U. S. Securities and Exchange Commission

Washington, D. C. 20549

 

FORM 10-Q

 

[X]     QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

             For the quarterly period ended May 31, 2014

 

[ ]    TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from _____ to _____

 

Commission File No. 0-54843

CHINA TIANFEIHONG WINE, INC. (Name of Registrant in its Charter)
Delaware	99-0360626
(State of Other Jurisdiction of incorporation or organization)	(I.R.S. Employer I.D. No.)
1849 Licheng Middle Avenue, Longqiao Street, Chengxiang District Putian City, Fujian Province, P.R. China 351100
(Address of Principal Executive Offices)
Issuer's Telephone Number: 86-0594-6258386

 

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Sections 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 shell company (as defined in Rule 12b-2 of the Exchange Act)  

Yes [ ]   No [X]  

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. (Check One)  

Large accelerated filer    Accelerated filer _Non-accelerated filer    Smaller reporting company [X]

APPLICABLE ONLY TO CORPORATE ISSUERS:  Indicate the number of shares outstanding of each of the Registrant's classes of common stock, as of the latest practicable date:

July 21, 2014

Common Voting Stock: 34,396,680

CHINA TIANFEIHONG WINE, INC.

QUARTERLY report on Form 10-Q

for the fiscal QUARTER ended MAY 31, 2014

Table of Contents

 

		Page No
Part I	Financial Information
Item 1.	Financial Statements (unaudited):
	Consolidated Balance Sheets – May 31, 2014 and August 31, 2013	2
	Consolidated Statements of Income and Comprehensive Income -
	for the Three and Nine Month Periods Ended May 31, 2014 and 2013	3
	Consolidated Statements of Changes in Stockholders’ Equity – for the
	Nine Months Ended May 31, 2014 and 2013	4
	Consolidated Statements of Cash Flows – for the
	Nine Months Ended May 31, 2014 and 2013	5
	Notes to Consolidated Financial Statements	6
Item 2.	Management’s Discussion and Analysis of Financial Condition and
	Results of Operations	18
Item 3	Quantitative and Qualitative Disclosures about Market Risk	25
Item 4.	Controls and Procedures	25
Part II	Other Information
Item 1.	Legal Proceedings	25
Items 1A.	Risk Factors	25
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	25
Item 3.	Defaults upon Senior Securities	26
Item 4.	Mine Safety Disclosures	26
Item 5.	Other Information	26
Item 6.	Exhibits	26

CHINA TIANFEIHONG WINE, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(IN U.S.$)

 

		May 31,				August 31,
		2014				2013
		(Unaudited)
ASSETS
Current assets:
Cash		$	4,862,235			$	3,994,502
Accounts receivable			420,035				609,890
Inventory, net			279,791				461,232
Prepaid income taxes			57,045				—
Prepaid expenses			3,564				—
Advances to suppliers			—				45,670
Total current assets			5,622,670				5,111,294
Fixed assets, net			59,819				104,054
Total Assets		$	5,682,489			$	5,215,348
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable		$	355,930			$	788,588
Taxes payable			18,289				31,222
Loans from stockholder			47,446				—
Accrued liabilities and other payables			40,946				12,039
Total current liabilities			462,611				831,849
Stockholders’ equity:
Common stock, $0.0006 par value per share, 80,000,000
shares authorized; 34,396,680 and 32,000,000 shares issued and outstanding as of May 31, 2014 and
August 31, 2013, respectively			20,638				19,200
Additional paid-in capital			726,548				812,159
Statutory reserve fund			80,642				—
Retained earnings			4,066,899				3,336,756
Other comprehensive income			192,432				124,618
Stockholders’ equity before noncontrolling interests			5,087,159				4,292,733
Noncontrolling interests			132,719				90,766
Total stockholders’ equity			5,219,878				4,383,499
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY		$	5,682,489			$	5,215,348

  

See accompanying notes to the consolidated financial statements.

CHINA TIANFEIHONG WINE, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME (LOSS)

FOR THE THREE AND NINE MONTHS ENDED MAY 31, 2014 AND 2013 (UNAUDITED) (IN U.S.$)

 

		Three Months Ended								Nine Months Ended
		May 31,								May 31,
		2014				2013				2014				2013
Revenue		$	1,415,640			$	1,986,773			$	6,230,213			$	6,904,576
Cost of goods sold			(972,077	)			(1,321,959	)			(4,172,484	)			(4,480,828	)
Gross profit			443,563				664,814				2,057,729				2,423,748
Operating expenses
Selling and marketing			168,077				206,336				677,691				676,148
General and administrative			58,733				81,567				260,168				255,413
Total operating expenses			226,810				287,903				937,859				931,561
Income from operations			216,753				376,911				1,119,870				1,492,187
Interest income			4,772				3,250				12,404				8,117
Income before provision for income taxes			221,525				380,161				1,132,274				1,500,304
Provision for income taxes			55,396				95,040				278,997				375,076
Net income			166,129				285,121				853,277				1,125,228
Noncontrolling interests			(8,131	)			(14,256	)			(42,492	)			(56,261	)
Net income attributable to common stockholders		$	157,998			$	270,865			$	810,785			$	1,068,967
Earnings per common share, basic and diluted		$	0.00			$	0.01			$	0.02			$	0.03
Weighted average shares outstanding, basic and diluted			34,396,680				32,000,000				33,331,489				32,000,000
Comprehensive Income:
Net Income		$	166,129			$	285,121			$	853,277			$	1,125,228
Foreign currency translation adjustment			(41,972	)			141,831				67,275				174,166
Comprehensive income			124,157				426,952				920,552				1,299,394
Comprehensive income attributable to noncontrolling interests			(1,364	)			(121,630	)			(41,953	)			(165,252	)
Net Comprehensive income attributable to common  stockholders		$	122,793			$	305,322			$	878,599			$	1,134,142

  

See accompanying notes to the consolidated financial statements.

CHINA TIANFEIHONG WINE, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY

FOR THE NINE MONTHS ENDED MAY 31, 2013 (UNAUDITED) (IN U.S.$)

 

		Common Stock				Additional Paid-in Capital				Statutory Reserve Fund				Retained Earnings				Other Comprehensive Income				Noncontrolling Interests				Total
Balance, August 31, 2013		$	19,200			$	812,159			$	—			$	3,336,756			$	124,618			$	90,766			$	4,383,499
Reverse acquisition equity adjustments			1,438				(85,611	)			—				—				—				—				(84,173	)
Net income			—				—				—				810,785				—				42,492				853,277
Appropriation to statutory reserve			—				—				80,642				(80,642	)			—				—				—
Foreign currency translation adjustment			—				—				—				—				67,814				(539	)			67,275
Balance, May 31, 2014 (Unaudited)		$	20,638			$	726,548			$	80,642				4,066,899			$	192,432			$	132,719			$	5,219,878

 

  

See accompanying notes to the consolidated financial statements.

CHINA TIANFEIHONG WINE, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE NINE MONTHS ENDED MAY 31, 2014 AND 2013 (UNAUDITED) (IN U.S.$)

 

		Nine Months Ended May 31,
		2014				2013
Cash flows from operating activities:
Net income		$	853,277			$	1,125,228
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation			45,176				38,896
Changes in operating assets and liabilities:
Decrease (increase) in accounts receivable			189,855				(185,549	)
Decrease (increase) in inventory			181,441				(114,901	)
(Increase) in prepaid income taxes			(57,045	)			—
(Increase) in prepaid expenses			(3,564	)			(17,428	)
Decrease in advances to suppliers			45,670				40,380
(Decrease) increase in accounts payable			(432,658	)			227,037
(Decrease) increase in taxes payable			(12,933	)			6,287
Increase (decrease) in accrued liabilities and other payables			28,907				(500	)
Net cash provided by operating activities			838,126				1,119,450
Cash flows from investing activities:
Purchase of equipment			(850	)			—
Net cash (used in) investing activities			(850	)			—
Cash flows from financing activities:
Capital contributed by one stockholder			—				557,200
Proceeds from stockholder loans			46,480				—
Net cash provided by financing activities			46,480				557,200
Effect of exchange rate changes on cash			(16,023	)			83,943
Net change in cash			867,733				1,760,593
Cash, beginning			3,994,502				1,908,784
Cash, end		$	4,862,235			$	3,669,377
Supplemental disclosure of cash flow information
Cash paid for:
Interest		$	—			$	—
Income taxes		$	333,997			$	368,907

  

See accompanying notes to the consolidated financial statements.

