ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Forward Looking Statements
This
Annual Report on Form 10-K and other reports filed by the Company from time to time with the Securities and Exchange Commission
(collectively, the “Filings”) contain or may contain forward-looking statements and information that are based upon
beliefs of, and information currently available to, the Company’s management as well as estimates and assumptions made by
Company’s management. Readers are cautioned not to place undue reliance on these forward-looking statements, which are only
predictions and speak only as of the date hereof. When used in the Filings, the words “anticipate”, “believe”,
“estimate”, “expect”, “future”, “intend”, “plan”, or the negative of
these terms and similar expressions as they relate to the Company or the Company’s management identify forward-looking statements.
Such statements reflect the current view of the Company with respect to future events and are subject to risks, uncertainties,
assumptions, and other factors (including the risks contained in the section of this report entitled “Risk Factors”)
relating to the Company’s industry, and the Company’s operations and results of operations. Should one or more of these
risks or uncertainties materialize, or should the underlying assumptions prove incorrect, actual results may differ significantly
from those anticipated believed, estimated, expected, intended, or planned.
Although
the Company believes that the expectations reflected in the forward-looking statements are reasonable, the Company cannot guarantee
future results, levels of activity, performance, or achievements. Except as required by applicable law, including the securities
laws of the United States, the Company does not intend to update any of the forward-looking statements to conform these statements
to actual results. Readers are urged to carefully review and consider the various disclosures made throughout the entirety of this
quarterly report, which attempt to advise interest parties of the risks and factors that may affect our business, financial condition,
results of operations, and prospects.
Our
financial statements are prepared in accordance with U.S. GAAP. These accounting principles require us to make certain estimates,
judgments and assumptions. We believe that the estimates, judgments and assumptions upon which are relied are reasonable based
upon information available to us at the time that these estimates, judgments and assumptions are made. These estimates, judgments
and assumptions can affect the reported amounts of assets and liabilities as of the date of the financial statements as well as
the reported amounts of expenses during the periods presented. Our financial statements would be affected to the extent there are
material differences between these estimates and actual results. In many cases, the accounting treatment of a particular transaction
is specifically dictated by U.S. GAAP and does not require management’s judgment in its application. There are also areas
in which management’s judgment in selecting any available alternative would not produce a materially different result.
Accounting Policy
of Revenue Recognition
The Company currently provides online game
services in the PRC and recognizes revenue in accordance to the criteria of ASC subtopic 605 (“ASC 605”), Revenue Recognition
when persuasive evidence of an arrangement exists, the service has been rendered, the sales price is fixed or determinable, and
collectability is reasonably assured. Online game revenues include our MMOG operations and Co-operation Web-based game revenues.
MMOG operations
The Company operates Massively Multiplayer
Online Role-Playing Games (“MMORPG”) under a free-to-play model. The online game revenue derives from the sale of in-game
virtual items and revenue was recognized pursuant to the item-based revenue model.
Under the item-based model, players are
able to play the basic features of the game for free. We generate revenues when players purchase virtual items that enhance their
playing experience, such as weapons, clothing, accessories and pets. The item-based revenue model allows us to introduce new virtual
items or change the features or properties of virtual items to enhance game player interaction and create a better game community.
The Company sells prepaid cards, in both
virtual and physical forms, to third party distributors who in turn sell the prepaid cards to end customers. The prepaid cards
provide customers with a pre-specified number of game points for consumption. All prepaid cards sold to distributors require upfront
advance cash payments. The prepaid game cards entitle end users to purchase virtual items in the Company’s online games.
Prepaid cards will expire two years after the date of card production if they have never been activated. The proceeds from the
expired game cards are recognized as revenue upon expiration of cards. In contrast, once the prepaid cards are activated and credited
to a player’s personal game account, they will not expire as long as the personal game account remains active. The personal
game account will always remain active before the game stop operating.
The end users also could choose bank recharge
method directly to exchange Santaro currency (“Long Bi”) or game currency of 108 warriors (“Silver”) through
third-party payment platforms.
