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YOSEN GROUP, INC. - 10-K - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS(Edgar Glimpses Via Acquire Media NewsEdge) The following discussion should be read in conjunction with the Consolidated Financial Statements and Notes thereto appearing elsewhere in this Form 10-K. The following discussion contains forward-looking statements. Our actual results may differ significantly from those projected in the forward-looking statements. Factors that may cause future results to differ materially from those projected in the forward-looking statements include, but are not limited to, those discussed in "Risk Factors" and elsewhere in this Form 10-K. Overview (All dollar amounts in thousands) Yosen Group owns 100% of Capital and Capital owns 100% of Joy & Harmony and Sanhe. Until August 14, 2007, when it made the change to its ownership structure described in the next paragraph to comply with certain requirements of the PRC law, Capital owned 100% of the capital stock of Zhejiang. Zhejiang owns 90% and Yiwu owns 10% of Wang Da. Zhejiang owns 90% and Wang Da owns 10% of Yiwu. On March 10, 2009 Zhejiang set up a new operating entity, Hangzhou Letong Digital Technology Co., Ltd. ("Letong") to establish an electronic retail franchise operation for Yosen Group. On July 6, 2009, Zhejiang and Yiwu completed the acquisition of Jinhua Baofa Logistic Ltd ("Jinhua"). Jinhua was incorporated under the laws of PRC on December 27, 2001. On December 21, 2005, Capital became a wholly owned subsidiary of Yosen through a merger with a wholly owned subsidiary of the Company (the "Merger Transaction"). Yosen acquired all of the issued and outstanding capital stock of Capital pursuant to a the Merger Agreement dated at December 21, 2005 by and among Yosen, XY Acquisition Corporation, Capital and the shareholders of Capital (the "Merger Agreement"). Pursuant to the Merger Agreement, Capital became a wholly owned subsidiary of Yosen and, for the Capital shares, Yosen issued 7,000,000 shares of its common stock to the shareholders of Capital, representing 93% of the issued and outstanding capital stock of Yosen at that time and cash of $500. On August 15, 2007, we executed a series of contractual agreements between Capital and Zhejiang. The contractual agreements gave Capital and its equity owners an obligation, and having ability to absorb, any losses, and rights to receive returns; however, these contractual agreements did not change the equity ownership of Zhejiang. We did not dispose Capital's equity ownership of Zhejiang when we executed the contractual agreements. Capital entered into share-holding entrustment agreements with five individuals: Zhenggang Wang, Yimin Zhang, Huiyi Lv, Xiaochun Wang and Zhongsheng Bao to hold 35%, 20%, 20%, 15% and 10%, respectively, of the equity interest of Zhejiang on behalf of Capital on November 21, 2005. The entrustment agreements confirm that Capital is the actual owner of Zhejiang. Capital enjoys the actual shareholder rights and has the right to obtain any benefits received by the nominal holders. Zhenggang Wang is the CEO and shareholder of Yosen Group. Yimin Zhang, Huiyi Lv, Xiaochun Wang and Zhongsheng Bao have no other relationship with Yosen Group. No consideration was given to these individuals who held the equity of Zhejiang on behalf of Capital. 18 As a result of the Merger Agreement, the reorganization was treated as an acquisition by the accounting acquiree, accounted for as a recapitalization and reverse merger by the legal acquirer for accounting purposes. Pursuant to the recapitalization, all capital stock shares and amounts and per share data were retroactively restated. Accordingly, the financial statements include the following: (1) The balance sheet consists of the net assets of the accounting acquirer at historical cost and the net assets of the legal acquirer at historical cost. (2) The statements of operations include the operations of the accounting acquirer for the period presented and the operations of the legal acquirer from the date of the merger. Pursuant to a share exchange agreement, dated August 3, 2006, we issued 183,150 shares of restricted common stock to the former shareholders of Sanhe, valued at $3,750, which was the fair value ("FV") of the shares at the date of