NOTE 1. ORGANIZATION

 

China Tianfeihong Wine, Inc. (the “Company”), formerly known as Zenitech Corporation, was incorporated under the laws of the State of Delaware on July 28, 2005. Since its inception until the closing of its reverse acquisition transaction, the Company was a development-stage company in the business of developing, manufacturing, distributing and marketing of environmentally friendly floral sleeves and wrappers for the floriculture industry.

 

On August 1, 2013, the Company filed a certificate of amendment to its articles of incorporation to change its name from “Zenitech Corporation” to “China Tianfeihong Wine Inc. ” (the “Name Change”) and to effect a 1 for 6  reverse stock split (the “Reverse Split”) of its outstanding shares of common stock. The Name Change and the Reserve Split were effective on August 12, 2013.  Upon the effectiveness of the Reverse Split, the number of outstanding shares of the Company’s common stock decreased from 14,380,266 to 2,396,680 shares. The number of authorized shares of common stock remained at 80,000,000 shares.

 

On December 30, 2013, the Company completed a reverse acquisition transaction through a share exchange with the stockholders of Fanwei Hengchang Co., Ltd (BVI) (“Fanwei Hengchang), whereby the Company acquired 100% of the outstanding shares of Fanwei Hengchang in exchange for the issuance of 32,000,000 shares of the Company’s common stock, representing 93.03% of issued and outstanding shares of common stock. As a result of the reverse acquisition, Fanwei Hengchang became the Company’s wholly-owned subsidiary and the former Fanwei Hengchang’s stockholders became our controlling stockholders. The share exchange transaction was treated as a reverse acquisition, with Fanwei Hengchang as the acquirer and the Company as the acquired party for accounting purposes. Unless the context suggests otherwise, when we refer in this report to the business and financial information for periods prior to the consummation of the reverse acquisition, we are referring to the business and financial information of Fanwei Hengchang and its consolidated subsidiaries and variable interest entity. 

 

As a result of the acquisition of Fanwei Hengchang, the Company now owns all of the issued and outstanding capital stock of Changshi Tongrong Limited (Hong Kong) (“Changshi Tongrong”), which in turn owns all of the issued and outstanding capital stock of Changshitong Consulting (Shenzhen) Co. Ltd (“Changshitong Consulting”). In addition, the Company effectively and substantially controls Fujian Tianfeihong Wine Co., Ltd (“Fujian Tianfeihong”) through a series of captive agreements with Changshitong Consulting.

 

Subsequent to the closing of the Share Exchange Agreement, the Company conducts operations through its controlled consolidated affiliate Fujian Tianfeihong. Fujian Tianfeihong is primarily engaged in distributing all kinds of fruit wine including green plum wine, loquat wine, olive wine, pomegranate wine, etc. to supermarkets and liquor stores in the People’s Republic of China (“PRC”).

 

On November 26, 2013, prior to the reverse acquisition transaction, Changshitong Consulting and Fujian Tianfeihong and its shareholders Jinxiang Fang and Zhiliang Fang entered into a series of agreements known as variable interest agreements (the “VIE Agreements”) pursuant to which Fujian Tianfeihong became Changshitong  Consulting’s contractually controlled affiliate. The VIE Agreements included:

 

Exclusive Technical Service and Business Consulting Agreement: Pursuant to the Exclusive Technical Service and Business Consulting Agreement, Changshitong Consulting (WFOE) is to provide technical support and consulting services to Fujian Tianfeihong in exchange for (i) 95% of the total annual net profit of  Fujian Tianfeihong plus (ii) RMB10,000 per month (U.S.$1,623). The Agreement has an unlimited term and only can be terminated upon written notice agreed to by both parties.

 

Proxy Agreement: Pursuant to the Proxy Agreement, Zhiliang Fang and Jinxiang Fang each authorize Changshitong Consulting to designate someone to exercise their entire shareholder decision rights with respect to Fujian Tianfeihong. The Agreement has an unlimited term and only can be terminated upon written notice agreed to by both parties.

NOTE 1. ORGANIZATION (continued)

 

Call Option Agreement: a Call Option Agreement among Zhiliang Fang and Jinxiang Fang (together referred to as “Fujian Tianfeihong Shareholders”), and Changshitong Consulting under which they have granted to Changshitong Consulting the irrevocable right and option to acquire all of the equity interests in Fujian Tianfeihong to the extent permitted by PRC law. If PRC law limits the percentage of Fujian Tianfeihong that Changshitong Consulting may purchase at any time, then Changshitong Consulting may repeatedly exercise its option in such increments as may be allowed by PRC law. The exercise price of the option is RMB1.00 (US$0.16) or the minimum price required by PRC laws if at that time there is any regulatory PRC laws regulating the minimum price. The Fujian Tianfeihong Shareholders agreed to refrain from taking certain actions which might harm the value of Fujian Tianfeihong or Changshitong Consulting’s option. This Agreement remains effective until all equity interest under the Agreement have been transferred to Changshitong Consulting or its designated entities or natural persons.

 

Share Pledge Agreement: a Share Pledge Agreement among Zhiliang Fang and Jinxiang Fang, Fujian Tianfeihong, and Changshitong Consulting under which the Fujian Tianfeihong Shareholders agree to pledge all of their equity in Fujian Tianfeihong to Changshitong Consulting to guarantee Fujian Tianfeihong’s and its shareholders’ performance of their obligations under the Exclusive Technical Service and Business Consulting Agreement, the Call Option Agreement and the Proxy Agreement. This Agreement remains effective until the obligations under the Exclusive Technical Service and Business Consulting Agreement, Call Option Agreement and Proxy Agreement have been fulfilled or terminated.

 

The VIE Agreements with the Company’s Chinese affiliate and its shareholders, which relate to critical aspects of the Company’s operations, may not be as effective in providing operational control as direct ownership. In addition, these arrangements may be difficult and costly to enforce under PRC law.

 

As a result of the entry into the foregoing agreements, the Company has a corporate structure which is set forth as follows:

NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

BASIS OF ACCOUNTING AND PRESENTATION

 

The accompanying consolidated financial statements have been prepared on the accrual basis of accounting. The unaudited financial statements for the three and nine months ended May 31, 2014, include China Tianfeihong Wine, Inc., Fanwei Hengchang, Changshi Tongrong and its wholly owned subsidiary, Changshitong Consulting and its VIE, Fujian Tianfeihong. The unaudited financial statements for the three and nine months ended May 31, 2013 include Fujian Tianfeihong, Changshi Tongrong and Fanwei Hengchang as all the other entities were not in existence at that time. All significant intercompany accounts and transactions have been eliminated in consolidation when applicable.

 

The unaudited interim consolidated financial statements of the Company as of May 31, 2014 and for the three and nine months periods ended May 31, 2014 and 2013, have been prepared in accordance with accounting principles generally accepted in the United States of America and the rules and regulations of the Securities and Exchange Commission (the “SEC”) which apply to interim financial statements. Accordingly, they do not include all of the information and footnotes normally required by accounting principles generally accepted in the United States of America for annual financial statements. In the opinion of management, such information contains all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of the results for the periods presented. The interim consolidated financial information should be read in conjunction with the consolidated financial statements and the notes thereto, included in the Company’s Form 8-K/A filed with the SEC on March 26, 2014. The results of operations for the three and nine months ended May 31, 2014 are not necessarily indicative of the results to be expected for future quarters or for the year ending August 31, 2014.

 

All consolidated financial statements and notes to the consolidated financial statements are presented in United States dollars (“US Dollar” or “US$” or “$”).

 

VARIABLE INTEREST ENTITY

 

Pursuant to Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 810, “Consolidation” (“ASC 810”), the Company is required to include in its consolidated financial statements the financial statements of its variable interest entities (“VIEs”). ASC 810 requires a VIE to be consolidated by a company if that company is subject to a majority of the risk of loss for the VIE or is entitled to receive a majority of the VIE’s residual returns. VIEs are those entities in which a company, through contractual arrangements, bears the risk of, and enjoys the rewards normally associated with ownership of the entity, and therefore the company is the primary beneficiary of the entity.