All proceeds received from distributors
or through direct online payment systems are deferred when received, revenues are recognized over estimated life of the virtual
items that game players purchase or as the virtual items are consumed. The below description are the detailed revenue recognition
method adopted by the company.
Instant
consumption mode is used when users purchase instant services or items with Silver. And as that service or item will be immediately
consumed right after the Silver is paid by the user, therefore the reflected RMB value (from equivalent Silver) can be confirmed
and recorded as revenue after the completion of the purchase (exchange Long Bi for Silver) by the user.
Limited
consumption mode is used when users purchase the items or services with limited effective time. This type of items or services
will be fully consumed by the end of the effective time. Therefore the reflected RMB value of that purchase will be confirmed as
revenue after the item or service has been fully consumed (expired).
Apportioned
consumption mode is used for perpetual virtual items and services, which can be used unlimited times through their estimated life
spans. The delivery criterion for perpetual virtual items is generally met ratably over the expected delivery obligation period,
which, in this case, is the estimated life of the perpetual virtual items purchased. Revenue is recognized proportionately over
the estimated life spans which are based on data related to paying game player usage patterns for each category of virtual item.
The game log, which records the whole process of a specific item or service being purchased and consumed, will be used periodically
to readjust the estimation on perpetual virtual items’ life spans.
Co-operation Web-based game
As the operator, the Company signed distribution
agreements with third-party developers to offer the games to users on its websites or platforms. Although the company is the party
that signs the user agreement with its users and is responsible for its users’ experience on its Websites or platforms, its
remaining obligation is deemed to be inconsequential and perfunctory after the end users recharge to exchange the game coins of
these web-based games. Besides, the third party developers obliged to provide on-going services to users, so a proportion of the
full revenue received from end users is recorded as revenue according to the distribution agreements.
Results of Operations
Because
the Company is in the development stage, our operations have been limited to developing our products. As a result, the
Company only has generated an insignificant amount of revenue during the period from August 9, 2006, its inception, through December
31, 2012. The Company’s business, financial condition and results of operations may be influenced by the political, economic
and legal environments in the PRC such as 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.
The
following table sets forth a summary, for the periods indicated, our consolidated results of operations. Our historical results
presented below are not necessarily indicative of the results that may be expected for any future period.
|
|
Years Ended December 31,
|
|
|
|
2012
|
|
|
2011
|
|
|
|
|
|
|
|
|
Revenue
|
|
$
|
27,571
|
|
|
$
|
-
|
|
Cost of revenue
|
|
|
693,059
|
|
|
|
-
|
|
Gross loss
|
|
|
(665,488
|
)
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
Operating expenses
|
|
|
|
|
|
|
|
|
Research and development expenses
|
|
|
2,683,443
|
|
|
|
2,439,991
|
|
Sales and marketing expenses
|
|
|
362,145
|
|
|
|
21,280
|
|
General and administrative expenses
|
|
|
1,409,898
|
|
|
|
1,312,272
|
|
Total operating expenses
|
|
|
4,455,486
|
|
|
|
3,773,543
|
|
|
|
|
|
|
|
|
|
|
Loss from operations
|
|
|
(5,120,974
|
)
|
|
|
(3,773,543
|
)
|
|
|
|
|
|
|
|
|
|
Gain on deconsolidation of subsidiary
|
|
|
(15,823
|
)
|
|
|
-
|
|
Non-operating (income) expenses
|
|
|
(7,020
|
)
|
|
|
925
|
|
|
|
|
|
|
|
|
|
|
Net loss
|
|
$
|
(5,098,131
|
)
|
|
$
|
(3,774,468
|
)
|
Revenue
For
the year ended December 31, 2012, revenues were $27,571, representing an increase of $27,571, compared to $0 for
the corresponding period in 2011.The increase in net revenues from online games was primarily due to the revenue
contribution from 108 Warriors an MMORPG launched in the third quarter of 2012, with an amount of $19,343. The Company
also generated a minor revenue from web games during the year ended December 31, 2012.
