UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
For the quarterly period ended September 30, 2012
For the transition period from to
Commission File No. 333-108715
Joway Health Industries Group Inc.
(Exact Name of Registrant as Specified in Its Charter)
(State or Other Jurisdiction of
Incorporation or Organization)
(I.R.S. Employer
Identification No.)
No. 2, Baowang Road, Baodi Economic Development
Zone, Tianjin, PRC 301800
(Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report)
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
The number of shares outstanding of the Issuer’s Common Stock as of November 14, 2012 was 20,036,000 shares.
TABLE OF CONTENTS
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Item 4. Controls and Procedures
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
Item 1A. Risk Factors
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Item 3. Defaults Upon Senior Securities
Item 4. Mine Safety Disclosures
Item 5. Other Information
Item 6. Exhibits
SIGNATURES
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Item 1. Financial Statements.
In the opinion of management, the accompanying unaudited financial statements included in this Form 10-Q reflect all adjustments (consisting only of normal recurring accruals) necessary for a fair presentation of the results of operations for the periods presented. The results of operations for the periods presented are not necessarily indicative of the results to be expected for the full year.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Consolidated Balance Sheets as of September 30, 2012 (Unaudited) and December 31, 2011 (Audited)
Consolidated Statements of Operations and Comprehensive Income (Loss) for the Three and the Nine months Ended September 30, 2012 and 2011 (Unaudited)
Consolidated Statements of Cash Flows for the Nine months Ended September 30, 2012 and 2011 (Unaudited)
Notes to Consolidated Financial Statements
3
JOWAY HEALTH INDUSTRIES GROUP INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
CURRENT ASSETS:
Cash
Accounts receivable
Other receivables
Inventories
Advances to suppliers
Prepaid taxes
Prepaid expense
Total current assets
PROPERTY, PLANT AND EQUIPMENT, net
OTHER ASSETS:
Long-term investment
Intangible assets, net
Long-term prepaid expenses
Total other assets
Total assets
CURRENT LIABILITIES:
Accounts payable
Advances from customers
Other payables
Due to related parties
Total current liabilities
COMMITMENTS
STOCKHOLDERS’ EQUITY:
Preferred stock - par value $0.001; 1,000,000 shares authorized; no shares issued and outstanding
Common stock - par value $0.001; 200,000,000 shares authorized; 20,036,000 and 20,018,000 shares issued and outstanding at September 30, 2012 and December 31, 2011, respectively
Additional paid-in-capital
Statutory reserves
Retained earnings
Accumulated other comprehensive income
Total stockholders’ equity
Total liabilities and stockholders’ equity
The accompanying notes are an integral part of these financial statements
4
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)
REVENUES
COST OF REVENUES
GROSS PROFIT
Selling expenses
General and administrative expenses
OPERATING EXPENSES
INCOME (LOSS) FROM OPERATIONS
Interest income
Other income
Other expenses
OTHER INCOME, NET
INCOME (LOSS) BEFORE INCOME TAXES
INCOME TAXES
NET INCOME (LOSS)
OTHER COMPREHENSIVE INCOME:
Foreign currency translation adjustment
COMPREHENSIVE INCOME (LOSS)
NET INCOME (LOSS) PER COMMON SHARE, BASIC AND DILUTED
SHARES OUTSTANDING, BASIC AND DILUTED
5
CONSOLIDATED STATEMENTS OF CASH FLOWS
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)
Adjustments to reconcile net income to net cash provided by operating activities
Depreciation
Amortization
Stock-based compensation
Changes in operating assets and liabilities:
Accounts receivable, trade
Other payable
Salary and welfare payable
Taxes payable
Net cash used in operating activities
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property plant and equipment
Net cash used in investing activities
CASH FLOWS FROM FINANCING ACTIVITIES:
Net cash used in financing activities
EFFECT OF EXCHANGE RATE CHANGES ON CASH
NET DECREASE IN CASH
CASH, beginning of period
CASH, end of period
SUPPLEMENTAL DISCLOSURES:
Income taxes paid
Interest paid
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JOWAY HEALTH INDUSTRIES GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 – ORGANIZATION
The consolidated financial statements include the financial statements of Joway Health Industries Group Inc. (referred to herein as “Joway Health”), its subsidiaries, and variable interest entities (“VIEs”) where Joway Health is deemed the primary beneficiary. Joway Health, its subsidiaries and VIEs are collectively referred to herein as the “Company”, “we” and “us”.
Joway Health (formerly G2 Ventures, Inc.) was originally incorporated under the laws of the State of Texas on March 21, 2003. On September 21, 2010, Joway Health entered into a Share Exchange Agreement (the “Share Exchange”) with the sole stockholder of Dynamic Elite International Limited. As a result of the Share Exchange, Dynamic Elite became a wholly-owned subsidiary of Joway Health and the stockholders of Dynamic Elite acquired approximately 76.08% of the issued and outstanding stock of Joway Health. The share exchange transaction resulted in the shareholders of Dynamic Elite acquiring a majority voting interest in Joway Health. Generally accepted accounting principles in the United States of America require that the company whose shareholders retain the majority interest in the combined business be treated as the acquirer for accounting purposes. The reverse acquisition process utilizes the capital structure of Joway Health and the assets and liabilities of Dynamic Elite recorded at historical cost. On December 22, 2010, Joway Health changed its jurisdiction of incorporation from the State of Texas to the State of Nevada.
Dynamic Elite International Limited (referred to herein as “Dynamic Elite”) was incorporated under the laws of the British Virgin Islands on June 2, 2010 as a limited liability company (a BVI company). Dynamic Elite engages in manufacturing and distributing tourmaline products in China. Its wholly owned subsidiary, Tianjin Junhe Management Consulting Co., Ltd. was incorporated on September 15, 2010 in Tianjin, People’s Republic of China (“PRC”). Other than the equity interest in Junhe Consulting, Dynamic Elite does not own any assets or conduct any operations.
Tianjin Junhe Management Consulting Co., Ltd. (referred to herein as “Junhe Consulting”) conducts its business through Tianjin Joway Shengshi Group Co., Ltd. that is consolidated as a variable interest entity.
Tianjin Joway Shengshi Group Co., Ltd. (referred to herein as “Joway Shengshi”) was incorporated in PRC on May 17, 2007. Joway Shengshi is currently owned 99% by Jinghe Zhang, the Company’s current CEO and President and 1% by Song Baogang. Joway Shengshi engages in manufacturing and distributing tourmaline products in China. Shenyang Joway Electronic Technology Co., Ltd., Tianjin Joway Decoration Engineering Co., Ltd. and Tianjin Oriental Shengtang Trading Import & Export Trading Co., Ltd are subsidiaries of Joway Shengshi.
Shenyang Joway Electronic Technology Co., Ltd. (referred to herein as “Joway Technology”) was originally named Liaoning Joway Technology Engineering Co., Ltd. which was incorporated on March 28, 2007 in PRC. The name was changed on June 22, 2011. It engages in the distribution of Tourmaline Activated Water Machines and Tourmaline Wellness Houses. Prior to July 25, 2010, Joway Shengshi owned 90.91% of Joway Technology. Joway Shengshi entered into a share acquisition agreement with Jingyun Chen, another stockholder of Joway Technology on July 25, 2010 to acquire the remaining 9.09% of the share of Joway Technology. As a result of the share acquisition, Joway Technology became a wholly-owned subsidiary of Joway Shengshi.
Tianjin Joway Decoration Engineering Co., Ltd. (referred to herein as “Joway Decoration”) was incorporated on April 22, 2009 in PRC. It engages in the distribution of Tourmaline Activated Water Machines, Tourmaline Wellness House for family use and Tourmaline Wellness House materials. Prior to July 9, 2010, Joway Shengshi owned 90% of Joway Decoration. Joway Shengshi entered into a share acquisition agreement with Jingyun Chen, another stockholder of Joway Decoration on July 9, 2010 to acquire the remaining 10% of the shares of Joway Decoration. As a result of the share acquisition, Joway Decoration became a wholly-owned subsidiary of Joway Shengshi. Jingyun Chen is currently the General Manager of Joway Decoration.