 

Under ASC 810, a reporting entity has a controlling financial interest in a VIE, and must consolidate that VIE, if the reporting entity has both of the following characteristics: (a) the power to direct the activities of the VIE that most significantly affect the VIE’s economic performance; and (b) the obligation to absorb losses, or the right to receive benefits, that could potentially be significant to the VIE. The reporting entity’s determination of whether it has this power is not affected by the existence of kick-out rights or participating rights, unless a single enterprise, including its related parties and de facto agents, have the unilateral ability to exercise those rights. Fujian Tianfeihong’s actual stockholders do not hold any kick-out rights that affect the consolidation determination.

 

Through the VIE agreements disclosed in Note 1, the Company is deemed the primary beneficiary of Fujian Tianfeihong. Accordingly, the results of Fujian Tianfeihong have been included in the accompanying consolidated financial statements. Fujian Tianfeihong has no assets that are collateral for or restricted solely to settle their obligations. The creditors of Fujian Tianfeihong do not have recourse to the Company’s general credit.

NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)

 

VARIABLE INTEREST ENTITY (continued)

 

The following financial statement amounts and balances of Fujian Tianfeihong have been included in the accompanying consolidated financial statements.

 

		May 31, 2014				August 31, 2013
		(Unaudited, in U.S. $)				(In U.S. $)
ASSETS
Current assets:
Cash		$	4,861,784			$	3,994,502
Accounts receivable			420,035				609,890
Inventory			279,791				461,232
Prepaid income taxes			57,045				—
Prepaid expenses			3,564				—
Advances to suppliers			—				45,670
Total current assets			5,622,219				5,111,294
Fixed assets, net			59,819				104,054
TOTAL ASSETS		$	5,682,038			$	5,215,348
LIABILITIES
Current liabilities:
Accounts payable		$	355,930			$	788,588
Payable to WFOE(1)			817,064				—
Taxes payable			15,657				21,941
Loans from stockholder			47,446				—
Accrued liabilities and other payables			31,226				12,039
Total current liabilities			1,267,323				822,568
TOTAL LIABILITIES		$	1,267,323			$	822,568

(1)

Payable to WFOE represents outstanding amounts due to Changshitong Consulting Co. Ltd. under the Exclusive Technical Service and Business Consulting Agreement for consulting services provided to Fujian Tianfeihong in exchange for 95% of Fujian Tianfeihong’s net income. The monthly payments of RMB 10,000 (approximately US$1,623) have not been paid as of May 31, 2014.

NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)

 

VARIABLE INTEREST ENTITY (continued)

 

		For the three months ended May 31,								For the nine months ended May 31,
		2014				2013				2014				2013
		(Unaudited)				(Unaudited)				(Unaudited)				(Unaudited)
Revenue		$	1,415,640			$	1,986,773			$	6,230,213			$	6,904,576
Net income (2)		$	162,625			$	285,121			$	849,836			$	1,125,228

(2)

Under the Exclusive Technical Service and Business Consulting Agreement, 95% of the net income is to be remitted to WFOE.

 

		For the nine months ended May 31,
		2014				2013
		(Unaudited)				(Unaudited)
Net cash provided by operating activities		$	841,334			$	1,119,450
Net cash (used in) investing activities			(850	)			—
Net cash provided by financing activities			46,480				557,200
Effect of exchange rate changes on cash			(19,682	)			83,943
Net increase in cash			867,282				1,760,593

 

The Company believes that Changshitong Consulting’s contractual agreements with Fujian Tianfeihong are in compliance with PRC law and are legally enforceable. The stockholders of Fujian Tianfeihong are also the senior management of the Company and therefore the Company believes that they have no current interest in seeking to act contrary to the contractual arrangements. However, Fujian Tianfeihong and its stockholders may fail to take certain actions required for the Company’s business or to follow the Company’s instructions despite their contractual obligations to do so. Furthermore, if Fujian Tianfeihong or its stockholders do not act in the best interests of the Company under the contractual arrangements and any dispute relating to these contractual arrangements remains unresolved, the Company will have to enforce its rights under these contractual arrangements through PRC law and courts and therefore will be subject to uncertainties in the PRC legal system. All of these contractual arrangements are governed by PRC law and provide for the resolution of disputes through arbitration in the PRC. Accordingly, these contracts would be interpreted in accordance with PRC law and any disputes would be resolved in accordance with PRC legal procedures. As a result, uncertainties in the PRC legal system could limit the Company’s ability to enforce these contractual arrangements, which may make it difficult to exert effective control over Fujian Tianfeihong, and its ability to conduct the Company’s business may be adversely affected.

 

CHANGE OF FISCAL YEAR END DATE

 

On December 30, 2013, the Board of Directors of the Company approved changing the fiscal year-end of the Company from December 31 to August 31 as a result of the Fanwei Hengchang Acquisition.

 

USE OF ESTIMATES

 

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect certain reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates.

NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued) 

 

FOREIGN CURRENCY TRANSLATION

 

Almost all Company assets are located in the PRC. The functional currency for the majority of the Company’s operations is the Renminbi (“RMB”). The Company uses the United States Dollar (“US Dollar” or “US$” or “$”) for financial reporting purposes. The financial statements of the Company have been translated into US dollars in accordance with FASB ASC 830, “Foreign Currency Matters.”

 

All asset and liability accounts have been translated using the exchange rate in effect at the balance sheet date. Equity accounts have been translated at their historical exchange rates when the capital transactions occurred. Statements of income amounts have been translated using the average exchange rate for the periods presented. Adjustments resulting from the translation of the Company’s financial statements are recorded as other comprehensive income (loss).

 

The exchange rates used to translate amounts in RMB into US dollars for the purposes of preparing the financial statements are as follows:

 

		May 31, 2014				August 31, 2013
Balance sheet items, except for stockholders’ equity, as of periods end			0.1620				0.1622

 

		For the three months ended May 31,								For the nine months ended May 31,
		2014				2013				2014				2013
Amounts included in the statements of income, statement of changes in stockholders’ equity and statements of cash flows for the periods			0.1623				0.1602				0.1629				0.1592

 

  

For the three months ended May 31, 2014 and 2013, foreign currency translation adjustments of $(41,972) and $141,831, respectively, have been reported as other comprehensive (loss) income. For the nine months ended May 31, 2014 and 2013, foreign currency translation adjustments of $67,275 and $174,166 have been reported as other comprehensive income. Other comprehensive income of the Company consists entirely of foreign currency translation adjustments. Pursuant to ASC 740-30-25-17, “Exceptions to Comprehensive Recognition of Deferred Income Taxes,” the Company does not recognize deferred U.S. taxes related to the undistributed earnings of its foreign subsidiaries and, accordingly, recognizes no income tax expense or benefit from foreign currency translation adjustments.

 

Although government regulations now allow convertibility of the RMB for current account transactions, significant restrictions still remain. Hence, such translations should not be construed as representations that the RMB could be converted into US dollars at that rate or any other rate.

 

The value of the RMB against the US dollar and other currencies may fluctuate and is affected by, among other things, changes in the PRC’s political and economic conditions. Any significant revaluation of the RMB may materially affect the Company’s financial condition in terms of US dollar reporting.

NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)

 

REVENUE RECOGNITION

 

Revenues are primarily derived from selling fruit wines to contract distributors and retail establishments. The Company’s revenue recognition policies comply with FASB ASC 605 “Revenue Recognition.” The Company recognizes product revenue when the following fundamental criteria are met: (i) persuasive evidence of an arrangement exists, (ii) delivery has occurred, (iii) the price to the customer is fixed or determinable and (iv) collection of the resulting accounts receivable is reasonably assured. The Company recognizes revenue for product sales upon transfer of title to the customer. Customer purchase orders and/or contracts are generally used to determine the existence of an arrangement. Shipping documents and the completion of any customer acceptance requirements, when applicable, are used to verify product delivery. The Company assesses whether a price is fixed or determinable based upon the payment terms associated with the transaction and whether the sales price is subject to refund or adjustment.

 

The Company has no product returns or sales discounts and allowances because goods delivered and accepted by customers are normally not returnable.

 

The Company recognizes gift sample products as cost of goods sold in compliance with ASC 605-50-S99. As such, when the Company gives a customer a free product, the expense associated with this free product at the time of sale is classified as cost of goods sold.