Cost of revenue
For
the year ended December 31, 2012, cost of revenues were $693,059, representing an increase of $693,059, compared to $0 for the
corresponding period in 2011. The increase in cost of revenues from online games was primarily due to the cost from 108 Warriors.
Gross loss
As
a result of the foregoing, our gross loss for the year ended December 31, 2012 was $(665,488) from $0 in the same period
of 2011. The reason for the negative gross profit was due to the new game 108 Warriors. Because the game was in introduction stage, the Company needed to spend more costs to launch and
operate this new game. These costs were primary composed by salaries of operation staffs, depreciations of the operation
equipments, and advertisement fees.
Research and Development
(R&D) expenses
R&D
expenses primarily consist of R&D employee salary, rent expenses, social assurance,
depreciation, service fee, property management fee and testing fee for R&D activities.
For the year ended December 31, 2012, R&D expenses were $2,683,443
, representing
an increase of $243,452 or 9.98%, compared to $
2,439,991
for the corresponding period
in 2011. The increase was primarily because rent expenses increased by $326,814 due to an increase in rental fee charge for a newly
rented Beijing office, service fee increased by $155,578,
consisting of $150,995 paid for outsourcing services required
by “Heroes of Sango, 108 Warriors and Demon Sword” development,
depreciation
increased by $76,550, property management fee increased by $80,548 and social assurance increased by $30,268 compared to the same
period of 2011. R&D employee salary decreased by $396,576 and design fee decreased by $47,139 compared to the corresponding
period of 2011, which was due to the Company changed part of “MMORPG” to web games to better meet customer demand,
since the technique requirement of Web game is lower than the “MMORPG”, the Company fired several junior technicians
to save labor cost and improve operational ability. Other variances include expenses for office, business entertainment, business
travelling, communication, water and electricity, sundries, computer accessories, etc., presenting a slight increase, accumulated
about $17,409.
Sales and marketing
expenses
Selling
expenses mainly represented selling employee salaries, advertising & promotion fees and water & electricity fees. For the year
ended December 31, 2012, selling expenses were $
362,145
, representing an increase
of $340,865 or 1,601.81% compared to $
21,280
for the corresponding period in 2011.
The increase was mainly due to increases in selling employee salaries, which increased by $198,171 due to the launch of 108 Warriors, and for the same reason, advertising & promotion fee was also increased by $117,560, besides,
water & electricity fee increased by $9,519. Meanwhile, car expenses decreased by $4,903 compared with the corresponding period.
Other miscellaneous fees increased by $20,518.
General and administrative
expenses
General
and administrative expenses consisted primarily of
G&A employee salaries, professional services fees, social insurance and
depreciation.
For the year ended December 31, 2012, total general and administrative expenses
were $1,409,898, representing an increase of $97,626 or approximately 7.44% as compared to $1,312,272 for the corresponding period
in 2011. The increase was due to increases in professional service fee, which increased by $167,476, in communication fee, which
increased by $19,636, in depreciation, which increased by $44,823, compared to the same period in 2011, respectively. Meanwhile,
office renovation costs decreased by $37,072, service fee decreased by $28,161, social insurance decreased by $27,094, rent expenses
decreased by $25,565, and office expenses decreased by $26,051, compared to the same period in 2011, respectively.
The increase
of $167,476 in professional service fee was due to the payment of audit fees for the Company’s 2011 annual audit and the
auditors’ review fees of the Company’s quarterly reports of 2012 and other professional consulting fees paid in connection
with the Sarbanes-Oxley Act of 2002 (“SOX”)
. Other variances include expenses
occurred for G&A employee salaries, membership expenses, travelling expenses, and welfare expenses, etc, presenting a slight increase,
accumulated at approximately $9,634.
Net loss
For
the year ended December 31, 2012, net loss increased to $
5,098,131
from $
3,774,468
for the corresponding period in 2011. The increase in net loss was primarily due to increases in cost of revenues, R&D expenses,
sales and marketing expenses and G&A expenses.