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Tianjin Oriental Shengtang Import & Export Trading Co., Ltd (referred to herein as “Shengtang Trading”) was incorporated on September 18, 2009 in the PRC. It engages in purchasing raw materials which it sells to other companies of the group. Prior to July 28, 2010, Joway Shengshi owned 95% of Shengtang Trading. Joway Shengshi entered into a share acquisition agreement with Wang Aiying, another stockholder of Shengtang Trading on July 28, 2010 to acquire the remaining 5% of the shares of Shengtang Trading. As a result of the share acquisition, Shengtang Trading became a wholly-owned subsidiary of Joway Shengshi.
The following table lists the Company and its subsidiaries:
Name
Domicile and
Date of
Incorporation
Paid in
Capital
Percentage of
Effective
Ownership
Principal Activities
March 21, 2003,
Nevada
86.88% owned by Crystal Globe
Limited
13.12%owned by other institutional and individual investors
Investment
Holding
Dynamic Elite International Limited
June 2, 2010,
British Virgin Islands
Tianjin Junhe Management Consulting Co., Ltd.
September 15,
2010, PRC
Tianjin Joway Shengshi Group Co., Ltd.
May 17, 2007,
PRC
Production and
distribution of tourmaline products
Shenyang Joway Electronic Technology Co., Ltd.
March 28, 2007,
Tianjin Joway Decoration Engineering Co., Ltd.
April 22, 2009,
Tianjin Oriental Shengtang Import & Export Trading Co., Ltd.
September 18,
2009, PRC
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On September 16, 2010, prior to the share exchange, Junhe Consulting entered into a series of contractual agreements (the “Contractual Agreements”) with Joway Shengshi and Joway Shengshi’s owners. The following is a brief description of the Contractual Agreements entered into between Junhe Consulting and Joway Shengshi or Joway Shengshi’s owners:
1. Consulting Services Agreement. Pursuant to the consulting services agreement between Junhe Consulting and Joway Shengshi, Junhe Consulting has the right to advise, consult, manage and operate Joway Shengshi, and collect and own all of the net profits of the Operating Entities.
2. Operating Agreement. Under the operating agreement between Junhe Consulting and Joway Shengshi, Junhe Consulting has the right to recommend director candidates and appoint the senior executives of Joway Shengshi, approve any transactions that may materially affect the assets, liabilities, rights or operations of Joway Shengshi, and guarantee the contractual performance by Joway Shengshi of any agreements with third parties, in exchange for a pledge by Joway Shengshi of its accounts receivable and assets.
3. Voting Rights Proxy Agreement. Under the voting rights proxy agreement between Joway Shengshi’s owners and Junhe Consulting, the owners of Joway Shengshi have vested their collective voting control over Joway Shengshi to Junhe Consulting and will only transfer their respective equity interests in Joway Shengshi to Junhe Consulting or its designee.
4. Option Agreement. Under the option agreement between Joway Shengshi’s owners and Junhe Consulting, the owners of Joway Shengshi have granted Junhe Consulting the irrevocable right and option to acquire all of their equity interests in Joway Shengshi.
5. Equity Pledge Agreement. Under the equity pledge agreement between Joway Shengshi’s owners and Junhe Consulting, the owners of Joway Shengshi have pledged all of their rights, titles and interests in Joway Shengshi to Junhe Consulting to guarantee Joway Shengshi’s performance of its obligations under the Consulting Services Agreement.
As a result of the Contractual Agreements, Joway Shengshi is effectively a variable interest entity of Junhe Consulting. Accordingly, the Company through its wholly-owned subsidiary Junhe Consulting, consolidates Joway Shengshi’s results of operation, assets and liabilities in its financial statements.
In connection with the Share Exchange and as consideration for entering into the VIE Agreements the shareholders of Joway Shengshi, entered into a Call Option Agreement with the sole shareholder of Crystal Globe (the controlling shareholder of Dynamic Elite), pursuant to which the shareholders of Joway Shengshi have the right to purchase up to 100% of the shares of Crystal Globe at an aggregate price equal to $20,000 over the next three years. The Call Option vests as to 34% of the shares of Crystal Globe on April 2, 2011 and as to 33% on April 2 of 2012 and 2013. As a result, the shareholders of Joway Shengshi will become the indirect beneficial owners of the shares of the Company held by Crystal Globe.
NOTE 2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The accompanying consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (“US GAAP”). The Company’s functional currency is the Chinese Renminbi (“RMB”); however, the accompanying consolidated financial statements have been translated and presented in United States Dollars (“USD”). All significant inter-company transactions and balances have been eliminated. The consolidated financial statements include all adjustments that, in the opinion of management, are necessary to make the financial statements not misleading.
The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information. Accordingly, they do not include all of the information and the footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments, consisting only of normal recurring accruals, considered necessary for a fair presentation have been included. Operating results for the nine month period ended September 30, 2012 are not necessarily indicative of the results that may be expected for the fiscal year ending December 31, 2012. The accompanying consolidated financial statements should be read in conjunction with the Company’s form 10-K for the fiscal year ended December 31, 2011 which was filed on March 30, 2012.
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Use of Estimates
The preparation of the consolidated financial statements in conformity with US GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting periods. Management makes these estimates using the best information available at the time the estimates are made. Actual results could differ from those estimates.
Basis of Consolidation
The accompanying consolidated financial statements include the Company and its wholly owned subsidiaries and controlled VIEs. All significant inter-company accounts and transactions have been eliminated in the consolidation.
Pursuant to Accounting Standards Codification Topic 810, “Consolidation”, Joway Shengshi, as a VIE of Junhe Consulting, has been consolidated in the Company’s financial statements. Joway Shengshi’s sales are included in the Company’s total sales, its income from operations is consolidated with the Company’s, and the Company’s net income includes all of Joway Shengshi’s net income.
Based on the various Contractual Agreements, the Company is able to exercise control over the VIEs, and to obtain in full the economic benefits. Accordingly, the non–controlling interests have no economic interest in the VIEs.
Foreign Currency Translation
The accompanying consolidated financial statements are presented in USD. The functional currency of the Company is RMB. The consolidated financial statements are translated into United States dollars from RMB at period-end exchange rates as to assets and liabilities and average exchange rates as to revenues and expenses. Equity accounts are translated at their historical exchange rates when the equity transactions occurred. The resulting transaction adjustments are recorded as a component of stockholders’ equity. Gains and losses from foreign currency transactions are included in net income.
Period ended RMB: USD Exchange rate
Average RMB: USD Exchange rate
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.
Foreign currency translation adjustments have been reported as comprehensive income in the consolidated financial statements and totaled negative $26,269 and $113,315 for the three months ended September 30, 2012 and 2011, respectively, and $59,314 and $375,051 for the nine months ended September 30, 2012 and 2011.
Other Comprehensive Income
Other comprehensive income is defined as the change in equity during the period from transactions and other events, excluding the changes resulting from investments by owners and distributions to owners, and is not included in the computation of income tax expense or benefit. Accumulated other comprehensive income represents the accumulated balance of foreign currency translation adjustments.
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Concentrations of Credit Risk
The Company’s operations are carried out in the PRC. Accordingly, the Company’s 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’s economy. The Company’s operations in the PRC are subject to specific considerations and significant risks not typically associated with companies in North America. The Company’s results may be adversely affected by changes in governmental policies with respect to laws and regulations, anti-inflationary measures, currency conversion and remittance abroad, and rates and methods of taxation, among other things. Financial instruments which potentially subject the Company to concentrations of credit risk consist principally of cash. Substantially all of the Company’s cash is maintained with state-owned banks within the PRC, and no deposits are covered by insurance. The Company has not experienced any losses in such accounts and believes it is not exposed to any risks on its cash in bank accounts.
Fair Value of Financial Instruments
Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 820 establishes a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value as follows:
Level 1—defined as observable inputs such as quoted prices in active markets for identical assets or liabilities;
Level 2—defined as inputs other than quoted prices in active markets that are either directly or indirectly observable; and
Level 3—defined as unobservable inputs in which little or no market data exists, therefore requiring an entity to develop its own assumptions.
The carrying amounts reported in the balance sheets for cash, accounts receivable, other receivable, accounts payable, other payable, and amounts due from related parties generally approximate their fair market values based on the short-term maturity of these instruments. ASC 825-10 “Financial Instruments” allows entities to voluntarily choose to measure certain financial assets and liabilities at fair value (fair value option). The fair value option may be elected on an instrument-by-instrument basis and is irrevocable, unless a new election date occurs. If the fair value option is elected for an instrument, unrealized gains and losses for that instrument should be reported in earnings at each subsequent reporting date. The Company did not elect to apply the fair value option to any outstanding instruments.