 

SHIPPING COSTS

 

Shipping costs incurred by the Company are recorded in selling expenses. Shipping costs for the three months ended May 31, 2014 and 2013 were $61,406 and $86,538, respectively; shipping costs for the nine months ended May 31, 2014 and 2013 were $271,554 and $291,973, respectively.

  

VULNERABILITY DUE TO OPERATIONS IN PRC

 

The Company’s operations may be adversely affected by significant political, economic and social uncertainties in the PRC. Although the PRC government has been pursuing economic reform policies for more than twenty years, no assurance can be given that the PRC government will continue to pursue such policies or that such policies may not be significantly altered, especially in the event of a change in leadership, social or political disruption or unforeseen circumstances affecting the PRC’s political, economic and social conditions. There is also no guarantee that the PRC government’s pursuit of economic reforms will be consistent, effective or continue.

 

CASH AND CASH EQUIVALENTS

 

The Company considers all demand and time deposits and all highly liquid investments with an original maturity of three months or less to be cash equivalents.

 

ACCOUNTS RECEIVABLE

 

Accounts receivable are recorded at the contract amount after deduction of trade discounts and allowances, if any, and do not bear interest. The allowance for doubtful accounts, when necessary, is the Company’s best estimate of the amount of probable credit losses of accounts receivable. The Company determines the allowance based on historical write-off experience, customer specific facts and economic conditions.

 

Account balances are charged off against the allowance after all means of collection have been exhausted and the potential for recovery is considered remote. The Company does not have any off-balance-sheet credit exposure related to its customers. As of May 31, 2014 and August 31, 2013, the Company considers accounts receivable of $420,035 and $609,890, respectively, fully collectible. For the periods presented, the Company did not write off any accounts receivable as bad debts.

NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)

 

INVENTORY

 

Inventory, comprised principally of bottled wine, is valued at the lower of cost or market value. The value of inventories is determined using the first-in, first-out method.

 

The Company periodically estimates an inventory allowance for estimated unmarketable inventories. Inventory amounts are reported net of such allowances, if any. There were no allowances for inventory as of May 31, 2014 and August 31, 2013.

 

FAIR VALUE OF FINANCIAL INSTRUMENTS

 

FASB ASC 820, “Fair Value Measurement,” defines fair value as the price that would be received upon sale of an asset or paid upon transfer of a liability in an orderly transaction between market participants at the measurement date and in the principal or most advantageous market for that asset or liability. The fair value should be calculated based on assumptions that market participants would use in pricing the asset or liability, not on assumptions specific to the entity.

 

FIXED ASSETS

 

Fixed assets are recorded at cost, less accumulated depreciation. Cost includes the prices paid to acquire the assets, and any expenditures that substantially increase the asset’s value or extends the useful life of an existing asset. Depreciation is computed using the straight-line method over the estimated useful lives of the assets. Major repairs and betterments that significantly extend original useful lives or improve productivity are capitalized and depreciated over the periods benefited. Maintenance and repairs are generally expensed as incurred. The estimated useful lives for fixed asset categories are as follows:

 

Computers and equipment 3 years

Motor vehicles 4 years

Fixture and furnitures 5 years

 

IMPAIRMENT OF LONG-LIVED ASSESTS

 

The Company applies FASB ASC 360, “Property, Plant and Equipment,” which addresses the financial accounting and reporting for the recognition and measurement of impairment losses for long-lived assets. In accordance with ASC 360, long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. The Company may recognize the impairment of long-lived assets in the event the net book value of such assets exceeds the future undiscounted cash flows attributable to those assets. No impairment of long-lived assets was recognized for the periods presented.

 

INCOME TAXES

 

The Company accounts for income taxes in accordance with FASB ASC 740, “Income Taxes” (“ASC 740”), which requires the recognition of deferred income taxes for differences between the basis of assets and liabilities for financial statement and income tax purposes. Deferred tax assets and liabilities represent the future tax consequences for those differences, which will either be taxable or deductible when the assets and liabilities are recovered or settled. As of May 31, 2014 and August 31, 2013, the company has no deferred tax assets or liabilities.

 

ASC 740 addresses the determination of whether tax benefits claimed or expected to be claimed on a tax return should be recorded in the financial statements. Under ASC 740, the Company may recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such a position would be measured based on the largest benefit that has a greater than 50% likelihood of being realized upon ultimate settlement. ASC 740 also provides guidance on de-recognition of income tax assets and liabilities, classification of current and deferred income tax assets and liabilities, and accounting for interest and penalties associated with tax positions. As of May 31, 2014 and August 31, 2013, the Company does not have a liability for any unrecognized tax benefits.

NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)

 

INCOME TAXES (continued)

 

The income tax laws of various jurisdictions in which the Company and its subsidiaries operate are summarized as follows:

 

United States

 

The Company is subject to United States tax at graduated rates from 15% to 35%. No provision for income taxes in the United States has been made as the Company had no U.S. taxable income for the three and nine months ended May 31, 2014 and 2013.

 

PRC

 

Changshitong Consulting and its VIE, Fujian Tianfeihong are subject to an Enterprise Income Tax at 25% and file their own tax returns. Consolidated tax returns are not permitted in China.

 

BVI

 

Fanwei Hengchang is incorporated in the BVI and is governed by the income tax laws of the BVI. According to the current BVI income tax law, the applicable income tax rate for the Company is 0%.

 

Hong Kong

 

Changshi Tongrong is incorporated in Hong Kong. Pursuant to the income tax laws of Hong Kong, the Company is not subject to tax on non-Hong Kong source income.

 

Advertising Costs

 

Advertising costs are charged to operations when incurred. For the three months ended May 31, 2014 and 2013, advertising expense was $54,533 and $58,249, respectively. For the nine months ended May 31, 2014 and 2013, advertising expenses was $190,267 and $123,686, respectively.

 

Statutory Reserve Fund

 

Pursuant to corporate law of the PRC, the Company is required to transfer 10% of its net income, as determined under PRC accounting rules and regulations, to a statutory reserve fund until such reserve balance reaches 50% of the Company’s registered capital. The statutory reserve fund is non-distributable other than during liquidation and can be used to fund previous years’ losses, if any, and may be utilized for business expansion or used to increase registered capital, provided that the remaining reserve balance after use is not less than 25% of registered capital. For nine months ended May 31, 2014, a statutory reserve of $80,642 was required to be allocated by the Company.

 

NOTE 3. RECENTLY ISSUED ACCOUNTING STANDARDS

 

In May 2014, the FASB issued ASU No. 2014-09, “Revenue from Contracts with Customers”, which supersedes the revenue recognition requirements in ASC 605, “Revenue Recognition”. The core principle of this updated guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The new rule also requires additional disclosure about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and changes in judgments and assets recognized from costs incurred to obtain or fulfill a contract. This guidance is effective for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period. Companies are permitted to adopt this new rule following either a full or modified retrospective approach. Early adoption is not permitted. The Company has not yet determined the potential impacts of this updated authoritative guidance on its consolidated financial statements.

NOTE 3. RECENTLY ISSUED ACCOUNTING STANDARDS (continued)

 

In April 2014, the FASB issued ASU 2014-08, “Presentation of Financial Statements (Topic 205) and Property, Plant, and Equipment (Topic 360), Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity”, which amends the requirements for reporting discontinued operations. Under ASU 2014-08, a disposal of a component of an entity or a group of components of an entity is required to be reported in discontinued operations if the disposal represents a strategic shift that has (or will have) a major effect on an entity's operations and financial results when the component or group of components meets the criteria to be classified as held for sale or when the component or group of components is disposed of by sale or other than by sale. In addition, this ASU requires additional disclosures about both discontinued operations and the disposal of an individually significant component of an entity that does not qualify for discontinued operations presentation in the financial statements. The guidance is effective for annual and interim periods beginning after December 15, 2014, with early adoption permitted. This accounting standard update is not expected to have a material impact on the Company’s consolidated financial statements.

