,698 91.18%
Cost of goods sold (70,699,082) -97.15% (35,368,682) -92.91% (35,330,400) 99.89%
Gross profit 2,077,323 2.85% 2,698,025 7.09% (620,702) -23.01%
Income from
commission and
licensing stores 406,479 0.56% 90,541 0.24% 315,938 348.94%
Operating expenses Selling expenses (371,175) -0.51% (1,900,373)
-4.99% 1,529,198 -80.47%
General and
administrative
expenses (3,246,998) -4.46% (307,734) -0.81% (2,939,264) 955.13%
Total operating
expenses (3,618,173) -4.97% (2,208,107) -5.80% (1,410,066) 63.86%
Income (loss) from
operations (1,134,371) -1.56% 580,459 1.52% (1,714,830) -295.43%
Total other expenses (538,755) -0.74% (42,896)
-0.11% (495,859) 1,155.96%
Income (loss) before
provision for income
taxes (1,673,126) -2.30% 537,563 1.41% (2,210,689) -411.24%
Provision for income
taxes (70,249) -0.10% (270,171) -0.71% 199,922 -74.00%
Net income (loss) $ (1,743,375) -2.40% $ 267,392
0.70% $ (2,010,767) -751.99%
Net Sales / Revenue:
For the nine months ended September 30, 2012, net sales increased by 91.18% to
$72.78 million from $38.07 million as compared to the nine months ended
September 30, 2011. The increase in our sales was primarily due to the following
factors:
(1) The addition of the retail store business line opened a new window for us to
sell mobile communication products to customers. As an authorized Apple
product retailer, we rapidly expanded our sales and market coverage by
retailing Apple products and other top smartphone brands in our retail
stores and in our licensed stores in Guangdong Province and nearby areas,
which in turn led to increased sales of our own Donxon brand products, as
customers were exposed to our products while shopping for Apple products.
(2) The increase in sales was also affected by higher product selling prices for
the period indicated. For the nine months ended September 30, 2012, a
significant portion of our sales were related to Apple iPhone, iPad, other
high-end branded smartphones and digital communication accessories in our
retail stores. The selling prices of such products are much higher than our
own Donxon brand products. As a result of the increased quantity sold and
higher selling price, our sales revenue increased accordingly.
(3) The rebranding and sale of third-party products under our Donxon brand also
increased for the nine months ended September 30, 2012 as compared to the
nine months ended September 30, 2011, primarily due to increased product
variety and increased quantity sold to target a broader range of customers.
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The following table sets forth the breakdown of our sales and gross profit for
our two business lines for nine months ended September 30, 2012 and 2011:
Nine months ended September 30, 2012 Nine months ended September 30, 2011
Mobile phone Mobile phone
manufacturing Retail stores Total manufacturing Retail stores Total
Sales $ 40,225,958 32,550,447 72,776,405 $ 33,037,198 $ 5,029,509 $ 38,066,707
Cost of goods (38,395,198 ) (32,303,884 ) (70,699,082 ) (30,695,597 ) (4,673,085 ) (35,368,682 )
Gross profit 1,830,760 246,563 2,077,323 2,341,601 356,424 2,698,025Gross profit margin 4.55% 0.76% 2.85% 7.09% 7.09% 7.09%
Cost of goods sold:
Cost of goods sold increased $35.33 million or 99.89% when comparing the nine
months ended September 30, 2012 to the nine months ended September 30, 2011. The
increase in our cost of goods sold was in line with our increased sales and the
overall increase in our cost of goods sold for the nine months ended September
30, 2012 as compared to the prior comparative period were attributable to the
following factors.
(1) Due to the addition of the retail store business line into our operation, we
incurred more cost to sell top brand products in our retail stores, such as
iPhones, other smartphones and digital products which we purchased from
other manufacturers and put into our retail store chain for resale.
(2) The purchase prices on these products were higher than our self-produced
Donxon brand products. The increase in our cost of goods sold was largely
attributable to the increased purchase cost incurred.