Cash and Cash Equivalents
For financial reporting purposes, the Company considers all highly liquid financial instruments with an original maturity of three months or less to be cash equivalents. The Company had no cash equivalents at any point during the period of the financial statements presented. Balances at financial institutions or state-owned banks within the PRC are not covered by insurance. The Company has not experienced any losses in such accounts and believes it is not exposed to any significant risks on its cash in bank accounts.
Accounts Receivable
Accounts receivable are carried at net realizable value. The Company maintains reserves for potential credit losses on accounts receivable. Management reviews the composition of the accounts receivable and analyzes historical bad debts, customer concentrations, customer credit worthiness, current economic trends and changes in customer payment patterns to evaluate the adequacy of these reserves. As of September 30, 2012 and December 31, 2011, respectively, the Company had no allowance for doubtful accounts.
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Inventories are stated at the lower of cost, as determined by the specific identification method on contract level (for each individual contract, inventories cost flow are determined by weighted-average method), or the net realizable value, which is determined on selling prices less any further costs expected to be incurred for completion and disposal. The Company regularly evaluates the composition of its inventories to identify slow-moving and obsolete inventories to determine whether a valuation allowance is required. As of September 30, 2012 and December 31, 2011, respectively, the Company has no reserves for inventories.
Advances to suppliers represent the cash paid in advance for inventory items or construction in progress. The advance payments are meant to ensure preferential pricing and delivery. The amounts advanced under such arrangements totaled $210,206 and $377,028 as of September 30, 2012 and December 31, 2011, respectively.
Investments
Investments in which the Company has a 20% to 50% interest are accounted for by the equity method. Under the equity method the carrying value of the investment is adjusted for the Company’s proportionate share of the investee’s income or loss.
Investments in which the Company has less than a 20% interest are accounted for by the cost method. Under the cost method, investments are carried at cost and income is recorded when dividends are received from those investments.
Property, Plant, and Equipment
Property, plant and equipment are stated at cost less accumulated depreciation, and include expenditures that substantially increase the useful lives of existing assets.
Depreciation is computed using the straight-line method over the estimated useful lives of the assets. Estimated useful lives are as follows:
Building
Operating Equipment
Office furniture and equipment
Vehicles
The cost and related accumulated depreciation of assets sold or otherwise retired are eliminated from the accounts, and any gain or loss is included in the consolidated statements of operations. Maintenance, repairs and minor renewals are charged directly to expenses as incurred. Significant renewals and betterment to buildings and equipment are capitalized. Leasehold improvements are depreciated over the lesser of the useful life or the life of the lease.
Intangible assets
Intangible assets mainly consist of land use rights. All land located in the PRC is owned by the government and cannot be sold to any individual or company. The land use rights granted to the Company are being amortized using the straight-line method over the lease term of 50 years. Other intangible assets are software programs that are amortized over their estimated useful life of 10 years.
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Impairment of Long-Lived Assets
Long-lived assets of the Company are reviewed annually as to whether their carrying value has become impaired, pursuant to the guidelines established in FASB ASC 360. The Company considers assets to be impaired if the carrying value exceeds the future projected cash flows from the related operations. The Company also re-evaluates the periods of depreciation and amortization to determine whether subsequent events and circumstances warrant revised estimates of useful lives. The Company did not record any impairment loss for the nine months ended September 30, 2012 and 2011.
Revenue Recognition
The Company recognizes revenue when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the purchase price is fixed or determinable and collectability is reasonably assured.
With respect to sales of product to both franchisee and non-franchisee customers, the Company prepares product shipments upon the receipt of a customer’s purchase order. Sales prices are based on fixed price lists that are different depending on whether the price list is for a franchisee customer or for non-franchisee customers. The Company recognizes revenue when the product is shipped. The Company does not sell product to any customers with a right of return as defined in ASC 605-15-25-4. Sales are presented net of value added tax (VAT).
For Tourmaline Wellness House sales, the Company recognizes revenue under the completed contract method. Customers contact the Company with requests to construct a Wellness House. The Company and the customer enter into a contract, at which time the customer pays a deposit of at least one-half of the sales price. A contract is considered completed when all significant costs have been incurred and the project has been accepted by the customer. The contracts have a place for the customer to sign indicating their acceptance of the completed Wellness House. At this time the customer will also pay any remaining balance on the contract. The Company recognizes the full contract revenue at this point. Contract costs consist primarily of materials and labor costs. The construction period of a Wellness House generally does not exceed five days.
Shipping costs
Shipping costs are included in selling expenses and totaled $8,148 and $8,435 for the three months ended September 30, 2012 and 2011, respectively, and $32,335 and $29,973 for the nine months ended September 30, 2012 and 2011, respectively.
Income Taxes
The Company is governed by the Income Tax Law and associated legislations of the PRC. The Company accounts for income taxes in accordance with FASB ASC 740 “Income Taxes”, which is an asset and liability approach that requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been recognized in the Company’s financial statements or tax returns. ASC 740 additionally requires the establishment of a valuation allowance to reflect the likelihood of realization of deferred tax assets. Realization of deferred tax assets is dependent upon future earnings, if any, of which the timing and amount are uncertain.
According to ASC 740, the evaluation of a tax position is a two-step process. The first step is to determine whether it is more likely than not that a tax position will be sustained upon examination, including the resolution of any related appeals or litigation based on the technical merits of that position. The second step is to measure a tax position that meets the more-likely-than-not threshold to determine the amount of benefit to be recognized in the financial statements. A tax position is measured at the largest amount of benefit that is greater than 50% likelihood of being realized upon ultimate settlement. Tax positions that previously failed to meet the more-likely-than-not recognition threshold should be recognized in the first subsequent period in which the threshold is met. Previously recognized tax positions that no longer meet the more-likely-than-not criteria should be de-recognized in the first subsequent financial reporting period in which the threshold is no longer met. ASC 740 also provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods, disclosures, and transition.
As of September 30, 2012 and 2011, the Company had no deferred tax assets or liabilities.
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Subsequent Events
The Company evaluates subsequent events for purposes of recognition or disclosure through the date that the financial statements are issued.
Recently Issued Accounting Pronouncements
In May 2011, the FASB issued ASU 2011-04, Fair Value Measurements (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRS. ASU 2011-04 changes the wording used to describe many of the requirements in U.S. GAAP for measuring fair value and for disclosing information about fair value measurements to ensure consistency between U.S. GAAP and International Financial Reporting Standards (“IFRS”). ASU 2011-04 also expands the disclosures for fair value measurements that are estimated using significant unobservable (Level 3) inputs. This new guidance is to be applied prospectively. ASU 2011-04 will be effective for interim and annual periods beginning after Dec. 15, 2011, with early adoption permitted. The adoption of this standard did not materially expand its consolidated financial statement footnote disclosures.
In June 2011, the FASB issued ASU 2011-05, Comprehensive Income (Topic 220): Presentation of Comprehensive Income, which amends the current comprehensive income guidance. This ASU eliminates the option to present the components of other comprehensive income as part of the statement of shareholders’ equity. Instead, we must report comprehensive income in either a single continuous statement of comprehensive income which contains two sections, net income and other comprehensive income, or in two separate but consecutive statements. ASU 2011-05 will be effective for interim and annual periods beginning after Dec. 15, 2011, with early adoption permitted. The adoption of ASU 2011-05 did not have a material impact on the Company’s consolidated financial statements.
In September 2011, the FASB issued ASU 2011-08, Testing Goodwill for Impairment, which amends the guidance in ASC 350-20, “Intangibles — Goodwill and Other – Goodwill”. Under ASU 2011-08, entities have the option of performing a qualitative assessment before calculating the fair value of the reporting unit when testing goodwill for impairment. If the fair value of the reporting unit is determined, based on qualitative factors, to be more likely than not less than the carrying amount of the reporting unit, then entities are required to perform the two-step goodwill impairment test. ASU 2011-08 is effective for fiscal years beginning after December 15, 2011, with early adoption permitted. The Company does not anticipate that the adoption of this standard will have a material effect on the Company’s consolidated financial statements.