 

In July 2013, FASB issued ASU No. 2013-11, Presentation of an Unrecognized Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists. This ASU requires an unrecognized tax benefit to be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward. An exception exists to the extent that a net operating loss carryforward, a similar tax loss, or a tax credit carryforward is not available at the reporting date under the tax law of the applicable jurisdiction to settle any additional income taxes that would result from the disallowance of a tax position or the tax of the applicable jurisdiction does not require the entity to use, and entity does not intend to use, the deferred tax asset for such a purpose, the unrecognized tax benefit should be presented in the financial statements as a liability and should not be combined with deferred tax assets. ASU No. 2013-11 is effective for fiscal years and interim periods beginning after December 15, 2013 and did not have a material impact on the Company's consolidated financial statements.

 

NOTE 4. FAIR VALUE OF FINANCIAL INSTRUMENTS

 

FASB ASC 820, “Fair Value Measurement,” specifies a hierarchy of valuation techniques based upon whether the inputs to those valuation techniques reflect assumptions other market participants would use based upon market data obtained from independent sources (observable inputs). In accordance with ASC 820, the following summarizes the fair value hierarchy:

 

Level 1 Inputs -

Unadjusted quoted market prices for identical assets and liabilities in an active market that the Company has the ability to access.

 

Level 2 Inputs -

Inputs other than the quoted prices in active markets that are observable either directly or indirectly.

 

Level 3 Inputs -

Inputs based on prices or valuation techniques that are both unobservable and significant to the overall fair value measurements.

 

ASC 820 requires the use of observable market data, when available, in making fair value measurements. When inputs used to measure fair value fall within different levels of the hierarchy, the level within which the fair value measurement is categorized is based on the lowest level input that is significant to the fair value measurements. Valuation techniques used need to maximize the use of observable inputs and minimize the use of unobservable inputs. As of May 31, 2014 and August 31, 2013, none of the Company’s assets and liabilities were required to be reported at fair value on a recurring basis. Carrying values of non-derivative financial instruments, including cash, receivable, payables and accrued liabilities, approximate their fair values due to the short term nature of these financial instruments. There were no changes in methods or assumptions during the periods presented.

NOTE 5. FIXED ASSETS

 

Fixed assets are summarized as follows:

 

		May 31, 2014				August 31, 2013
		(Unaudited)
Computers and equipment		$	24,543			$	23,732
Motor vehicles			148,047				148,269
Fixtures and furniture			13,835				13,856
			186,425				185,857
Less: Accumulated depreciation			(126,606	)			(81,803	)
		$	59,819			$	104,054

 

For the three months ended May 31, 2014 and 2013, depreciation expense was $11,916 and $33,360, respectively. For the nine months ended May 31, 2014 and 2013, depreciation expense was $45,176 and $38,896, respectively.

 

NOTE 6. ACCRUED LIABILITIES AND OTHER PAYABLES

 

Accrued liabilities and other payables consisted of the following:

 

		May 31, 2014				August 31, 2013
		(Unaudited)
Accrued payroll		$	9,221			$	9,783
Professional fees			20,844				—
Other			10,881				2,256
		$	40,946			$	12,039

 

NOTE 7. LEASES

 

The Company leases the office under an eight-year operating lease from an unrelated third party, expiring on June 30, 2017. This lease provides for renewal option. This lease requires the Company to pay the total rent in advance for one year of $43,006 (RMB 264,000).

 

The minimum future rentals under this lease as of May 31, 2014 are as follows:

 

Period Ending
August 31,				Amount
	2014			$	7,168
	2015				43,006
	2016				43,006
	2017				35,838
				$	129,018

 

The Company had an operating lease for another office at a monthly rent of approximately $1,439 that expired on April 22, 2014 and was not renewed.

 

Rent expense for the three months ended May 31, 2014 and 2013 was $12,127 and $11,799, respectively, and for the nine months ended May 31, 2014 and 2013 was $42,271 and $40,352, respectively.

NOTE 8. INCOME TAXES

 

The provision for income taxes consisted of the following:

 

				For the three months ended May 31,								For the nine months ended May 31,
				2014				2013				2014				2013
				(Unaudited)				(Unaudited)				(Unaudited)				(Unaudited)
	Current			$	55,396			$	95,040			$	278,997			$	375,076
	Deferred				—				—				—				—
				$	55,396			$	95,040			$	278,997			$	375,076

 

The Company did not generate any income in the United States or otherwise have any U.S. taxable income. The Company does not believe that it has any U.S. federal income tax liabilities with respect to any transactions that the Company or any of its subsidiaries may have engaged in through May 31, 2014. However, there can be no assurance that the IRS will agree with this position, and therefore the Company ultimately could be liable for U.S. federal income taxes, interest and penalties.

 

NOTE 9. RELATED PARTY TRANSACTIONS

 

From time to time, one majority stockholder has loaned money to the Company, primarily to meet the non-RMB cash requirements. The loans are non-interest bearing and due on demand. The balance of $47,446 and $0 at May 31, 2014 and August 31, 2013, respectively, represents professional and legal fees incurred in the U.S. paid by this stockholder. The balance is reflected as loans from stockholder.

 

NOTE 10. CONTINGENCIES

 

The Company did not file the information report for the year ended December 31, 2013 concerning its interest in foreign bank accounts on form TDF 90-22.1, “Report of Foreign Bank and Financial Accounts” (“FBAR”). Not complying with the FBAR reporting and recordkeeping requirements will subject the Company to civil penalties up to $10,000 for each of its foreign bank accounts. The Company has not determined the amount of any penalties that may be assessed at this time and believes that penalties, if any, that may be assessed would not be material to the consolidated financial statements.

 

NOTE 11. CONCENTRATION OF CREDIT AND BUSINESS RISK

 

Cash and cash equivalents

 

Substantially all of the Company’s assets and bank accounts are in banks located in the PRC and are not covered by protection similar to that provided by the FDIC on funds held in United States banks.

 

 

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULT OF OPERATIONS

 

Overview

 

We conduct our operations through our consolidated affiliate, Fujian Tianfeihong Wine, Co., Ltd. (hereinafter referred to as “Fujian Tianfeihong”).  Fujian Tianfeihong, founded in April 24, 2009, is primarily engaged in distributing a wide variety of fruit wine, including green plum wine, loquat wine, olive wine, and pomegranate wine, to supermarkets and liquor stores. The headquarters of Fujian Tianfeihong are located at 1849 Licheng Middle Avenue, Longqiao Street, Chengxiang District, Putian City, Fujian Province, China.

 

Our U.S parent corporation was incorporated in the state of Delaware on July 28, 2005. Since its inception and until its acquisition of Fanwei Hengchang, the Company was a development stage company without significant assets or any revenue. On August 1, 2013, the Company filed a certificate of amendment to its articles of incorporation, effective on August 9, 2013, to change its name from “Zenitech Corporation” to “China Tianfeihong Wine Inc.” and to effect a 1 for 6  reverse split of its outstanding shares of common stock. Upon the effectiveness of the Reverse Split, the number of outstanding shares of the Company’s common stock decreases from 14,380,266 to 2,396,680 shares. The number of authorized shares of common stock continues to be 80,000,000 shares.

 

Recent Developments

 

Acquisition of Fanwei Hengchang

 

On December 30, 2013, we completed a reverse acquisition transaction through a share exchange with the shareholders of Fanwei Hengchang Co., Ltd. (BVI) (“Fanwei Hengchang”), whereby we acquired 100% of the outstanding shares of Fanwei Hengchang in exchange for a total of 32,000,000 shares of our common stock, representing 93.03% of our issued and outstanding shares of common stock.  As a result of the reverse acquisition, Fanwei Hengchang became our wholly-owned subsidiary and the former Fanwei Hengchang shareholders became our controlling stockholders. The share exchange transaction was treated as a reverse acquisition, with Fanwei Hengchang as the acquirer and the Company as the acquired party for accounting purposes. Unless the context suggests otherwise, when we refer in this report to business and financial information for periods prior to the consummation of the reverse acquisition, we are referring to the business and financial information of Fanwei Hengchang and its consolidated subsidiaries and variable interest entity. 

 

As a result of our acquisition of Fanwei Hengchang, we now own all of the issued and outstanding capital stock of Changshi Tongrong, which in turn owns all of the issued and outstanding capital stock of Changshitong Consulting. In addition, we effectively and substantially control Fujian Tianfeihong through a series of captive agreements with Changshitong Consulting.