the share exchange agreement. This amount is included in the cost of net assets and goodwill purchased. Pursuant to a share exchange agreement, dated November 28, 2006, we issued 544,622 newly issued shares of common stock to the former shareholders of Joy & Harmony, valued at $11,000, which was the FV of the shares at the date of exchange agreement. This amount is included in the cost of net assets and goodwill purchased. On July 6, 2009, Yosen's subsidiaries, Zhejiang and Yiwu completed acquisition of Jinhua, a company organized under the laws of the PRC. Zhejiang acquired 90% and Yiwu acquired 10% of the equity interests in Jinhua from the shareholders of Jinhua for RMB 120,000 ($17,500) in cash. Results of Operations Year Ended December 31, 2012 compared to Year Ended December 31, 2011 Reportable Operating Segments In 2011, Sanhe closed all its 210 stores in stores, Joy & Harmony closed all its 196 stores in stores, and Letong closed its direct retail and franchise operation. In 2012, Yiwu closed all its 178 stores in stores, and Jinhua closed its logistics operations. As such, Sanhe, Joy & Harmony, Letong, Yiwu and Jinhua were reported as discontinued operations in the financial statements. The Company reports financial and operating information in continuing operations only in the mobile phones segment through Wang Da and Zhejiang: a) Wang Da b) Zhejiang a) Wang Da Wang Da focuses on distributing domestic brands mobile phones. All amounts, except percentage of revenues, in thousands of US dollars. 19 Year Ended December 31, Percentage Wang Da 2012 2011 Change Revenue $ 17,190 $ 39,009 (55.9 )% Gross Profit 762 2,376 (67.9 )% Profit Margin 4.4 % 6.1 % (1.7 )% Operating loss (6,083 ) (4,474 ) (36.0 )% For 2012, Wang Da generated revenue of $17,190, a decrease of $21,819 or 55.9% compared to $39,009 for 2011. Gross profit decreased $1,614 or 67.9% from $2,376 for 2011 to $762 for 2012. The decrease in revenue was primarily due to increased competition from government-owned large telecommunication service providers. Telecommunication service providers opened their direct operating stores to sell communication products. The decrease in revenue was also a result of splitting part of the mobile business to Zhejiang. Operating losses was $6,083 in 2012, increased $1,609 or 36.0% compared to $4,474 in 2011. Operating losses as a percentage of sales increased from 11.5% in 2011 to 35.4% in 2012, primarily as a result of paying additional compensation to terminate employment contracts with staff when Wang Da closed 154 stores in 2012. Profit margin decreased from 6.1% in 2011 to 4.4% in 2012 as a result of lower profit margin on cell phone products. b) Zhejiang Starting from the third quarter 2012, Zhejiang operated as part of the mobile phone business focusing on distribution of Samsung and Apple brand products. 2012 Revenue $ 4,307 Gross Profit 143 Profit Margin 3.3 % Operating Loss (1,133 ) Total Company Net Sales Net sales for 2012 totaled $21,497, a year-over-year decrease of $17,512 or 44.9% compared to $39,009 for 2011. The decrease was attributable to the increased competition in the cell phone products market in China. Percentage of sales In 2012, the Company earned 92.9% of its sales from its retail and 7.1% from its wholesale operations compared to 68.1% from retail and 31.9% from wholesalein 2011. Percentage of sales from retail and wholesale operations for each segment is as follows in 2012: Wang Da Zhejiang Total Retail 87.9 % 98.0 % 92.9 % Wholesale 12.1 % 2.0 % 7.1 % Percentage of sales from retail and wholesale operations for each segment is as follows in 2011: Wang Da Zhejiang Total Retail 68.1 % - % 68.1 % Wholesale 31.9 % - % 31.9 % 20 Cost of Sales Cost of sales ("COS") for 2012 totaled $20,592, or 95.8% of sales compared to $36,632, or 93.9% of for 2011. The decrease in the COS was a result of the decrease in sales. The COS as a percentage increased during 2012 primarily due to increased costs of electronics products. The increase in purchase rebates paid to suppliers, accounted for as an addition to COS, also contributed tothe increase in COS. Top Ten Suppliers of Each of Our Subsidiaries in 2012 Wang Da Zhejiang 1 Shenzhen Tianyin Telecommunication Hangzhou Dingfeng Digital Company Limited Telecommunication CompanyLimited 2 Zhejiang Zhaotian Digital