In December 2011, the FASB issued ASU 2011-11, Disclosures about Offsetting Assets and Liabilities, which is codified in ASC Topic 210, Balance Sheet. This pronouncement contains new disclosure requirements about a company’s right of setoff and related arrangements associated with its financial and derivative instruments. ASU 2011-11 will be effective retrospectively for annual and interim periods beginning on or after January 1, 2013. The Company does not anticipate that the adoption of this standard will have a material effect on the Company’s consolidated financial statements.
NOTE 3 – ACCOUNTS RECEIVABLE
Accounts receivable consisted of the following:
Less: Allowance for bad debt
As of the periods presented, the Company has no allowance for bad debts, because the Management, based on their analysis, considers all the accounts receivable to be collectible.
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NOTE 4 – INVENTORIES
Inventories consisted of the following:
Raw materials
Packages
Finished goods
Low value consumables
Total
Low value consumables represent low priced and easily worn articles and are amortized on equal-split amortization method. Pursuant to this method, half value of the low value consumable should be amortized once used and the remaining half value should be amortized when disposed.
NOTE 5 – PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment consisted of the following:
Less: accumulated depreciation
Property, plant and equipment, net
Depreciation expense for the three months ended September 30, 2012 and 2011 amounted to $118,176 and $116,110, respectively, and for the nine months ended September 30, 2012 and 2011 amounted to $372,027 and $333,375, respectively.
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NOTE 6 – INTANGIBLE ASSETS
Intangible assets consisted of the following:
Land use rights
Other intangible assets
Less: accumulated amortization
Amortization expense of intangible assets for the three months ended September 30, 2012 and 2011 was $4,156 and $4,783, respectively, and for the nine months ended September 30, 2012 and 2011 was $13,252 and $14,233, respectively.
The estimated amortization expense for the next five years is as follows:
Estimated amortization expense for the year ending December 31,
2012
2013
2014
2015
2016
Thereafter
NOTE 7 – RELATED PARTY TRANSACTIONS
Payables due to related parties consist of the following:
Shenyang Joway Industrial Development Co., Ltd.
Jinghe Zhang
Transactions with Shenyang Joway
Shenyang Joway Industrial Development Co., Ltd. (“Shenyang Joway”) was formed in 2005 in Shenyang, China by Mr. Jinghe Zhang and three other individuals. Mr. Zhang holds more than 50% of the equity in Shenyang Joway. Shenyang Joway was in the business of marketing and distributing clothing and related products to other companies. In 2009 Mr. Zhang decided to shut down the operations of Shenyang Joway in order to focus his attention on Joway Shengshi’s business. Shenyang Joway has ceased operations, although it still exists as a legal entity, and Joway Shengshi was able to find new suppliers with no material adverse impact to the Company.
On January 15, 2009, Joway Shengshi entered into a sales contract with Shenyang Joway, pursuant to which Joway Shengshi agreed to purchase inventory of $27,560 from Shenyang Joway.
On February 15, 2009, Joway Shengshi entered into an Equipment Sales Contract with Shenyang Joway. Pursuant to the agreement, Joway Shengshi agreed to purchase certain operating and office equipment in the amount of $158,832 from Shenyang Joway.
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On December 1, 2009, we, through our subsidiary Joway Shengshi, entered into a royalty-free license agreement with Shenyang Joway. Pursuant to the license agreement, we are authorized to use the trademark “Xi” for a term of nine years.
On December 20, 2009, Joway Shengshi entered into a sales contract with Shenyang Joway. Pursuant to the sales contract, Joway Shengshi agreed to purchase inventory of $137,395 from Shenyang Joway.
On May 7, 2007, the Company’s subsidiary Joway Shengshi entered into an agreement with Shenyang Joway pursuant to which Joway Shengshi and Shenyang Joway agreed to provide each other with interest-free, unsecured advances for working capital. On May 10, 2007, the Company’s subsidiary Joway Technology and Shenyang Joway entered into an agreement pursuant to which Joway Technology and Shenyang Joway agreed to provide each other with interest-free, unsecured advances for working capital. Through December 31, 2008, Joway Technology advanced $58,568 to Shenyang Joway, which was paid off by Shenyang Joway to Joway Technology in 2009. Through December 31, 2010, Shenyang Joway advanced an aggregate of $791,701 to Joway Shengshi and Joway Technology of which $720,347 has been repaid. For the nine months ended September 30, 2012, the Company repaid $216,955 of these advances. As of September 30, 2012, the total unpaid principal balance due Shenyang Joway for advances was $71,354. Shenyang Joway ceased operations at the end of 2009.
Transactions with Jinghe Zhang
On December 1, 2009, the Company, through its subsidiary Joway Shengshi, entered into a royalty-free license agreement with Jinghe Zhang, our President, Chief Executive Officer and director. Pursuant to the license agreement, we are authorized to use the trademark “Joway” for a term of nine years and five patents from December 1, 2009 till the expiration dates of the patents.
On May 10, 2007, Joway Shengshi entered into a cash advance agreement with Jinghe Zhang, our President, Chief Executive Officer and director. Pursuant to the agreement, Jinghe Zhang agreed to advance operating capital to Joway Shengshi. The advances are interest free, unsecured, and have no specified repayment terms. The agreement is valid throughout Joway Shengshi’s term of operation. During the period beginning May 17, 2007 (inception of Joway Shengshi) through December 31, 2009, Joway Shengshi received cash advances in the aggregate principal amount of $4,637,397 from Jinghe Zhang of which $4,593,133 has been repaid. In 2010, 2011 and 2012, Joway Shengshi was advanced $0 by Jinghe Zhang. As of September 30, 2012, the total unpaid principal balance due Jinghe Zhang for advances was $44,264.
On May 10, 2007, Joway Technology entered into a cash advance agreement with Jinghe Zhang, our President, Chief Executive Officer and director. Pursuant to the agreement, Jinghe Zhang agreed to advance operating capital to Joway Technology. The advances are interest free, unsecured, and have no specified repayment terms. The agreement is valid throughout Joway Technology’s term of operation. During the period beginning March 28, 2007 (inception of Joway Technology) through December 31, 2010, Joway Technology received cash advances in the aggregate principal amount of $22,031 from Jinghe Zhang all of which has been repaid. As of September 30, 2012, the total unpaid principal balance due Jinghe Zhang for advances was $0.
The amounts owed to related parties are non-interest bearing and have no specified repayment terms.
NOTE 8 – INCOME TAXES
The Company operations in the People’s Republic of China are subject to the Income Tax Law of the People’s Republic of China. Pursuant to the PRC Income Tax Laws, the Company is subject to the Enterprise Income Tax (“EIT”) which is generally a statutory rate of 25% beginning January 2008, on income as reported in its statutory financial statements after appropriate tax adjustments. The Company’s subsidiary, Joway Decoration, as a wholesale and retail enterprise, is subject to taxable income at a verified rate of 5% of revenue in 2011 pursuant to “Measures for Verification Collection of Enterprise Income Tax” issued by the PRC State Administration of Taxation.
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The table below summarizes the differences between the PRC statutory federal rate and the Company’s effective tax rate:
Tax computed at China statutory rates
Effect of reduced rate on Joway Decoration (1)
Tax adjustment from China tax authority for 2010 income tax (2)
Effect of losses
Effective rate
NOTE 9 – STATUTORY RESERVES
Pursuant to the laws and regulations of the PRC, annual income of the Company’s subsidiaries is required to be partly allocated to the statutory reserves funds after the payment of the PRC income taxes. The allocation to the statutory reserves funds should be at least 10% of income after tax until the reserves reaches 50% of the entities’ registered capital or members’ equity. The reserve funds are not transferable to the Company in the form of cash dividends, loans or advances. Thus the reserve funds are not available for distribution except in liquidation. As of September 30, 2012, the Company had allocated $354,052 to statutory reserves.
NOTE 10 – OTHER INCOME
Other income mainly consists of subsidy income from Tianjin Baodi District Management Committee and short-term investment income.