 

Fanwei Hengchang was established in the British Virgin Islands on May 29, 2013.  It is a holding company whose sole asset is the capital stock of Changshi Tongrong Limited (Hong Kong), a holding company established in Hong Kong on August 10, 2012 whose sole asset is the registered equity of Changshitong Information Consulting (Shenzhen) Co., Ltd. (“Changshitong Consulting”). Changshitong Consulting was established by Changshi Tongrong as a wholly foreign owned enterprise (the “WFOE”) in the People's Republic of China (“PRC”) on September 23, 2013.

 

Contractual Arrangements with our Controlled Consolidated Affiliate and its Shareholders

 

On November 26, 2013, prior to the reverse acquisition transaction, Changshitong Consulting and Fujian Tianfeihong and its shareholders, Jinxiang Fang and Zhiliang Fang, entered into a series of agreements (the “VIE Agreements”) pursuant to which Fujian Tianfeihong became Changshitong  Consulting’s contractually controlled affiliate. The VIE Agreements included:

 

(1)

an Exclusive Technical Service and Business Consulting Agreement between Changshitong Consulting and Fujian Tianfeihong pursuant to which Changshitong Consulting is to provide technical support and consulting services to Fujian Tianfeihong in exchange for (i) 95% of the total annual net profit of  Fujian Tianfeihong plus (ii) RMB10,000 per month (U.S.$1,623)

 

(2)

a Call Option Agreement among Zhiliang Fang and Jinxiang Fang (together referred to as “Fujian Tianfeihong Shareholders”) and Changshitong Consulting under which the  Fujian Tianfeihong  Shareholders have granted to Changshitong Consulting the irrevocable right and option to acquire all of the equity interests in Fujian Tianfeihong to the extent permitted by PRC law. If PRC law limits the percentage of Fujian Tianfeihong that Changshitong Consulting may purchase at any time, then Changshitong Consulting may repeatedly exercise its option in such increments as may be allowed by PRC law. The exercise price of the option is RMB1.00 ($0.16) or the minimum price permitted by PRC laws if at that time there is any regulatory PRC laws regulating the minimum price. The Fujian Tianfeihong Shareholders agreed to refrain from taking certain actions which might harm the value of Fujian Tianfeihong or Changshitong Consulting’s option;

 

(3)

a Proxy Agreement by Zhiliang Fang, Jinxiang Fang, Changshitong Consulting and Fujian Tianfeihong pursuant to which each of the Fujian Tianfeihong  Shareholders authorizes Changshitong Consulting to designate someone to exercise all of their shareholder decision rights with respect to Fujian Tianfeihong; and

 

(4)

a Share Pledge Agreement among Zhiliang Fang and Jinxiang Fang, Fujian Tianfeihong, and Changshitong Consulting under which the Fujian Tianfeihong Shareholders pledge all of their equity in Fujian Tianfeihong to Changshitong Consulting to guarantee Fujian Tianfeihong’s and its shareholders’ performance of their obligations under the Exclusive Technical Service and Business Consulting Agreement, the Call Option Agreement and the Proxy Agreement.

 

There are risks involved with the operation of our business in reliance on the VIE Agreements, including the risk that the VIE Agreements may be determined by PRC regulators or courts to be unenforceable.  Our PRC counsel has provided a legal opinion that the VIE Agreements are binding and enforceable under PRC law, but has further advised that if the VIE Agreements were for any reason determined to be in breach of any existing or future PRC laws or regulations, the relevant regulatory authorities would have broad discretion in dealing with such breach, including:

 

•	imposing economic penalties;
•	discontinuing or restricting the operations of Changshitong Consulting or Fujian Tianfeihong;
•	imposing conditions or requirements in respect of the VIE Agreements with which Changshitong Consulting or Fujian Tianfeihong may not be able to comply;
•	requiring our company to restructure the relevant ownership structure or operations;
•	taking other regulatory or enforcement actions that could adversely affect our company’s business; and
•	revoking the business licenses and/or the licenses or certificates of Fujian Tianfeihong, and/or voiding the VIE Agreements.

 

Our ability to control Fujian Tianfeihong under the VIE Agreements may not be as effective as direct ownership. We conduct our business in the PRC and currently generate virtually all of our revenues through the VIE Agreements. Our plans for future growth are based substantially on growing the operations of Fujian Tianfeihong.  However, the VIE Agreements may not be as effective in providing us with control over Fujian Tianfeihong as direct ownership.  The VIE Agreements do not provide us with day-to-day control over the operations of Fujian Tianfeihong.  Under the current VIE arrangements, as a legal matter, if Fujian Tianfeihong fails to perform its obligations under these contractual arrangements, we may have to (i) incur substantial costs and resources to enforce such arrangements, and (ii) rely on legal remedies under PRC law, which we cannot be sure would be effective. Therefore, if we are unable to effectively control Fujian Tianfeihong, it may have an adverse effect on our ability to achieve our business objectives and grow our revenues.

 

For accounting purposes, the acquisition of these entities has been treated as a recapitalization with no adjustment to the historical basis of their assets and liabilities.  The restructuring has been accounted for using the “as if” pooling method of accounting and the operations were consolidated as if the restructuring had occurred as of the beginning of the earliest period presented in our consolidated financial statements and the current corporate structure had been in existence throughout the periods covered by our consolidated financial statements.

Results of Operations

 

The following table sets forth key components of our results of operations during the three months periods ended May 31, 2014 and 2013, and the percentage changes between 2014 and 2013.

		May 31,				May 31,
		2014				2013				Change
		$				$				%
Revenue		$	1,415,640			$	1,986,773			$	(29	)%
Cost of goods sold			(972,077	)			(1,321,959	)			(26)	%
Gross profit			443,563				664,814				(33	)%
Selling and marketing expenses			168,077				206,336				(19)	%
General and administrative expenses			58,733				81,567				(28)	%
Total operating expenses			226,810				287,903				(21)	%
Income from operations			216,753				376,911				(42	)%
Other income			4,772				3,250				47	%
Income before provision for income taxes			221,525				380,161				(42	)%
Provision for income taxes			55,396				95,040				(42)	%
Net income			166,129				285,121				(42	)%
Less: Non controlling interests			8,131				14,256				(43	)%
Net income attributable to the company			157,998				270,865				(42	)%
Comprehensive income:
Net income			166,129				285,121				(42	)%
Foreign Currency Translation Adjustment			(41,972	)			141,831				(70)	%
Total comprehensive income		$	124,157			$	426,952				(71	)%

 

The following table sets forth key components of our results of operations during the nine months period ended May 31, 2014 and 2013, and the percentage change between 2014 and 2013.

 

		May 31, 2014				May,31 2013				Change
		$				$				%
Revenue			6,230,213					6,904,576						(1)	(10)%
Cost of goods sold			(4,172,484)					(4,480,828)							(7)%
Gross profit			2,057,729					2,423,748							(15)%
Selling and marketing expenses			677,691					676,148							0.23%
General and administrative expenses			260,168					255,413							2%
Total operating expenses			937,859					931,561							1%
Income from operations			1,119,870					1,492,187							(25)%
Other income			12,404					8,117							53%
Income before provision for income taxes			1,132,274					1,500,304							(25)%
Provision for income taxes			278,997					375,076							(26)%
Net income			853,277					1,125,228					(24)%
Less: Non controlling interests			42,492					56,261						(24		%)
Net income attributable to the company			810,785					1,068,967						(24		%)
Comprehensive income:
Net income			853,277					1,125,228						(24		)%
Foreign currency translation adjustment			67,275					174,166						(61)		%
Total comprehensive income		$	920,552				$	1,299,394						(29		%)

Sales. Our sales declined by 29% from the third quarter of fiscal year 2013 to the third quarter of fiscal 2014, and by 10% from the first nine months of fiscal 2013 to the first nine months of fiscal 2014. That decrease appears to reflect an overall depressed market which resulted in our distributors decreasing their inventories. Our unit sales fell by 6% from the third quarter of fiscal 2013 and slightly increased by 1% from the first nine months of fiscal 2013 to the comparable periods of fiscal 2014. From the third quarter of 2013 to the third quarter of 2014, the average selling price of per case of wine decreased from $41.65 to $39.08. For nine months period ended May 31, 2013 and 2014, the average selling price slightly increased from $39.35 to $39.90.