(3) Due to the general inflation and increase in market price for raw materials
and labor costs, the production costs incurred in our Donxon brand products
also increased as compared to the comparable period a year ago, which led to
the increased costs to be allocated to products sold.
Gross profit and Gross margin:
Gross profit decreased by 23.01% to $2.08 million for the nine months ended
September 30, 2012, as compared with the same period in 2011. The decrease in
our gross profit was primarily due to the significantly decreased gross profit
margin in our retail business. Our gross profit margin for the nine months ended
September 30, 2012 was 2.85%, decreased from 7.09% for the nine months ended
September 30, 2011. The decrease in gross profit margin was due to higher
purchase costs and lower gross margin from retail sales of Apple products and
re-branding products, and reduced sales of self-produced Donxon brand products
during the nine months ended September 30, 2012.
Operating Expenses:
Total operating expenses increased from $2.21 million for the nine months ended
September 30, 2011 to $3.62 million for the nine months ended September 30,
2012, representing a 63.86% increase. The increase in our total operating
expense was primarily due to increased general and administrative expenses for
the period ended September 30, 2012 as discussed below:
(1) For the nine months ended September 30, 2012, we opened a new subsidiary,
Shenzhen Xintiankong Technology, and also a new factory in Henan Xinyang and
accordingly incurred increased travel, office, salary and other
administration expenses in order to manage the Xinyang factory.
(2) For the nine months ended September 30, 2012, we had more subsidiaries and
company stores than in the same period of 2011. We also increased employee
hiring, leased more office space, incurred more administrative and office
expenses, accrued more stock-based compensation expense, and faced increased
audit, legal and consulting fees as a public company. Accordingly, our
operating expenses for the nine months ended September 30, 2012 was higher
than the prior comparative period.
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We expect that our operating expenses will increase as we expand our business
and operations. The Company will need to enhance our management's skill level to
adapt to the complex business environment because we are subject to the rules
and regulations of the United States securities laws as well as a certain level
of corporate governance and internal controls. We believe that we will need to
devote additional resources to increase our corporate governance and internal
controls and to develop experience in complying with the laws, rules and
regulations applicable to us as a U.S. public company that conducts business in
China.
Net Income/Loss:
Net loss for the nine months ended September 30, 2012 was $1.74 million,
compared with net income of $0.27 million for the nine months ended September
30, 2011. The increase in our net loss for the nine months ended September 30,
2012 was primarily due to (i) the increase in our cost of goods sold, which
reduced the gross margin, and (ii) the increase in our general and
administrative expense, as discussed above. We are designing new products with
the goal of attracting more customers to address these challenging trends in our
business. In addition, we will expand our retail store business line by opening
more retail stores and grant licenses to third parties to operate retail stores
in expanded geographic areas.
Liquidity
Total current assets increased by $3.58 million from $20.73 million as of
December 31, 2011 to $24.31 million as of September 30, 2012. The primary
changes in our current assets during the nine months ended September 30, 2012
were from changes in cash, accounts receivable, inventory, trade deposit, other
receivables and amounts due from related parties.
· The increase in our inventories from $3.63 million as of December 31, 2011 to
$8.25 million was because we purchased and stock-piled more materials,
components to be used in manufacturing our Donxon brand products and digital
products from outside manufacturers to be used to expand our retail store
business lines.
· The increase in trade deposits from $1.04 million as of December 31, 2011 to
$3.66 million as of September 30, 2012 was because we made advances to certain
vendors for purchase of inventory items, raw materials for our self-produced
products and semi-finished third-party products for rebranding and sale under
our Donxon brand.
· The increase in other receivables from $0.12 million as of December 31, 2011
to $1.82 million as of September 30, 2012 was mainly due the increased
temporarily lent funds to third parties, and it will be repaid back to us in
the near future.
· The increase in due from related parties from $0 as of December 31, 2011 to
$2.37 million as of September 30, 2012 was because we temporarily lent funds
to these parties to generate interest income, and such amount will be repaid
back to us in the near future.
· The increase of total current assets was offset in part by a decrease in cash
and accounts receivable.