Joway Shengshi and Joway Decoration are located in Tianjin Baodi District. Pursuant to a series of investment encouragement policies issued by the Tianjin Baodi government, in January 2011 Joway Shengshi and Joway Decoration were awarded by Tianjin Baodi District Management Committee a total of RMB 2,307,012 (~ US $350,110) for the contribution to tax revenue for the years 2009 and 2010 in Tianjin Baodi District.
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NOTE 11 – SEGMENTS
In 2012 and 2011, the Company operated in three reportable business segments: (1) Healthcare Knitgoods Series, (2) Daily Healthcare and Personal Care Series and (3) Wellness House and Activated Water Machine Series. The Company’s reportable segments are strategic business units that offer different products. They are managed separately based on the fundamental differences in their operations. Information with respect to these reportable business segments is as follows:
For the three months ended September 30, 2012
Healthcare Knitgoods Series
Daily Healthcare and Personal Care Series
Wellness House and Activated Water Machine Series
Segment Totals
Other Income, net
Income Tax
Unallocated Assets
Net Loss
Total Assets
For the three months ended September 30, 2011
Other Income (Expense), net
Net Income
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For the nine months ended September 30, 2012
For the nine months ended September 30, 2011
NOTE 12 - FRANCHISE REVENUES
The Company enters into franchising agreements to develop retail outlets for the Company’s products. The agreements provide that franchisees will sell Company products exclusively at a predetermined retail price. In exchange the Company provides them with geographic exclusivity, discounted products, training and support. The agreements also require franchisees to adhere to certain standards of product merchandising, promotion and presentment. The agreements also prohibit franchisees from selling competitor’s products. The agreements do not require any initial franchise fees from the franchisees, nor do they require the franchisees to pay continuing royalties. The agreements do not require the franchisees to purchase any minimum levels of product, but do require that they make at least one purchase during each year. The Company does not act to manage the franchisees’ levels of product. Franchisees hold periodic conferences, assisted by the Company’s marketing department, to promote product awareness and the
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introduction of new products. The franchising agreements are generally for terms of three years and are renewable at the mutual agreement of both parties. The franchising agreements are cancelable at the Company’s discretion if franchisees violate the terms of the agreements.
The following is a breakdown of revenue between franchise and non-franchise customers:
Sales to franchise customers
Sales to non-franchise customers
Total sales
NOTE 13 - INVESTMENT
On August 28, 2011, Joway Shengshi and Tianjin Hezhi Pharmaceutical Co., Ltd. (referred to herein as “Tianjin Hezhi”) entered a cooperative contract, pursuant to which Joway Shengshi and Tianjin Hezhi established a new company named Tianjin Joway Hezhi Pharmaceutical Co., Ltd. (referred to herein as “Joway Hezhi”) with registered capital of RMB 20,000,000. Joway Hezhi was incorporated on October 21, 2011 with initial registered capital of RMB5,000,000. It will engage in the production and distribution of Chinese-Western preparations, health food, healthcare products, medical instruments and plain food. On October 11, 2011, Joway Shengshi contributed RMB 1,500,000 and owned 30% of Joway Hezhi. As of the date of this Report, Joway Hezhi is in the early preparatory period and has no operations.
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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operation.
The following discussion and analysis should be read in conjunction with the consolidated financial statements and notes thereto included in Item 1 of this Quarterly Report on Form 10-Q and with Management’s Discussion and Analysis of Financial Condition and Results of Operations contained in our Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 30, 2012.
FORWARD-LOOKING STATEMENTS:
Certain statements made in this report may constitute “forward-looking statements on our current expectations and projections about future events.” These forward-looking statements involve known or unknown risks, uncertainties, and other factors that may cause our actual results, performance, or achievements to be materially different from any future results, performance or achievements expressed or implied by the forward-looking statements. In some cases you can identify forward-looking statements by some words such as “may,” “should,” “potential,” “continue,” “expects,” “anticipates,” “intends,” “plans,” “believes,” “estimates,” and similar expressions. These statements are based on our current beliefs, expectations, and assumptions, and are subject to a number of risks and uncertainties. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. These forward-looking statements are made as of the date of this report, and we assume no obligation to update these forward-looking statements whether as a result of new information, future events, or otherwise, other than as required by law. In light of these assumptions, risks, and uncertainties, the forward-looking events discussed in this report might not occur and actual results and events may vary significantly from those discussed in the forward-looking statements.
Overview
General
We develop, manufacture, market, distribute, and sell products, including knit goods, daily healthcare and personal care products, and wellness house and activated water machine products, that are coated, embedded or filled with tourmaline. Most of our products, such as clothing, bedding, and mattresses are purchased as finished products which we then coat and/or infuse with liquid or granular tourmaline using one or more of our manufacturing techniques. We conduct all of our operations in Tianjin City, China and distribute most of our products to more than 200 franchisees in China. Our franchisees, in turn, sell the products to their customers. All of our revenues to date have been generated by sales to customers located in the PRC.
All of our operations are conducted through Joway Shengshi and its three subsidiaries, Joway Technology, Joway Decoration, and Shengtang Trading. Joway Shengshi engages in the manufacturing and distribution of tourmaline health-related products such as knit goods, and daily healthcare and personal care products. Joway Technology and Joway Decoration engage in the manufacturing and distribution of activated water machines and wellness houses. We utilize our Shengtang Trading subsidiary to purchase raw materials, which are then sold to Joway Shengshi and Joway Decoration.
Beginning in 2009, we began to develop a franchise network to distribute our healthcare knit goods, daily healthcare products and personal care products. Through these franchisees, we were able to significantly increase sales of our healthcare knit goods segment and daily healthcare and personal care segment. In 2010, we began distributing our wellness house and activated water machine products through our franchise network.
Description of Selected Income Statement Items
Revenues. We generate revenue from sales of our Healthcare Knit goods Series, Daily Healthcare and Personal Care Series and Wellness House and Activated Water Machine Series.
Cost of goods sold. Cost of goods sold consists of costs directly attributable to production, including the cost of raw materials, salaries for staff engaged in production activity, electricity, depreciation, packing materials, and related expenses.
Operating expenses. Our total operating expenses consist of sales and marketing expenses and general and administrative expenses. Sales and marketing expenses consist primarily of salaries and traveling expenses of our marketing department employees, transportation expenses, and advertising expenses. General and administrative expenses consist primarily of salaries of our administrative department employees, payroll taxes and benefits, general office expenses and depreciation. We expect administrative expenses to continue to increase as we incur expenses related to costs of compliance with U.S. securities laws and regulations, and our reporting obligations thereunder, including increased audit and legal fees and investor relations expenses.
Other (expense) income. Our other (expense) income consists primarily of interest income, subsidy income, and other revenue from sales of obsolete equipment.
Income taxes. According to the revised Enterprise Income Tax Law effective as of January 1, 2008, the income tax rate of our PRC subsidiaries is generally 25%. Joway Health Industries Group Inc. was established under the laws of the State of Nevada and is subject to U.S. federal income tax and Nevada annual reporting requirements. No provision for income taxes in the United States has been made as the Company has no income taxable in the United States. The Company’s PRC subsidiaries expect to use their retained earnings to support their PRC operations, and do not expect to declare any dividends within the foreseeable future.
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Results of Operations
The following table sets forth certain information regarding our results of operations.
Business Segments
In 2012 and 2011, we operated in three reportable business segments: (1) Healthcare Knitgoods, (2) Daily Healthcare and Personal Care Products and (3) Wellness House and Activated Water Machine Products. The following table sets forth the contributions of each reportable business segment in dollars and as a percent of revenue:
GROSS MARGIN
INCOME FROM OPERATIONS
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For The Three Months Ended September 30, 2012 Compared to September 30, 2011
Revenue. For the three months ended September 30, 2012, revenue was $294,959 compared to $908,973 for the three months ended September 30, 2011, a decrease of $614,014 or 67.6%. This decrease was mainly attributable to the decrease in revenue from healthcare knit goods segment and wellness houses and activated water machines segment. In the third quarter of 2012, China’s GDP growth dropped to 7.4 percent, compared with 8.1 percent in the first quarter of 2012 and 7.6 percent in the second quarter. The demand to our products has been affected by the slowdown of the economy. In addition, the number of our franchisees keeps dropping in 2012, caused by the slowdown of economy and our enhanced enforcement of the terms of our franchise agreements and policies in 2012. Further, our main products are mostly durable consumables, including mattress products the useful life of which is typically three or more years. Our franchisees’ demand for our products may have been affected because of the large amount of our main products they purchased in 2010. Aimed at this situation, we are developing more new products, especially fast consumables.