Liquidity and Capital
Resources
For the fiscal years 2012 and 2011, we
met our working capital requirement mainly by using cash flows from related parties.
We anticipate
that the existing cash and cash equivalents on hand, together with the net cash flows supported by related parties, will be sufficient
to meet our working capital requirements for our on-going projects and to sustain the business operations for the next twelve months.
Since
we initiated our business operations, we have been funded primarily by related parties. During the past two years, Mr. Zhilian
Chen, our Chairman, and CixiYide Auto Co., Ltd. (“CixiYide”), a company 100% beneficially owned by Mr. Chen,
provided
continuous financial support to
the Company. As of December 31, 2011, the total amount of the balance of the loan that had
been provided by CixiYide was $1,577,639, and the balance of the loan from Mr. Zhilian Chen was $154,720. As of December 31, 2012,
CixiYide and Mr. Zhilian Chen had provided the Company loans in the aggregate amount of $4,222,732 and $170,589, respectively.
Going concern and Liquidity
The
accompanying financial statements are presented on a going concern basis. The Company is in a development stage and
only
generated an insignificant amount of revenue during the period from its inception (August 9, 2006) to December 31, 2012.
The
company has recurring net losses and negative cash flows from operations and has been dependent on debt and equity financing. The
Company has an accumulated deficit of $
14,628,454 as of December 31, 2012
.
During
the year ended December 31, 2011, the Company obtained funding in the amount of $4,750,000 from the issuance of 2,375,000 shares
of our common stock, and warrants to purchase a total of 1,187,500 shares of our common stock.
On December 5, 2011, Mr. Zhilian Chen converted parts of the loan provided by CixiYide to Beijing Sntaro, i.e., $4,626,818
(RMB 29,260,000), into the registered capital of Beijing Sntaro by the way of subscribing for the increased capital of Beijing
Sntaro and then let Beijing Sntaro to pay back the increased capital to CixiYide. There can be no assurance that the Company will
be able to obtain additional debt or equity financing on terms acceptable to it, or if at all. Management plans to fund continuing
operations through new financing from related parties and equity financing arrangements. These factors raise substantial doubt
about our ability to continue as a going concern.
Cash
Flows
|
|
Years ended December 31,
|
|
|
|
2012
|
|
|
2011
|
|
|
|
|
|
|
|
|
Net cash used in operating activities
|
|
$
|
(4,418,714
|
)
|
|
$
|
(3,578,700
|
)
|
Net cash used in investing activities
|
|
|
(205,565
|
)
|
|
|
(402,008
|
)
|
Net cash provided by financing activities
|
|
|
2,631,412
|
|
|
|
5,711,309
|
|
Effect of foreign currency exchange rate changes on cash and cash equivalents
|
|
|
13,759
|
|
|
|
(22,076
|
)
|
Net (decrease) increase in cash and cash equivalents
|
|
$
|
(1,979,108
|
)
|
|
$
|
1,708,525
|
|
Net
cash used in operating activities:
The Company had insignificant amount of revenue from its inception in 2006
to December 31, 2012.
Our net cash used in operating activities increased by $840,014 in
the year ended December 31, 2012 compared to that in the year ended December 31, 2011, representing an increase of 23.47%. Most
operating cash flow is the result of cash-paid expenditure during operation. The increase of net cash used in operating activities
was due to increases in salary expense,
rent expense and professional service fee.
Since the Company will complete its R&D of
Heroes of Sango and Demon Sword, and also in order to cope with the release
of the Company’s new game 108 warriors
, the Company hired more high level staffs for
the preparation of operating. Rent expenses increased due to the payment for a newly rented Beijing office. And
professional
service fee increased due to the payment of audit fees for the Company’s 2011 annual audit and the auditors’ review
fees of the Company’s quarterly reports of 2012 and other professional consulting fees paid in connection with the Sarbanes-Oxley
Act of 2002 (“SOX”).