Company ESC Technology (Shanghai ) Ltd Limited 3 Hangzhou Tianchen Digital Taizhou Yuanben ElectronicsCompany Telecommunication Company Limited Limited 4 Hangzhou Qianwang Telecommunication Zhejiang Wangyuda Trade Company Equipment Company Limited Limited 5 ESC Technology (Shanghai ) Ltd Zhejiang Zhongye Digital Telecommunication Company Limited 6 Hangzhou Weihua Telecommunication Sichuang ChanghongIT products Company Limited Company Limited 7 Shanghai Post&Telecom Appliances Xinchang Xuntong Communication Company (Hangzhou) Appliances Company Ltd8 Hangzhou Huajie Computer Technology Tianyin Telecommunication Company Company Limited Limited (Zhejiang) 9 Shenzhen Liansheng Technology Company Zhejiang Oupo Digital Company Limited Limited 10 Hisense Electric Company Limited Telecom Huasheng Communication (Hangzhou) Company Limited Profit Margin Profit margin in 2012 decreased to 4.2% compared to 6.1% in 2011. The profit margin decrease was mainly attributed to the decreased unit price of cell phone products while the cost did not decrease correspondingly. Because the Company does not include the costs for its distribution network in COS, its gross profit and profit margin as a percentage of net sales ("profit margin") may not be comparable to those of other retailers that may include distribution costs in cost of sales and in gross profit and profit margin.Selling, General and Administrative Expenses Selling, general and administrative expenses for 2012 totaled $10,159, or 47.3% of net sales, compared to $7,915, or 20.3% for 2011. General and administrative expense increased as a percentage of sales, primarily due to additional compensation paid to terminate employment contracts with staff at the timeWang Da closed its stores. Operating loss from Continuing Operations Operating loss for 2012 was $9,254 or (43.0)% of net sales compared to $5,538 or (14.2)% for 2011. Lower sales and profit margin and increased general and administrative expenses led to the increase in loss from operations. 21 Provision for Income Taxes Provision for income taxes for 2012 and 2011 were $0 due to losses incurred by both Wang Da and Zhejiang. Net Loss from Continuing Operations Net loss from continuing operations for 2012 was $9,214 or (42.9)% of net sales compared to $5,556 or (14.2)% for 2011. Declined sales and profit margin and increased general and administrative expenses led to the increase in loss from operations. Net Loss from Discontinued Operations Net loss from discontinued operations for 2012 was $6,653 compared to $47,288 for 2011, a decrease of $40,635. The decrease in net loss from discontinued operations was due to Sanhe and Joy & Harmony having had net losses in the past years, not operating in 2012, as well as Yiwu closing its stores in stores and Jinhua ceasing operations to avoid further operating losses. Net Loss Net loss for 2012 was $15,867 compared to $52,844 for 2011, a decrease of $36,977. The decrease in net loss was due to closing Sanhe, Joy & Harmony, Yiwu and Jinhua to avoid additional operating losses. Foreign Currency Translation Adjustments The impact of foreign translation from our accounts in RMB to US dollar on Yosen's operating results was not material. During the translation process, the assets and liabilities of all PRC subsidiaries are translated into US dollars at period-end exchange rates. The revenues and expenses are translated into US dollars at average exchange rates of the periods. Resulting translation adjustments are recorded as a component of accumulated other comprehensive income within stockholders' equity. 2012 2011 RMB/$ exchange rate at year end 0.1591 0.1574 Average RMB/$ exchange rate for the years 0.1589 0.1549 Transaction gains or losses arising from exchange rate fluctuation on transactions denominated in a currency other than the functional currency were included in the consolidated results of operations. As a result of the translation, Yosen recorded a foreign currency gain of $132 in 2012 and $1,057 in 2011, which is a separate line item on the Statements of Operations andComprehensive Loss. Retail locations The following table reflects a roll forward during 2011 and 2012 of our retail locations (i.e. number of stores opened, number of stores closed and number of stores open at year-end). "Store in store" refers to the sales