Revenue from healthcare knit goods segment decreased by $343,849 or 82.5% to $73,046 for the three months ended September 30, 2012 from $416,895 for the three months ended September 30, 2011. This decrease was mainly due to $0.3 million of decrease in sales of our mattress products.
Revenue from daily healthcare and personal care products decreased by $4,803 or 3.8% to $120,107 for the three months ended September 30, 2012 from $124,910 for the three months ended September 30, 2011. This was primarily due to the decrease in sales of Tourmaline Waist Protector and Xin-Nao-Ling Fish Oil Soft Gel.
Revenue from wellness houses and activated water machines decreased by $265,362 or 72.3% to $101,806 for the three months ended September 30, 2012 from $367,168 for the three months ended September 30, 2011. This decrease was mainly due to the decrease in sales of Tourmaline Water Machine.
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Cost of Goods Sold. For the three months ended September 30, 2012, cost of goods sold was $107,285 compared to $227,052 for the three months ended September 30, 2011, a decrease of $119,767, or 52.7%. This decrease was mainly due to the decrease in sales.
Cost of goods sold for healthcare knit goods segment decreased to $25,225 for the three months ended September 30, 2012 from $64,393 for the three months ended September 30, 2011, a decrease of $39,168 or 60.8%. This decrease was mainly due to the decrease in the cost of Mattress products.
Cost of goods sold for the daily healthcare and personal care segment decreased to $31,416 for the three months ended September 30, 2012 from $43,700 for the three months ended September 30, 2011, a decrease of $12,284 or 28.1%. This decrease was primarily due to the decrease in the cost of Xin-Nao-Ling Fish Oil Soft Gel.
Cost of goods sold for our wellness house and activated water machine segment decreased to $50,644 for the three months ended September 30, 2012 from $118,959 for the three months ended September 30, 2011, a decrease of $68,315 or 57.4%. This decrease was mainly due to the decrease in the cost of Wellness House.
Gross profit. Our gross profit decreased by $494,247 or 72.5% to $187,674 for the three months ended September 30, 2012, compared to $681,921 for the three months ended September 30, 2011. This decrease was mainly due to the decrease in gross profit for healthcare knit goods segment. Our gross margin decreased from 75% for the three months ended September 30, 2011 to 63.6% for the three months ended September 30, 2012. This decrease was mainly due to the decrease in the gross margin of our healthcare knit goods segment.
Gross profit for the healthcare knit goods segment decreased by $304,681 or 86.4% to $47,821 for the three months ended September 30, 2012 compared to $352,502 for the three months ended September 30, 2011. This decrease was mainly attributable to decreased sales of our mattress products. The gross margins of healthcare knit goods segment decreased from 84.6% for the three months ended September 30, 2011 to 65.5% for the three months ended September 30, 2012. This decrease was mainly due to the more discount to our franchisees for all our mattress products from July 2012.
Gross profit of daily healthcare and personal care segment increased by $7,481 or 9.2% to $88,691 for the three months ended September 30, 2012, compared to $81,210 for the three months ended September 30, 2011. This increase was primarily due to the increase in gross profit of our cosmetic products. The gross margin of daily healthcare and personal care segment increased from 65% for the three months ended September 30, 2011 to 73.8% for the three months ended September 30, 2012. This increase was mainly due to our cosmetic products, which were newly introduced in 2012 and have higher gross profit margin of over 80 percent.
Gross profit of the wellness house and activated water machine segments decreased by $197,047 or 79.4% to $51,162 for the three months ended September 30, 2012, compared to $248,209 for the three months ended September 30, 2011. This decrease was mainly due to the decrease in gross profit of our Tourmaline Water Machines. The gross margin of our wellness house and activated water machine segments decreased from 67.6% for the three months ended September 30, 2011 to 50.3% for the three months ended September 30, 2012. This decrease was mainly due to the more discount to our franchisees for our wellness house and activated water machine products from July 2012.
Operating expenses. Our total operating expenses consist of sales and marketing expenses and general and administrative expenses. Our total operating expenses decreased by $68,696, or 10.8%, from $633,388 for the three months ended September 30, 2011 to $564,692 for the three months ended September 30, 2012. This decrease was mainly due to the decrease of marketing fees and R&D expenses. Operating expenses for healthcare knit goods segment decreased by $156,852 or 47.2% to $175,525 for the three months ended September 30, 2012 from $332,377 for the three months ended September 30, 2011. Operating expenses for daily healthcare and personal care segment increased by $96,086 or 99.6% to $192,514 for the three months ended September 30, 2012 from $96,428 for the three months ended September 30, 2011. Operating expenses for our wellness house and activated water machine segment decreased by $7,930 or 3.9% to $196,653 for the three months ended September 30, 2012 from $204,583 for the three months ended September 30, 2011.
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Income from operations. As a result of the foregoing, our income from operations was negative $377,018 for the three months ended September 30, 2012, compared to $48,533 for the three months ended September 30, 2011, a decrease of $425,551. This decrease was mainly due to the decrease in sales.
Income taxes. Our income tax expenses was $4,331 for the three months ended September 30, 2012, compared to negative $21,266 for the three months ended September 30, 2011.
Net income. For the three months ended September 30, 2012, our net income was negative $339,153 compared to $74,457 for the three months ended September 30, 2011. This significant decrease was mainly due to a signficant decrease in our income from operations.
For the Nine months Ended September 30, 2012 Compared to September 30, 2011
Revenue. For the nine months ended September 30, 2012, revenue was $1,511,274 compared to $3,605,549 for the nine months ended September 30, 2011, a decrease of $2,094,275 or 58.1%. This decrease was mainly due to the durable consumables feature of our main products. In addition, we strengthened the enforcement of the terms of our franchise agreements and policies in 2011 after focusing mostly on increasing franchise stores in 2010. As a result, the number of our franchisees dropped in 2012. Further, the slowdown in the economy of China has also affected the purchases of our products in general. China’s GDP growth dropped from 9.4 percent for the nine months ended September 30, 2011 to 7.7 percent for the nine months ended September 30, 2012.
Revenue from healthcare knit goods segment decreased by $1,537,007, or 71.5% to $612,547 for the nine months ended September 30, 2012 from $2,149,554 for the nine months ended September 30, 2011. This decrease was mainly due to the decrease in sales of our mattress products.
Revenue from daily healthcare and personal care products decreased by $206,076 or 36.1% to $365,427 for the nine months ended September 30, 2012 from $571,503 for the nine months ended September 30, 2011. This was primarily due to the decrease in sales of our Tourmaline Scarf products and Tourmaline Waist Protector.
Revenue from wellness houses and activated water machines decreased by $351,192 or 39.7% to $533,300 for the nine months ended September 30, 2012 from $884,492 for the nine months ended September 30, 2011. This decrease was mainly due to the decrease in sales of Tourmaline Water Machine.
Cost of Goods Sold. For the nine months ended September 30, 2012, cost of goods sold was $414,021 compared to $781,201 for the nine months ended September 30, 2011, a decrease of $367,180, or 47%. This decrease was mainly due to a decrease in sales.
Cost of goods sold for healthcare knit goods segment decreased to $147,992 for the nine months ended September 30, 2012 from $358,455 for the nine months ended September 30, 2011, a decrease of $210,463 or 58.7%. This decrease was mainly due to the decrease in the cost of our mattress products.
Cost of goods sold for the daily healthcare and personal care segment decreased to $99,681 for the nine months ended September 30, 2012 from $154,581 for the nine months ended September 30, 2011, a decrease of $54,900 or 35.5%. This decrease was mainly due to the decrease in the cost of our Tourmaline Scarf products.
Cost of goods sold for our wellness house and activated water machine segment decreased to $166,348 for the nine months ended September 30, 2012 from $268,165 for the nine months ended September 30, 2011, a decrease of $101,817 or 38%. This decrease was mainly due to the decrease in sales.
Gross profit. Our gross profit decreased by $1,727,095 or 61.2% to $1,097,253 for the nine months ended September 30, 2012, compared to $2,824,348 for the nine months ended September 30, 2011. This decrease was primarily due to the decrease in gross profit for healthcare knit goods segment. In addition, our gross margin decreased from 78.3% for the nine months ended September 30, 2011 to 72.6% for the nine months ended September 30, 2012.