Net
cash used in investing activities:
Our net cash used in investing activities
decreased by $196,443 in the year ended December 31, 2012 compared to that in the year ended December 31, 2011. The decrease in
net cash used in investing activities was the result of a decrease in the purchasing of new equipment with an amount of $154,660,
and the decrease in intangibles with an amount of $25,960 during the year ended December 31, 2012.
Net
cash provided by financing activities:
Our cash provided by financing
activities significantly decreased from $5,711,309 for the year ended December 31, 2011 to $2,631,412 for the year ended December
31, 2012, representing a decrease of 53.93%. The current financed capital could not support current operation and product development.
Through December 31, 2012, CixiYide Auto Company, which is 100% beneficially owned by Mr. Zhilian Chen, continuously provides financial
support.
Working capital
We
have working capital deficit of $(4,927,588) as of December 31, 2012, compared with working capital of
$228,657 as of December
31, 2011, representing an increase of deficit of 2255%.
The significant change in working
capital is due to the development stage of the Company’s games.
Because the Company’s games only produced insignificant
amount of revenue, the Company had to obtain loans to support daily operations.
Beijing
Sntaro, a subsidiary of the Company, obtained loans in the amount of $1,577,639 in the aggregate as of December 31, 2011 from CixiYide.
As of December 31, 2012, the Company accumulatively obtained loans in the amount of $4,393,321 from CixiYide and Mr. Zhilian Chen.
On December 5, 2011, Mr. Zhilian Chen converted parts of the loan provided by CixiYide to Beijing Sntaro, i.e., $4,626,818 (RMB
29,260,000), into the registered capital of Beijing Sntaro by the way of subscribing for the increased capital of Beijing Sntaro
and then let Beijing Sntaro to pay back the increased capital to CixiYide.
The Company also received proceeds in the aggregate
of $4.75 million upon the issuance of 2.375 million shares of common stock and warrants to purchase up to 1,187,500 shares of our
common stock in 2011.
Description of Property
The
Company’s property and equipment consisted wholly of computer equipment, leasehold improvements, and furniture. The book value
of the Company’s property and equipment was $
556,884
as of December 31, 2012.
Employees
As of December 31, 2012, t
he
Company employed approximately 103 designers and programmers. The majority of employees have three to five years’
of experience in the online games industry.
Competition
for talented and well-educated professionals is intense among local online gaming companies. Management has set up an attractive
work environment to stimulate employee creativity. A career advancement program has been prepared to provide opportunities for
employees to receive additional training and promotion.
Recent issued accounting
pronouncements
The
Company does not believe any recently issued but not yet effective accounting standards, if currently adopted, would have a material
effect of the consolidated financial position, results of operation and cash flows.
Off-Balance Sheet
Arrangements
The
Company does not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect
on its financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that
are material.
Additional Disclosure
In July 2006, the Ministry
of Industry and Information Technology of the PRC, or MIIT, issued the Circular on Strengthening the Administration of Foreign
Investment in and Operation of Value-added Telecommunications Business, or the MIIT Circular. The MIIT Circular reiterated the
regulations on foreign investment in telecommunications businesses, which require foreign investors to set up foreign-invested
enterprises and obtain a business operating license for Internet content provision to conduct any value-added telecommunications
business in China. Under the MIIT Circular, a domestic company that holds an Internet content provision license is prohibited from
leasing, transferring or selling the license to foreign investors in any form, and from providing any assistance, including providing
resources, sites or facilities, to foreign investors that conduct value-added telecommunications business illegally in China. Furthermore,
the relevant trademarks and domain names that are used in the value-added telecommunications business must be owned by the local
Internet content provision license holder. Due to a lack of interpretative materials from the regulator, it is unclear what impact
the MIIT Circular will have on us or the other Chinese Internet companies that have adopted the same or similar corporate and contractual
structures as ours.