 

Gross Profit. Our cost of goods sold primarily consists of the cost for wine purchases and the VAT surcharge. In addition, to stimulate new distribution channels, Fujian Tianfeihong has been aggressively offering rewards to customers, so that when the customer contracts to purchase a certain amount, we give the customer a certain amount of free goods, which are recorded as an additional cost of goods sold. Rewards added $95,991 to cost of goods sold during the three months ended May 31, 2014 and $411,215 during the nine months then ended May 31, 2014

 

Our quarter-to-quarter decrease of 6% in unit price exceeded the decrease of 4% in unit costs from the quarter ended May 31, 2013 to the quarter ended May 31, 2014. As a result, our gross margin felt by 33% for the three months periods ended May 31, 2014. For the nine months ended May 31, 2014, although unit prices increased by 1% and unit costs decreased by 5%, our gross margin fell from 35.1% to 33.0%.  The reduction in nine month gross margin occurred because of a discrepancy between U.S. GAAP accounting for customer rewards and the rules by which Value Added Tax is applied to those rewards in China, which resulted in a substantial increase in VAT during the recent nine month period as compared to the prior period.

 

Impact of Exchange Rates. In preparing our financial statements for inclusion in our SEC filings, we translate the elements of our statement of income from Chinese Renminbi to U.S. Dollars using the average exchange rate during the reporting period. Accordingly, our period-to-period comparisons may be influenced by changes in the average exchange rate, resulting in increases or decreases that do not reflect actual changes in operating results. The following table shows the influence of variation in exchange rates on the comparison of our sales, cost of goods sold, and gross profit in three month periods ended May 31, 2014 and 2013 by presenting (a) the results as reported and (b) the results that would have been reported if there had been no decrease in the average exchange rate from the three month period ended May 31, 2013 to the three month period ended May 31, 2014.

 

	As Reported			Modified to a Uniform Exchange Rate (3 months average rate 0.1602 for 2013)
	5/31/14	5/31/13	% Change	5/31/14	5/31/13	% Change
Sales	$1,415,640	$1,986,773	(29%)	$1,397,323	$1,986,773	(30%)
Cost of Goods Sold	972,007	1,321,959	(26%)	959,499	1,321,959	(27%)
Gross Profit	443,563	664,814	(33%)	437,824	664,814	(34%)

 

The following table presents the same analysis, with respect to our results for the nine month periods ended May 31, 2014 and 2013.

 

	As Reported			Modified to a Uniform Exchange Rate (9 months average rate 0.1629)
	5/31/14	5/31/13	% Change	5/31/14	5/31/13	% Change
Sales	6,230,213	$6,904,576	(10%)	$6,149,601	$6,904,576	(11%)
Cost of Goods Sold	4,172,484	4,480,828	(7%)	4,118,496	4,480,828	(8%)
Gross Profit	2,057,729	2,423,748	(15%)	2,031,105	2,423,748	(16%)

 

Selling expenses. Our selling expenses primarily consist of transportation expense, marketing expenses, and any daily expenses incurred for sales function, such as salaries, travelling expenses, entertainment and rent. Our selling expenses increased to $677,691 for the nine months ended May 31, 2014 from $676,148 for the nine months ended May 31, 2013, representing a 0.23% increase. However, during the three months ended on May 31, 2014, selling expense decreased by 19%. In both the nine-month and three-month comparisons the dominant factor was the decrease in transportation expenses due to our reduced sales. Our transportation expenses decreased to $271,554 for the nine months ended May 31, 2014 from $291,973 for the nine months ended May 31, 2013, representing an decrease of $20,419 or 7%, which was offset by increases in several of the other components of selling expense. During the three month period ended May 31, 2014, decreases in transportation costs caused the entire reduction in selling costs.

 

General and administrative expenses. Our general and administrative (“G&A”) expenses primarily consist of office expenses, entertainment expenses, travelling expenses, depreciation expenses, rent and salaries. Our G&A. expenses increased by 2%, to $260,168 for the nine months ended May 31, 2014 from $255,413 for the nine months ended May 31, 2013. Our G&A expenses decreased by 28%, to $58,733 for the three months ended May 31, 2014 from $81,567 for the three months ended May 31, 2013. The changes in G&A expenses occurred in all categories, and were not attributable to any single situation. The reduction in G&A expense in the recent quarter was attributable to our efforts to reduce costs as sales have decreased recently, resulting in reductions in entertainment expenses, office expenses, travelling expenses and, particularly, reduction in the large exhibition expenses that we incurred in fiscal 2013.

 

Other income. Our other income consisted entirely of interest income earned on our bank balances. Due to the increase in our cash position and a modest increase in prevailing interest rates, interest income increased to $12,404 for the nine months ended May 31, 2014 from $8,117 for the nine months ended May 31, 2013, and to $4,772 from $3,250 for the three months ended May 31, 2014 and 2013.

 

Provision for income tax. Due to the 25% decrease in our pre-tax income, our provision for income tax decreased to $278,997 for the nine months ended May 31, 2014 from $375,076 for the May 31, 2013, representing a 26% decrease. For the three months ended May 31, 2014, when our pre-tax income fell by 42%, our provision for income tax decreased to $55,396 from $95,040 for the three months ended May 31, 2013, representing a 42% decrease. Our effective tax rate was the same as the statutory rate of 25% for the nine months ended May 31, 2014 and 2013.   

 

Net income. After deducting the income tax, Fujian Tianfeihong reported net income of $853,277 and $1,125,228 for the nine months ended May 31, 2014 and 2013, respectively, and $166,129 and $285,121 for the three months ended May 31, 2014 and 2013, respectively. The entrusted management agreements assign to Changshitong Consulting only 95% of the net profit generated from Fujian Tianfeihong.  For that reason, we deducted a “non-controlling interest” of $42,492 and $56,261, respectively, and $8,131 and $14,256, respectively, before recognizing net income attributable to the Company on our Consolidated Statements of Operations and Comprehensive Income.  After that deduction and taking into account the income and expenses incurred by the parent corporation, our net income attributable to the Company for the nine months ended May 31, 2014 and 2013 was $878,599 and $1,134,142, respectively, an decrease of 23%, and for the three months ended May 31, 2014 and 2013 was $122,793 and $305,322, respectively, a decrease of 60%.  

 

Foreign Currency Translation Adjustment. Our reporting currency is the U.S. dollar. Our local currency, Renminbi (RMB), is our functional currency. Results of operations and cash flow are translated at average exchange rates during the period being reported upon, and assets and liabilities are translated at the unified exchange rate as quoted by the People’s Bank of China at the end of the period. Translation adjustments resulting from this process are included in accumulated other comprehensive income in the statement of shareholders’ equity. Transaction gains and losses that arise from exchange rate fluctuations on transactions denominated in a currency other than the functional currency are included in the results of operations as incurred. RMB is not freely convertible into the currency of other nations. All such exchange transactions must take place through authorized institutions. There is no guarantee the RMB amounts could have been, or could be, converted into US dollars at rates used in translation. For the nine months ended May 31, 2014 and 2013, and for the three months ended May 31, 2014 and 2013, foreign currency translation adjustments of $67,275 and $174,166, respectively, and ($41,972) and $141,831, respectively, have been reported as other comprehensive income in the consolidated statements of income and other comprehensive income.

 

Liquidity and Capital Resources

 

As of May 31, 2014, our working capital totaled $5,160,059, an increase of $880,614 since August 31, 2013.  The increase is approximately equal to our net income for the nine months ended May 31, 2014, due to the fact that we have very little in fixed or intangible assets on our balance sheet and so record very little depreciation or amortization expense. Cash and cash equivalents represented almost 86% of our current assets at May 31, 2014. 

 

Since our operations provided $838,126 in cash during the nine months ended May 31, 2014, and have been cash flow positive for the past two years, we believe that our liquid assets are adequate to finance our operations for the foreseeable future.

 

The following table sets forth a summary of our cash flows for the periods indicated:

Cash Flow

(all amounts in U.S. dollars)

 

		Nine Months   Ended  May 31,  2014				Nine Months  Ended  May 31,  2013
Net cash provided by (used in) operating activities		$	838,126			$	1,119,450
Net cash provided by (used in) investing activities			(850	)			—
Net cash provided by (used in) financing activities			46,480				557,200
Effects of Exchange Rate Change in Cash			(16,023	)			83,943
Net  Increase in Cash and Cash Equivalents			867,733				1,760,593
Cash and Cash Equivalent at Beginning of the Period			3,994,502				1,908,784
Cash and Cash Equivalent at End of the Period		$	4,862,235			$	3,669,337

 

Operating activities

 

Cash provided by operating activities was $838,126 for the nine months ended May 31, 2014, as compared to $1,119,450 for the nine months ended May 31, 2013. In both periods, cash provided by operations was approximately equal to net income, as we record little depreciation and amortization and control our cash flow by balancing accounts payable against changes in our accounts receivable and inventory. 