· The decrease in cash by $5.7 million was because we repaid $4.30 million (RMB
27.10 million) of bank loans upon maturity, repaid $2.56 million (RMB16.13
million) of stockholder loans, and paid $5.37 million (RMB 33.88 million) to
the local government to obtain the land use right in Henan Xinyang. The
decrease in accounts receivable by $1.56 million was because we systematically
follow up on collection of outstanding accounts.
Total current liabilities as of September 30, 2012 amounted to $25.41 million,
compared with $15.54 million as of December 31, 2011. The increase in current
liabilities was primarily due to an increase in short-term bank loans, notes
payable, accounts payable and advance from customers balance, partially offset
by amounts due to related parties and loans from third parties.
· The increase in short-term bank loans was because we received bank loans of
$9.43 million (RMB 59.50 million) and repaid bank loans of $4.30 million (RMB
27.10 million) upon maturity.
· The increase in notes payable was because Shenzhen Donxon issued bank-accepted
notes of $2.38 million (RMB 15 million) to vendors for the purpose of
inventory purchase.
· The increase in our accounts payable was because we purchased more materials,
components, and digital products from various suppliers, and such amount had
not been paid as of September 30, 2012.
· The increase of advance from customers was because we received cash advance
from customer sales orders for several of our newly developed smart phone
models, which are still under manufacturing as of the balance sheet date. We
expect such sales orders will be fulfilled in November 2012 once the
production is completed and the products are delivered to these customers.
· Amounts due to related parties also decreased by approximately $2.29 million
because we made a repayment of $2.29 million to the relevant related parties.
· The decrease in loans from third parties from $2.86 million as of December 31,
2011 to $1.73 million as of September 30, 2012 was because we repaid the funds
to these parties when cash became available.
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As reflected in the Company's condensed consolidated financial statements as of
September 30, 2012, the Company suffered recurring net losses and negative cash
flow from operating activities. The Company also has a working capital deficit.
The Company relies upon funds from financing activities to support its ongoing
operations.
The Company plans to improve its liquidity and strengthen working capital source
through the following efforts:
(1) Utilizing funds from local banks to support daily operation, including ICBC
Xinyang branch with an amount of $791,264 (RMB5,000,000), which is expected
to be granted by the Bank in December 2012, assuming successful completion
of the approval process. We are also negotiating with other financial
institutions to obtain further loans to meet our operating demand.
(2) With the aid of our newly strengthened R&D team, we plan to launch a series
of new products in the next twelve months, including our smart phone Model
SK8, Model SK9 and first and second generation of Xinghe smart phones. These
new products will increase our product variety and diversify our product
offerings to target a broader range of customers.
(3) Open more licensed stores and Company stores in broadened geographic areas
to expand our market share.
(4) Improve the sales and marketing skills of our sales person through training.
With the aid of strong marketing personnel, we believe our sales will be
increased within our entire retail network.
(5) Reducing costs and expenditures through integrating our internal resources,
improving facility utilization, maximize our production capacity, improve
employee work efficiency. We believe such efforts will cut our costs and
improve our profitability in the near future.
Based on the above remedial plan, the Company believes that it will generate
sufficient capital to meet its ongoing needs for the next 12 months.
Capital Resources
In summary, our cash flows for the periods indicated are as follows:
Nine months ended
September 30,
2012 2011Cash flows (used in) provided by operating activities $ (3,222,150 ) $ 1,399,119
Cash flows used in investing activities
(6,758,503 ) (1,253,998 )
Cash flows provided by financing activities 4,231,584 8,156,625
Operating Activities
Net cash used in operating activities was $3.22 million for the nine months
ended September 30, 2012, which consisted of our net loss of $1.74 million and
noncash adjustments of $0.61 million which mainly derived from depreciation and
amortization of $0.41 million and stock-based compensation of $0.14 million,
offset by net changes in operating assets and liabilities due to our expanded
operating activities, including an increase of inventory of $4.65 million
because we purchased and stock-piled more materials, components to be used in
manufacturing our Donxon brand products and digital products to be used in our
retail store business lines, and an increase in accounts payable of $3.37
million because we increased our purchases of inventory on credit.