On September 28, 2009,
the General Administration of Press and Publications, or the GAPP, the National Copyright Administration (hereinafter referred
to as “NCA”), and National Office of Combating Pornography and Illegal Publications (hereinafter referred to as “NOCPIP”)
jointly published the “Stipulations on ‘Three Provisions’ ” of the State Council and the Relevant Interpretations
of the State Commission Office for Public Sector Reform and the Further Strengthening of the Administration of Pre-examination
and Approval of Online games and the Examination and Approval of Imported Online games (Xin Chu Lian [2009] No. 13), or Circular
13. Circular 13 restates the general principle espoused in recently promulgated regulations that foreign investment is not permitted
in online game operating businesses in China. According to the Article IV of Circular 13, foreign investors are prohibited from
participating in online game operating businesses via wholly owned, equity joint venture or cooperative joint venture investments
in China, and from controlling and participating in such businesses directly or indirectly through contractual or technical support
arrangements. In the event of a violation of these provisions, GAPP shall, in conjunction with the relevant government authorities
of the PRC, investigate and handle the same in accordance with the law. In serious cases, the relevant licenses and registrations
shall be revoked. However, due to the lack of a detailed interpretation of Circular 13, it is not yet clear how it will be implemented.
Moreover, Circular 13 was issued solely by GAPP, NCA and NOCPIP, instead of being jointly issued by the publication administration
authorities and other government authorities which are in charge of the related business operations, like the Ministry of Commerce,
or the MOFCOM, and the MIIT, and the scope, implementation and enforcement of Circular 13 from the views of the above mentioned
other authorities remain uncertain.
In the opinion of Han
Kun Law Offices, our PRC legal counsel, subject to the interpretation and implementation of the MIIT Circular and Circular 13,
the ownership structure of Ningbo Sntaro and Beijing Sntaro and our contractual arrangements with Beijing Sntaro and its shareholders
comply with all existing PRC laws, rules and regulations. However, in the opinion of our PRC legal counsel, there are substantial
uncertainties regarding the interpretation and application of current or future PRC laws and regulations and there may be changes
and other developments in the PRC laws and regulations or their interpretations. Accordingly, we cannot give assurance that the
Chinese government authorities will ultimately take a view that is consistent with the opinion of our PRC legal counsel.
If the past or current
ownership structures, contractual arrangements and businesses of our company Beijing Sntaro is found to be in violation of any
existing or future PRC laws or regulations, including the MIIT Circular and Circular 13, the relevant supervisory authorities would
have broad discretion in dealing with such violations, including but not limited to: revoking our business and operating licenses;
levying fines; confiscating our income or the income of Beijing Sntaro; shutting down our servers or blocking our website; imposing
conditions or requirements with which we may not be able to comply; requiring us to restructure the relevant ownership structure,
operations or contractual arrangements; restricting or prohibiting our use of the proceeds from our public offering to finance
our business and operations in China; and taking other regulatory or enforcement actions that could be harmful to our business.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY
DATA
SANTARO INTERACTIVE ENTERTAINMENT COMPANY
CONSOLIDATED AUDITED FINANCIAL STATEMENTS
AS OF DECEMBER 31, 2012
SANTARO INTERACTIVE ENTERTAINMENT COMPANY
AND SUBSIDIARIES
CONTENTS
|
Pages
|
Report of Independent Registered Public Accounting Firm
|
F1
|
Consolidated Balance Sheets
|
F2
|
Consolidated Statements of Operations and Comprehensive Loss
|
F3
|
Consolidated Statements of Changes in Stockholders' Equity (Deficit)
|
F4
|
Consolidated Statements of Cash Flows
|
F5
|
Notes to Consolidated Audited Financial Statements
|
F6 - F19
|
Report of Independent Registered Public
Accounting Firm
To the Board of Directors and Shareholders of
Santaro Interactive Entertainment Company
We have audited the accompanying consolidated
balance sheets of Santaro Interactive Entertainment Company and its subsidiaries (A development stage company) (the “Company”)
as of December 31, 2012 and 2011, and the related consolidated statements of operations and comprehensive loss, changes in stockholders’
equity (deficit), and cash flows for the years then ended and for the period from August 9, 2006 (Inception) through December 31,
2012. The Company’s management is responsible for these consolidated financial statements. Our responsibility is to express
an opinion on these financial statements based on our audits.