 

Investing activities

 

Cash used in investing activities for nine months ended May 31, 2014 was $850 used for the purchase of equipment. We did not have any investing activities for the nine months ended May 31, 2013. The net book value of our fixed assets at May 31, 2014 was $59,819, reflecting the fact that our business activities do not need significant fixed assets.  Accordingly, unless we expand our business activities in the future, investing activities will involve similarly insignificant amounts of cash.

 

Financing activities

 

Cash provided by financing activities was $46,480 for the nine months ended May 31, 2014 which represented a loan from related party. From time to time, we will take modest loans from related parties, primarily to provide the dollars needed to pay expenses incurred by our parent company in the U.S.

During the nine months ended May 31, 2013, our financing activities consisted of a $557,200 capital contribution by a stockholder. The contribution was made to the registered capital of Fujian Tianfeihong Wine Co., Ltd., and represented funds in excess of the contribution to capital required by Chinese law. The contribution was made in order to demonstrate the financial strength of Fujian Tianfeihong Wine Co., Ltd. to potential suppliers and customers.

 

Because of our ample cash position and the profitability of our operations, we do not anticipate incurring significant additional debt.  Therefore, our liquidity should be adequate to sustain the full implementation of our business plan for the foreseeable future.

 

Transfer of Cash

 

All of our sales are generated by Fujian Tianfeihong in the PRC, and 95% of the net income is then assigned to Changshitong Consulting. PRC regulations restrict the ability of our PRC subsidiary, Changshitong Consulting, to make dividend and other payments to its offshore parent company.  PRC legal restrictions permit payments of dividends by our PRC subsidiary only out of its accumulated after-tax profits, if any, determined in accordance with PRC accounting standards and regulations.  Our PRC subsidiary is also required under PRC laws and regulations to allocate at least 10% of its annual after-tax profits determined in accordance with PRC GAAP to a statutory general reserve fund until the amount of said fund reaches 50% of its registered capital. Allocations to this statutory reserve fund can only be used for specific purposes and are not transferable to us in the form of loans, advances or cash dividends. Any limitations on the ability of our PRC subsidiary to transfer funds to us could materially and adversely limit our ability to grow, make investments or acquisitions that could be beneficial to our business, pay dividends and otherwise fund and conduct our business.

 

The Chinese government strictly regulates conversion of RMB into foreign currencies.  Currently, Fujian Tianfeihong and Changshitong Consulting may purchase foreign currencies for settlement of current account transactions, including payments of dividends to us, without the approval of the State Administration of Foreign Exchange (“SAFE”), by complying with certain procedural requirements. Pursuant to applicable Chinese laws and regulations, foreign invested enterprises incorporated in China, such as Changshitong Consulting, are required to apply for “Foreign Exchange Registration Certificates.” Currently, conversion within the scope of the “current account” (e.g. remittance of foreign currencies for payment of dividends, trade and service-related foreign exchange transactions, etc.) can be effected without requiring the approval of SAFE, but must be effected through authorized Chinese banks in accordance with regulatory procedures. However, conversion of currency in the “capital account” (e.g. for capital items such as direct investments, loans, securities, etc.) still requires the approval of SAFE. Compliance with those procedural requirements can result in delays in obtaining foreign exchange, which could interfere with offshore activities by the Company, such as acquisitions, offshore investments, or the payment of dividends to the Company’s shareholders.  

 

Chinese regulations also limit the ability of our parent company to transfer money into China, as needed to fund the operations of Fujian Tianfeihong.  If in the future, China Tianfeihong raises funds and wishes to utilize them in the operations of Fujian Tianfeihong, one of the following methods will have to be employed:

 

1.

Acquisition.  China Tianfeihong could transfer capital to Fujian Tianfeihong by causing its Hong Kong subsidiary, Changshi Tongrong Limited, to apply to MOFCOM for approval of an acquisition of Fujian Tianfeihong by Changshi Tongrong Limited.  MOFCOM would approve such an acquisition only after a lengthy review process, and only if it determined that the price paid by Changshi Tongrong Limited for Fujian Tianfeihong represented a commercially fair price.

 

2.

Joint venture.  If China Tianfeihong Wine, Inc. obtained capital that was less than the purchase price for Fujian Tianfeihong deemed acceptable by MOFCOM, Changshi Tongrong Limited could still inject the funds into Fujian Tianfeihong by complying with the provisions of the PRC Sino-Foreign Equity Joint Venture Law.  To accomplish this capital transfer, we would be required to apply to the Chinese government for approval to convert Fujian Tianfeihong into an equity joint venture, in which Changshi Tongrong Limited would be its equity joint venturer. If approved, Changshi Tongrong would then own a portion of the equity in Fujian Tianfeihong, and the VIE agreements between Fujian Tianfeihong and Changshitong Consulting would be modified accordingly to reduce the portion of net income payable by Fujian Tianfeihong to Changshitong Consulting.

We have no current plans for China Tianfeihong Wine, Inc. to fund Fujian Tianfeihong, and expect the VIE structure to remain in place for the foreseeable future.

 

Off-Balance Sheet Arrangements

We do not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition or results of operations.

 

Recent accounting pronouncements

There were no recent accounting pronouncements that have or will have a material effect on the Company’s financial position or results of operations.

 

ITEM 3 QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

Not applicable.

 

ITEM 4.   CONTROLS AND PROCEDURES

 

Evaluation of Disclosure Controls and Procedures.  Our Chief Executive Officer and Chief Financial Officer carried out an evaluation of the effectiveness of the Company’s disclosure controls and procedures (as defined in Rule13a-15(e) promulgated by the Securities and Exchange Commission) as of May 31, 2014. The evaluation revealed that there are material weaknesses in our disclosure controls, specifically:

 

• The relatively small number of employees who are responsible for accounting functions prevents us from segregating duties within our internal control system.
• Our accounting personnel lack expertise in identifying and addressing complex accounting issues under U.S. Generally Accepted Accounting Principles.

 

Based on their evaluation, our Chief Executive Officer and Chief Financial Officer concluded that the Company’s system of disclosure controls and procedures was not effective as of May 31, 2014.

 

Changes in Internal Controls.  There was no change in internal controls over financial reporting (as defined in Rule 13a-15(f) promulgated under the Securities Exchange Act or 1934) identified in connection with the evaluation described in the preceding paragraph that occurred during the Company’s second fiscal quarter that has materially affected or is reasonably likely to materially affect the Company’s internal control over financial reporting.

 

 PART II   -   OTHER INFORMATION

 

Item 1. Legal Proceedings

None.

Item 1A Risk Factors

There have been no material changes from the risk factors included in Amendment No. 1 to our Current Report on Form 8-K filed on March 26, 2014.

 

Item 2. Unregistered Sale of Securities and Use of Proceeds

 

(a) Unregistered sales of equity securities

 

None.

 

(c) Purchases of equity securities

 

The Company did not repurchase any of its equity securities that were registered under Section 12 of the Securities Exchange Act during the 3^rd quarter of fiscal 2014.

 

Item 3. Defaults Upon Senior Securities.

None.

 

Item 4. Mine Safety Disclosures

None.

 

Item 5. Other Information.

None.

 

Item 6.	Exhibits
31.1	Rule 13a-14(a) Certification – CEO
31.2	Rule 13a-14(a) Certification – CFO
32	Rule 13a-14(b) Certification
101.INS	XBRL Instance
101.SCH	XBRL Schema
101.CAL	XBRL Calculation
101.DEF	XBRL Definition
101.LAB	XBRL Label
101.PRE	XBRL Presentation

 

SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned thereunto duly authorized.

    

CHINA TIANFEIHONG WINE, INC.

 

Date: July 21, 2014	By: /s/ Zhiliang Fang
	Zhiliang Fang, Chief Executive Officer
	By: /s/ Lirong Zheng
	Lirong Zheng, Chief Financial Officer, Chief Accounting Officer