counters where the Company's products are displayed for sale within large-scale supermarkets, department stores and other sites. At present, all of our "stores in stores" are in Zhejiang province. Joy & Wang Da Yiwu Sanhe Harmony Zhejiang Total Locations at January 1, 2011 215 211 199 196 - 821 Opened during 2011 3 - - - - 3 Closed during 2011 (65 ) (33 ) (199 ) (196 ) - (493 ) Locations at December 31, 2011 153 178 - - - 331 Opened during 2012 8 - - - 37 45 Closed during 2012 (154 ) (178 ) - - (3 ) (335 ) Locations at December 31, 2012 7 - - - 34 41 22 The following table reflects the square footage of each store space during 2011 and 2012. Joy & (In square feet) Wang Da Yiwu Sanhe Harmony Zhejiang Total Area at January 1, 2011 28,398 32,463 29,108 23,523 - 113,492 Opened during 2011 1,050 - - - - 1,050 Closed during 2011 (8,065 ) (5,021 ) (29,108 ) (23,523 ) - (65,717 ) Area at December 31, 2011 21,383 27,442 - - - 48,825 Opened during 2012 5,160 - - - 19,410 24,570 Closed during 2012 (23,603 ) (27,442 ) - - (1,350 ) (52,395 ) Area at December 31, 2012 2,940 - - - 18,060 21,000 The following table reflects net sales per square foot for 2011 and 2012: (In US dollars) Wang Da Zhejiang Average 2011 $ 1,824 $ - $ 1,824 2012 5,847 248 3,048 The following table reflects the amount of comparable or same store sales for each period (i.e. the change in sales from stores that were open for each year presented). A "comparable store" is defined as the same "store in store," for which sales of that "store in store" is compared in the same month or same quarter of different years, such as the comparison of the sales occurring during March 2010 and March 2011 in the same "store in store." (In US dollars) Wang Da Zhejiang Average 2011 $ 7,233 $ - $ 7,223 2012 5,219 6,251 5,735 Assessment of whether the stores are "comparable" is based on: (1) stores are in the same address; (2) relatively same business area (e.g. if the business area of a store has changed no more than 30%, it is regarded as having same business area; if the change in business area is more than 30%, the change in business area will be regarded as too significant as to be comparable; (3) relatively same business layout (e.g. if the layout of sales counter in a store remains unchanged over time, then that store would be regarded as a comparable store; if there is significant change in layout of a sales counter in a store, that store will not be regarded as a comparable store); (4) stores with same product mix would be regarded as comparable; if there is significant change in product mix in a store, that store will not be regarded as a comparable store; (5) with respect to net sales per square foot each year and how we treat changes in square footage, this depends on the materiality of the impact on sales per square foot as a result of an increase or decrease in square footage. By way of example, a store with an area of 130 square feet had sales of $14,000 per month in 2006, which results in approximately $108 in sales per square foot. In 2007, if the same store increased the area of operation to 140 square feet and had sales of $16,000 per month that would result in approximately $114 in sales per square foot. We would deem the $6 increase in sales per square foot to be immaterial. Accordingly, in this case, we will use the area of 130 square feet to compare same store sales, and the additional 10 square feet will be ignored in the calculation of same store sales. 23 We consider changes in store square footage of more than 30% to be material. Stores that undergo such changes will not be accounted for as "comparable stores" because the change is too significant. (6) with respect to net sales per square foot each year and how we treat relocated stores, if a "store in store" is relocated to a different retail location, which we would refer to as a different operating environment, during the period, then that "store in store" will not be used in the same store comparison. However, if the "store in store" is relocated to another location within the same retail location (or same operating environment) then the "store in store" sales will be used in the calculation of the same store comparison; and (7) with respect to net sales per square foot each year and how we treat closed stores, we treat a closed "store in store" the same