We conducted our audits in accordance with
generally accepted auditing standards as established by the Auditing Standards Board (United States) and in accordance with the
auditing standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company
is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits
included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate
in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control
over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable
basis for our opinion.
In our opinion, the consolidated financial
statements referred to above present fairly, in all material respects, the consolidated financial position of the Company as of
December 31, 2012 and 2011, and the consolidated results of their operations and its cash flows for the years then ended and for
the period from August 9, 2006 (Inception) through December 31, 2012, in conformity with accounting principles generally accepted
in the United States of America.
The accompanying consolidated financial
statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 2, the Company has
incurred significant losses from operations for the years ended December 31, 2012 and 2011, and has a working capital deficiency.
These conditions raise substantial doubt about the Company’s ability to continue as a going concern. Management’s plans
in regard to these matters are also described in Note 2. The consolidated financial statements do not include any adjustments that
might result from the outcome of this uncertainty.
/S/ Marcum Bernstein & Pinchuk LLP
New York, New York
March 29, 2013
Santaro
Interactive Entertainment Company
(A
Development Stage Company)
Consolidated
Balance Sheets
|
|
December 31,
|
|
|
|
2012
|
|
|
2011
|
|
ASSETS
|
|
|
|
|
|
|
|
|
Current assets
|
|
|
|
|
|
|
|
|
Cash and cash equivalents
|
|
$
|
49,504
|
|
|
$
|
2,028,612
|
|
Prepaid expenses
|
|
|
4,751
|
|
|
|
322,580
|
|
Other receivables
|
|
|
10,592
|
|
|
|
156,268
|
|
|
|
|
|
|
|
|
|
|
Total current assets
|
|
|
64,847
|
|
|
|
2,507,460
|
|
|
|
|
|
|
|
|
|
|
Property and equipment, net
|
|
|
556,884
|
|
|
|
494,412
|
|
Long term investment
|
|
|
644
|
|
|
|
644
|
|
Intangibles, net
|
|
|
31,575
|
|
|
|
33,272
|
|
|
|
|
|
|
|
|
|
|
Total Assets
|
|
$
|
653,950
|
|
|
$
|
3,035,788
|
|
|
|
|
|
|
|
|
|
|
LIABILITIES AND STOCKHOLDERS’ (DEFICIT) EQUITY
|
|
|
|
|
|
|
|
|
Current liabilities
|
|
|
|
|
|
|
|
|
Advance from Customers
|
|
$
|
79,861
|
|
|
$
|
-
|
|
Taxes payable
|
|
|
737
|
|
|
|
-
|
|
Deferred revenue
|
|
|
17,461
|
|
|
|
-
|
|
Other payables and accrued expenses
|
|
|
467,976
|
|
|
|
533,034
|
|
Due to related parties
|
|
|
4,426,400
|
|
|
|
1,745,769
|
|
|
|
|
|
|
|
|
|
|
Total current liabilities
|
|
|
4,992,435
|
|
|
|
2,278,803
|
|
Commitments and contingencies
|
|
|
|
|
|
|
|
|
STOCKHOLDERS’ (DEFICIT) EQUITY
|
|
|
|
|
|
|
|
|
Common stock ($0.001 par value; authorized –100,000,000 shares; issued and outstanding –69,875,000 shares at December 31, 2012 and 2011, respectively)
|
|
|
69,875
|
|
|
|
69,875
|
|
Additional paid-in capital
|
|
|
10,578,169
|
|
|
|
10,578,169
|
|
Deficit accumulated during the development stage
|
|
|
(14,628,454
|
)
|
|
|
(9,530,323
|
)
|
Accumulated other comprehensive loss
|
|
|
(358,075
|
)
|
|
|
(360,736
|
)
|
|
|
|
|
|
|
|
|
|
Total stockholders’ (deficit) equity
|
|
|
(4,338,485
|
)
|
|
|
756,985
|
|
|
|
|
|
|
|
|
|
|
Total Liabilities and Stockholders’ (Deficit) Equity
|
|
$
|
653,950
|
|
|
$
|
3,035,788
|
|
See notes to the consolidated financial
statements
* None of the assets
of the VIEs can be used only to settle obligations of the consolidated VIEs. Conversely, liabilities recognized as a result of
consolidating these VIEs do not represent additional claims on the Company’s general assets (Note 3).