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Investing Activities
Net cash used in investing activities primarily relates to expenditures
associated with the acquisition of property and equipment as well as intangible
assets, such as system application software and land use rights.
Net cash used in investing activities increased approximately $5.51 million,
from approximately $1.25 million for the nine months ended September 30, 2011 to
approximately $6.76 million for the nine months ended September 30, 2012. This
increase was primarily attributable to an increase of $1.39 million in the
purchase of property, plant and equipment, an increase of $5.37 million due to
the acquisition of land use rights on which our new factory was opened in April
2012.
Financing Activities
Net cash used in financing activities mainly consists of proceeds from
short-term bank loans and shareholders' loans, repayment of related party loans,
third party loans and bank loans.
Our net cash provided by financing activities significantly decreased $3.93
million, from $8.16 million for the nine months ended September 30, 2011 to
$4.23 million for the nine months ended September 30, 2012. This was because we
borrowed a bank loan of $9.43 million and at the same time repaid $4.30 million
in bank loans upon maturity, repaid third-party loans of $1.15 million, and
borrowed and repaid related party loans of $2.56 million and $2.38 million,
respectively. The net change in our cash flows from financing activities
reflects the above factors.
Off-Balance Sheet Arrangements
Guarantee of Third-Party Indebtedness-No Liability Is Recorded
As China only began its economic reform and development of a market economy in
the 1980s, its credit evaluation system has had only a very short history and is
far less sophisticated than that in the developed countries. Therefore, when an
enterprise applies for a loan from a commercial bank, it is difficult for the
bank to evaluate the credit risk of the applicant. As an alternative tool, it is
a common practice in China for commercial banks to require the applicant to find
an unrelated third party in its local economy to provide a loan guarantee for
the applicant, which serves as a sort of credit check for the bank. In return,
and also to avoid the risk of having to make payments under the guarantee, such
guarantors often require the counterparty to provide similar guarantees on their
own debt. Therefore, this type of guarantee is usually a cross-guarantee.
For mutual benefit, the Company reached agreements with three unrelated third
parties to provide such a cross-guarantee on bank loans as of September 30, 2012
and December 31, 2011.
As of September 30, 2012, the Company, through its subsidiary is contingently
liable as guarantor with respect to the maximum exposure of $3,323,311
(RMB21,000,000) to unrelated third parties, AIV Technology, Huafoli and SPA
Moment on a cross-guarantee basis. The term of these guarantees are for one
year, expiring on October 16, 2012. At any time from the date of guarantees,
should AIV Technology, Huafoli and SPA Moment fail to make their due debt
payments, the Company will be obligated to perform under the guarantees by
primarily making the required payments, including late fees and penalties.
Subsequently on October 16, 2012, the four parties did not repay the bank loans
upon maturity but entered into amended agreements with the bank to extend the
bank loan for additional one year, expiring on October 15, 2013. The related
cross-guarantee agreement has also been extended for one year.
Guarantee of Subsidiaries' Indebtedness-No Liability Is Recorded
As of July 17, 2012, Sky Digital became contingently liable as guarantor with
respect to the maximum exposure of $3,956,322 (RMB 25,000,000) to Shenzhen
Donxon, which is one of the subsidiaries of the Company. The term of this
guarantee is for one year, expiring on July 16, 2013. At any time from the date
of guarantees, should Shenzhen Donxon fail to make its due debt payments, Sky
Digital will be obligated to perform under the guarantees by primarily making
the required payments, including late fees and penalties.
As of August 29, 2012, Shenzhen Donxon became contingently liable as pledgor
with respect to the maximum exposure of $1,503,402 (RMB 9,500,000) to Shenzhen
Dasen, which is one of the subsidiaries of the Company. The term of this pledge
is for one year, expiring on August 28, 2013. At any time from the date of
guarantees, should Shenzhen Dasen fail to make its due debt payments, Shenzhen
Donxon will be obligated to perform under the guarantees by primarily making the
required payments, including late fees and penalties.
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