way we treat a "store in store" relocated to different retail location. A closed "store in store" is not used in the same store comparison. Opened and closed "stores in stores" are primarily recognized based on the duration of the agreements with the shopping centers, as well as the sale and profits of a "store in store." Prior to opening a new "store in store" we are usually approached by a large-scale department store or supermarket that offers us the opportunity to open a "store in store." Our decision is based on our study of the population traffic flow, the department store and supermarkets themselves, and the level of expected profitability of a potential "store in store." Following our inspection, we sign contracts with the department store and supermarkets, which specifically address the terms and conditions of opening, closing and relocating the "stores in stores." Liquidity and Capital Resources (amounts in thousands of US dollars) Cash has historically been generated from operations. Operations and liquidity needs are funded primarily through cash flows from operations and short-term borrowings. Cash and equivalents were $456 at December 31, 2012 and current assets totaled $4,738. The Company's current liabilities were $4,820 at December 31, 2012. Working capital deficit at December 31, 2012 was $(82). During 2012, net cash used in operating activities was $7,961. Cash and equivalents were $5,778 at December 31, 2011 and current assets totaled $20,914. The Company's current liabilities were $7,648 at December 31, 2011. Working capital at December 31, 2011 was $13,266. During 2011, net cash used in operating activities was $21,752. The Company has short-term loans of $2,546 as of December 31, 2012. The WFOE Law (1986), as amended and The WFOE Law Implementing Rules (1990), as amended, contain the principal regulations governing dividend distributions by WFOEs. Under these regulations, WFOEs, such as Wang Da and Zhejiang may pay dividends only out of their accumulated profits, if any, determined in accordance with PRC accounting standards and regulations. Additionally, Wang Da and Zhejiang are required to set aside a certain amount of any accumulated profits each year (a minimum of 10%, and up to an aggregate amount equal to half of its registered capital), to fund certain reserve funds. These reserves are not distributable as cash dividends except in the event of liquidation and cannot be used for working capital purposes. The PRC government also imposes controls on the conversion of RMB into foreign currencies and the remittance of currencies out of the PRC. The Company's two operating subsidiaries in China paid $525 in dividends during 2005, however, we do not intend to pay dividends on our common stock in the foreseeable future. If we ever determine to pay a dividend, we may experience difficulties in completing the administrative procedures necessary to obtain and remit foreign currency for the payment of such dividends from the profits of Wang Da and Zhejiang. 24 In summary, our cash flows were: Year Ended December 31, 2012 2011Net cash used in operating activities $ (7,961 ) $ (21,752 ) Net cash provided by (used in) investing activities 143 (11 ) Net cash provided by financing activities 2,546 - Effect of exchange rate change on cash and equivalents (50 ) 1,292 Net decrease in cash and equivalents (5,322 ) (20,471 ) Cash and equivalents at beginning of year 5,778 26,249 Cash and equivalents at end of year $ 456 $ 5,778 Operating Activities Net cash used in operating activities was $7,961 in 2012 compared to $21,752 in 2011. This decrease was mainly attributable to (i) a decrease in net losses of $36,977 from $(52,844) in 2011 to $(15,867) in 2012, (ii) decrease in accounts payable and accrued expenses of $5,770, offset by the decrease in accounts receivable of $9,198, decrease in inventory of $1,421 in 2012, adding back the non-cash item, stock compensation expense of $2,327. Investing activities 2012 2011Net cash used in investing activities $ 143 $ (11 ) Net cash used in investing activities in 2011 was nominal. Net cash used in investing activities in 2012 was $143, which included proceeds from disposal of property and equipment of $147 and purchase of equipment of $4. Financing Activities There was no cash used in financing activities in 2011. In 2012, the Company received $2,546 in short-term bank loans. 