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Gross profit for the healthcare knit goods segment decreased by $1,326,544 or 74.1% to $464,555 for the nine months ended September 30, 2012 compared to $1,791,099 for the nine months ended September 30, 2011. This decrease was mainly due to the decrease in gross profit for our mattress products. The gross margins of healthcare knit goods segment decreased from 83.3% for the nine months ended September 30, 2011 to 75.8% for the nine months ended September 30, 2012. This decrease was mainly due to the decrease in the sales of our mattress products with higher gross margin.
Gross profit of daily healthcare and personal care segment decreased by $151,176 or 36.3% to $265,746 for the nine months ended September 30, 2012, compared to $416,922 for the nine months ended September 30, 2011. This decrease was primarily due to the decrease in gross profit of our Tourmaline Scarf products. Our gross margin of daily healthcare and personal care segment decreased from 73% for the nine months ended September 30, 2011 to 72.7% for the nine months ended September 30, 2012. This decrease was mainly due to the decrease in sales of our scarf products, which have higher gross margins.
Gross profit of the wellness house and activated water machine segments decreased by $249,375 or 40.5% to $366,952 for the nine months ended September 30, 2012, compared to $616,327 for the nine months ended September 30, 2011. This decrease was mainly due to the decrease in sales of Tourmaline Water Machines. The gross margin of our wellness house and activated water machine segments decreased from 69.7% for the nine months ended September 30, 2011 to 68.8% for the nine months ended September 30, 2012.
Operating expenses. Our total operating expenses consist of sales and marketing expenses and general and administrative expenses. Our total operating expenses decreased by $59,563, or 2.9%, from $2,019,750 for the nine months ended September 30, 2011 to $1,960,187 for the nine months ended September 30, 2012. This decrease was mainly due to the decrease of R&D expenses. Operating expenses for healthcare knit goods segment decreased by $530,373 or 40% to $794,500 for the nine months ended September 30, 2012 from $1,324,873 for the nine months ended September 30, 2011. Operating expenses for daily healthcare and personal care segment increased by $121,735 or 34.6% to $473,975 for the nine months ended September 30, 2012 from $352,240 for the nine months ended September 30, 2011. Operating expenses for our wellness house and activated water machine segment increased by $349,075 or 101.9% to $691,712 for the nine months ended September 30, 2012 from $342,637 for the nine months ended September 30, 2011. The increase was due to the fact that we have been increasing our marketing and sales efforts on our wellness house and activated water machine segment since the beginning of 2012.
Income from operations. As a result of the foregoing, our income from operations was negative $862,934 for the nine months ended September 30, 2012, compared to $804,598 for the nine months ended September 30, 2011, a decrease of $1,667,532. This decrease was mainly due to the decrease in sales.
Income taxes. Our income tax expenses were $16,710 for the nine months ended September 30, 2012, compared to $282,042 for the nine months ended September 30, 2011. This was mainly due to the loss from our operations in 2012.
Net income. Our net income was negative $823,887 for the nine months ended September 30, 2012, compared to $905,498 for the nine months ended September 30, 2011. This decrease was mainly due to the significant decrease in sales.
Franchising
We enter into franchise agreements to develop retail outlets for our products. These agreements provide that franchisees will sell our products exclusively. In exchange, we provide them with geographic exclusivity, discounted products, training, and support. The agreements also require franchisees to adhere to certain standards of product merchandising, promotion, and presentment. The agreements do not require the franchisees to purchase any minimum levels of product, but do require that they make at least one purchase during each year. The agreements are generally for terms of three years and are renewable at the mutual agreement of both parties. The Agreements are cancelable at our discretion if franchisees violate the terms of the agreements.
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Liquidity and Capital Resources
Our cash at the beginning of the nine months ended September 30, 2012 was $3,372,189 and decreased to $2,172,103 by the end of June 2012, a decrease of $1,200,086. At September 30, 2012, we had net working capital of $3,862,230, a decrease of $478,089 from $4,340,319 at December 31, 2011.
Our cash flow information summary is as follows:
Net cash used in :
Operating activities
Investing activities
Financing activities
Net Cash Used In Operating Activities
Net cash used in operating activities was $891,289 for the nine months ended September 30, 2012 compared to $125,951 for the nine months ended September 30, 2011. This change was primarily due to the reduced cash collection driven by $1,729,385 of decrease in net income, which was offset by reduced cash payment driven by $551,870 of difference in the impact of changes in taxes payable and $286,975 of difference in the impact of changes in inventory.
For the nine months ended September 30, 2012, cash was mainly used to cover the loss of $823,887 and purchase materials of $291,310, which were primarily offset by an add-back of $372,027 of depreciation for non-cash expense.
For the nine months ended September 30, 2011, cash was mainly used to purchase materials of $578,285, pay tax of $574,617 and increase the advances to suppliers of $241,346, which were primarily offset by cash provided from net income of $905,498 and an add-back of $333,375 of depreciation for non-cash expense.
Net Cash Used In Investing Activities
Net cash used in investing activities was $120,591 for the nine months ended September 30, 2012, compared to $1,167,418 for the nine months ended September 30, 2011. For the nine months ended September 30, 2012, cash was mostly used to remodel our training building and purchase some operating equipment. For the nine months ended September 30, 2011, $0.8 million was used to purchase four vehicles and $0.36 million was used for operating and office equipment.
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Net Cash Used In Financing Activities
Net cash used in financing activities was $243,060 for the nine months ended September 30, 2012, compared to $272,140 for the nine months ended September 30, 2011. The cash was used to repay Jinghe Zhang and Shenyang Joway for advances made in prior periods.
On May 10, 2007, our operating subsidiaries, Joway Shengshi entered into a cash advance agreement with Jinghe Zhang, our President, Chief Executive Officer and director. Pursuant to the agreements, Jinghe Zhang agreed to advance operating capital to Joway Shengshi. These advances are interest free, unsecured and are repayable upon demand. During the period beginning May 17, 2007 (inception of Joway Shengshi) through December 31, 2010, Joway Shengshi received cash advances in the aggregate principal amount of $4,637,397 from Jinghe Zhang. We repaid $26,105 and $190,905 of these advances for the nine months ended September 30, 2012 and 2011, respectively. As of September 30, 2012, the total unpaid principal balance due Jinghe Zhang for advances made to Joway Shengshi was $44,264.
On May 7, 2007, our operating subsidiary, Joway Shengshi entered into an agreement with Shenyang Joway pursuant to which Joway Shengshi and Shenyang Joway agreed to provide each other with interest-free, unsecured advances for working capital. On May 10, 2007, our subsidiary, Joway Technology and Shenyang Joway entered into an agreement pursuant to which Joway Technology and Shenyang Joway agreed to provide each other with interest-free, unsecured advances for working capital. Pursuant to these agreements, Shenyang Joway advanced an aggregate of $791,701 to Joway Shengshi and Joway Technology through December 31, 2010. We repaid $216,955 and $78,159 of these advances for the nine months ended September 30, 2012 and 2011, respectively. As of September 30, 2012, the total unpaid principal balance due Shenyang Joway for advances was $71,354. Shenyang Joway ceased operations at the end of 2009, although it still exists as a legal entity.
The Company has sufficient liquidity to meet the Company’s operating cash needs over the next 12 months if Mr. Zhang and Shenyang Joway were to demand immediate repayment of the remaining balance under these loans and no longer wish to provide future loans to us.
STATUTORY RESERVES
Pursuant to the laws and regulations of the PRC, the Company’s PRC subsidiaries are required to allocate a portion of their after-tax income to statutory reserves funds. The minimum statutory reserves allocation is 10% of after-tax income until the reserves reach 50% of the entities’ registered capital or members’ equity. The reserve funds are not transferable to the Company in the form of cash dividends, loans or advances. Thus, the reserve funds are not available for distribution except in liquidation. As of September 30, 2012, the Company had allocated $354,052 to statutory reserves.
Critical Accounting Policies
Management’s discussion and analysis of its financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. Our financial statements reflect the selection and application of accounting policies which require management to make significant estimates and judgments. Management bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions. We believe that the following reflect the more critical accounting policies that currently affect our financial condition and results of operations.