2012 2011 Net cash used in financing activities $ 2,546 $ - Net decrease in cash and equivalents 2012 2011 Net decrease in cash and equivalents $ (5,322 ) $ (20,471 ) Cash and equivalents 2012 2011 Cash and equivalents $ 456 $ 5,778 25 Cash and equivalents as of December 31, 2012 and 2011 were solely bank accounts in US and China. Specifically, cash and equivalents for each subsidiary as of December 31, 2012 and 2011 included: (all amounts are denominated at thousands) Name of Entity Region Currency 2012 2011 Yosen Group US entity USD 384 26 Capital BVI entity USD - - Zhejiang Chinese entity RMB 360 4,847 Yiwu Chinese entity RMB 53 4,611 Sanhe Chinese entity RMB 8 1,442 Wang Da Chinese entity RMB 32 20,182 Joy & Harmony Chinese entity RMB 2 2,607 Jinhua Chinese entity RMB 2 2,852 Cash equivalents held in the PRC subsidiaries are not freely transferrable outside the country. The amounts not freely transferable as of December 31, 2012 and 2011 were RMB457 ($70) and RMB36,541 ($5,752). Capital Expenditures Capital expenditures for purchase of fixed assets during 2012 and 2011 were $4 and $11, respectively. Working Capital Requirements Historically operations and short term financing have been sufficient to meet our cash needs. We believe we will be able to generate revenues from sales and raise capital through private placement offerings of our equity securities or from short-term borrowings to provide the necessary cash flow to meet anticipated working capital requirements. However, our actual working capital needs for the long and short term will depend upon numerous factors, including operating results, competition, and the availability of credit facilities, none of which can be predicted with certainty. Future expansion will be limited by the availability of financing products and raising capital. Off-Balance Sheet Arrangements We have never entered into any off-balance sheet financing arrangements and have never established any special purpose entities. We have not guaranteed any debt or commitments of other entities or entered into any options on non-financial assets. Critical Accounting Policies Our discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these consolidated financial statements requires us to make estimates, judgments and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and the related disclosure of contingent assets and liabilities. We base our estimates on historical experience and on various other assumptions that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates. An accounting policy is considered to be critical if it requires an accounting estimate to be made based on assumptions about matters that are highly uncertain at the time the estimates are made, and if different estimates that reasonably could have been used, or changes in the accounting estimates that are reasonably likely to occur, could materially impact the consolidated financial statements. We believe the following critical accounting policies reflect the more significant estimates and assumptions used in the preparation of the consolidated financial statements. Revenue Recognition Our revenues are generated from sales of electronics products. All of our revenue transactions contain standard business terms and conditions. We determine the appropriate accounting for these transactions after considering (1) whether a contract exists; (2) when to recognize revenue on the deliverables; (3) whether all elements of the contract have been fulfilled and delivered; and (4) whether collection is reasonably assured, which inherently requires us to evaluate the creditworthiness of our customers. Changes in judgments on these assumptions and estimates could materially impact the timing or amount of revenue recognition. 26 Please refer to Note 2 in the footnotes to the financial statements for detailed description of our revenue recognition policy. After Sales Service The after-sales services that we provide to our customers are primarily repair and maintenance. If a customer buys a product from us and needs repairs, we can usually arrange to have the manufacturer repair the product. In certain cases, clerks in our stores are able to make the repairs directly. Tabular Disclosure of Contractual Obligations Not applicable. |