The accompanying consolidated financial statements include Joway Health, its wholly owned subsidiaries, and controlled VIEs. All significant inter-company accounts and transactions have been eliminated in the consolidation. Pursuant to Accounting Standards Codification Topic 810 “Consolidation,” Joway Shengshi, as a VIE of Junhe Consulting, have been consolidated in our financial statements. Joway Shengshi’s sales are included in our total sales, its income from operations is consolidated with ours, and our net income includes all of Joway Shengshi’s net income. Based on the various VIE Agreements, we are able to exercise control over the VIEs, and to obtain the full economic benefits. Accordingly, the non–controlling interests have no economic interest in the VIEs.
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We recognize revenue when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the purchase price is fixed or determinable and collectability is reasonably assured.
With respect to sales of product to both franchisee and non-franchisee customers, we prepare product shipment upon the receipt of a customer’s purchase order. Sales prices are based on fixed price lists that are different depending on whether the price list is for franchisee customers or for non-franchisee customers. We recognize revenue when the product is shipped. We do not sell product to any customers with a right of return as defined in ASC 605-15-25-4. Sales are presented net of value added tax (VAT).
We recognize revenue on the sale of our wellness houses under the completed contract method. At the time when we enter into a contract with a customer to build a wellness house, the customer pays a deposit of at least one-half of the sales price. We consider the contract to be completed when all significant costs have been incurred and the customer accepts the project in writing by signing in the appropriate place on the contract. At this time the customer will also pay any remaining balance on the contract. We recognize the full contract revenue at this point. Contract costs consist primarily of materials and labor costs. The construction period of a wellness house generally does not exceed five days.
Accounts receivable are carried at net realizable value. We provide reserves for potential credit losses on accounts receivable. Management reviews the composition of the accounts receivable and analyzes historical bad debts, customer concentrations, customers’ credit worthiness, current economic trends, and changes in customer’s payment patterns to evaluate the adequacy of these reserves.
Inventories are stated at the lower of cost, as determined by the specific identification method on contract level (for each individual contract, inventories cost flow is determined by weighted-average method), or the net realizable value, which is determined on selling prices less any further costs expected to be incurred for completion and disposal. Management regularly evaluates the composition of its inventories to identify slow-moving and obsolete inventories to determine whether a valuation allowance is required.
The cost and related accumulated depreciation of assets sold or otherwise retired are eliminated from the accounts, and any gain or loss is included in the consolidated statements of income and other comprehensive income. Maintenance, repairs and minor renewals are charged directly to expenses as incurred. Significant renewals and betterment to buildings and equipment are capitalized. Leasehold improvements are depreciated over the lesser of the useful life or the life of the lease.
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Recent Accounting Pronouncements
In May 2011, the FASB issued ASU 2011-04, Fair Value Measurements (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRS. ASU 2011-04 changes the wording used to describe many of the requirements in U.S. GAAP for measuring fair value and for disclosing information about fair value measurements to ensure consistency between U.S. GAAP and International Financial Reporting Standards (“IFRS”). ASU 2011-04 also expands the disclosures for fair value measurements that are estimated using significant unobservable (Level 3) inputs. This new guidance is to be applied prospectively. ASU 2011-04 will be effective for interim and annual periods beginning after Dec. 15, 2011, with early adoption permitted. The adoption of this standard did not materially expand our consolidated financial statement footnote disclosures.
In June 2011, the FASB issued ASU 2011-05, Comprehensive Income (Topic 220): Presentation of Comprehensive Income, which amends the current comprehensive income guidance. This ASU eliminates the option to present the components of other comprehensive income as part of the statement of shareholders’ equity. Instead, we must report comprehensive income in either a single continuous statement of comprehensive income which contains two sections, net income and other comprehensive income, or in two separate but consecutive statements. ASU 2011-05 will be effective for interim and annual periods beginning after Dec. 15, 2011, with early adoption permitted. The adoption of ASU 2011-05 did not have a material impact on our consolidated financial statements.
In September 2011, the FASB issued ASU 2011-08, Testing Goodwill for Impairment, which amends the guidance in ASC 350-20, “Intangibles — Goodwill and Other – Goodwill.” Under ASU 2011-08, entities have the option of performing a qualitative assessment before calculating the fair value of the reporting unit when testing goodwill for impairment. If the fair value of the reporting unit is determined, based on qualitative factors, to be more likely than not less than the carrying amount of the reporting unit, then entities are required to perform the two-step goodwill impairment test. ASU 2011-08 is effective for fiscal years beginning after December 15, 2011, with early adoption permitted. We do not anticipate that the adoption of this standard will have a material effect on our consolidated financial statements.
In December 2011, the FASB issued ASU 2011-11, Disclosures about Offsetting Assets and Liabilities, which is codified in ASC Topic 210, Balance Sheet. This pronouncement contains new disclosure requirements about a company’s right of setoff and related arrangements associated with its financial and derivative instruments. ASU 2011-11 will be effective retrospectively for annual and interim periods beginning on or after January 1, 2013. We do not anticipate that the adoption of this standard will have a material effect on our consolidated financial statements.
Item 3. Quantitative and Qualitative Disclosures about Market Risk.
Not applicable.
Item 4. Controls and Procedures.
Evaluation of Disclosure Controls and Procedures
Our management, under the supervision and with the participation of our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), has evaluated the effectiveness of our disclosure controls and procedures as defined in SEC Rules 13a-15(e) and 15d-15(e) as of the end of the period covered by this quarterly report. The purpose of this evaluation is to determine if, as of Evaluation Date, our disclosure controls and procedures were operating effectively such that the information, required to be disclosed in our Securities and Exchange Commission (“SEC”) reports (i) was recorded, processed, summarized and reported within the time periods specified in SEC rules and forms, and (ii) was accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.
Based on their evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that, as of September 30, 2012, our disclosure controls and procedures were not effective, based on the material weakness described below:
We did not have sufficient skilled accounting personnel that are either qualified as Certified Public Accountants in the U.S. or that have received education from U.S. institutions or other educational programs that would provide enough relevant education relating to U.S. GAAP. The Company’s CFO and Financial Manager have worked for U.S. listed companies but have limited experience with U.S. GAAP and are not U.S. Certified Public Accountants. Further, our operating subsidiaries are based in China, and in accordance with PRC laws and regulations, are required to comply with PRC GAAP, rather than U.S. GAAP. Thus, the accounting skills and understanding necessary to fulfill the requirements of U.S. GAAP-based reporting, including the preparation of financial statements and consolidation, are inadequate, and determined to be a material weakness.
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Remediation Initiative
We have started a training program in the principles and rules of U.S. GAAP, SEC reporting requirements and the application thereof. The program is provided by an independent training institution, for our finance and accounting personnel, including our Chief Financial Officer, Financial Manager and others.
We are in the process of designing a program to provide ongoing company-wide training regarding the Company’s internal controls, with particular emphasis on our finance and accounting staff.
We have implemented an internal review process over financial reporting to review all recent accounting pronouncements and to verify that the accounting treatment identified in such report have been fully implemented and confirmed by our internal control department.
In 2011 we established the position of internal audit manager. In September 2011, we hired an internal audit manager who implemented an internal review process over financial reporting to review all recent accounting pronouncements and to verify that the accounting treatments identified in such report have been fully implemented and confirmed by our internal control department.
We have identified a potential hire who has sufficient experience in internal control and audit to fill the position vacated in July 2012 by the internal audit manager.
We believe that the foregoing steps will remediate the significant deficiencies identified above, and we will continue to monitor the effectiveness of these steps and make any changes that our management deems appropriate.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation.
Changes in Internal Control over Financial Reporting
Our internal audit manager resigned in July 2012. In the near future, we expect a new internal audit manager will fill the vacancy.
Item 1. Legal Proceedings.
None.
Item 1A. Risk Factors.
This information has been omitted based on our status as a smaller reporting company.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
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Item 3. Defaults upon Senior Securities.
Item 4. Mine Safety Disclosures.
Item 5. Other Information.
Item 6. Exhibits.
EXHIBIT INDEX
ExhibitNo.
Description
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Pursuant to the requirements of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
Date: November 14, 2012
/s/ Jinghe Zhang
/s/ Yuan Huang
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