Santaro Interactive Entertainment Company
(A Development Stage Company)
Consolidated Statements of Operations and
Comprehensive Loss
|
|
Years Ended December 31,
|
|
|
|
|
|
|
2012
|
|
|
2011
|
|
|
August 9, 2006
(inception of Beijing
Sntaro) through
December 31, 2012
|
|
|
|
|
|
|
|
|
|
|
|
Revenue
|
|
$
|
27,571
|
|
|
$
|
-
|
|
|
$
|
27,571
|
|
Cost of revenue
|
|
|
693,059
|
|
|
|
-
|
|
|
|
693,059
|
|
Gross loss
|
|
|
(665,488
|
)
|
|
|
-
|
|
|
|
(665,488
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
Research and development expenses
|
|
|
2,683,443
|
|
|
|
2,439,991
|
|
|
|
9,056,654
|
|
Sales and marketing expenses
|
|
|
362,145
|
|
|
|
21,280
|
|
|
|
548,921
|
|
General and administrative expenses
|
|
|
1,409,898
|
|
|
|
1,312,272
|
|
|
|
4,512,553
|
|
Total operating expenses
|
|
|
4,455,486
|
|
|
|
3,773,543
|
|
|
|
14,118,128
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss from operations
|
|
|
(5,120,974
|
)
|
|
|
(3,773,543
|
)
|
|
|
(14,783,616
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gain on deconsolidation of subsidiary
|
|
|
(15,823
|
)
|
|
|
-
|
|
|
|
(15,823
|
)
|
Non-operating (income) expenses
|
|
|
(7,020
|
)
|
|
|
925
|
|
|
|
433,480
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss before non-controlling interest
|
|
|
(5,098,131
|
)
|
|
|
(3,774,468
|
)
|
|
|
(15,201,273
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Less: loss attributable to the non-controlling interests
|
|
|
-
|
|
|
|
-
|
|
|
|
(572,819
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss attributable to the Company
|
|
|
(5,098,131
|
)
|
|
|
(3,774,468
|
)
|
|
|
(14,628,454
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other comprehensive loss
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss
|
|
|
(5,098,131
|
)
|
|
|
(3,774,468
|
)
|
|
|
(15,201,273
|
)
|
Foreign currency translation adjustment
|
|
|
2,661
|
|
|
|
(247,528
|
)
|
|
|
(358,075
|
)
|
Comprehensive loss
|
|
|
(5,095,470
|
)
|
|
|
(4,021,996
|
)
|
|
|
(15,559,348
|
)
|
Less: Comprehensive loss attributable to the non-controlling interest
|
|
|
-
|
|
|
|
-
|
|
|
|
(572,819
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive loss attributable to the Company
|
|
$
|
(5,095,470
|
)
|
|
$
|
(4,021,996
|
)
|
|
$
|
(14,986,529
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic and diluted
|
|
|
(0.07
|
)
|
|
|
(0.06
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average number of common shares outstanding – basic and diluted
|
|
|
69,875,000
|
|
|
|
68,470,959
|
|
|
|
|
|
See notes to the consolidated financial
statements
Santaro Interactive Entertainment Company
(A Development Stage Company)
Consolidated Statements of Changes in Stockholders’
Equity (Deficit)
|
|
Common Stock
|
|
|
Additional
|
|
|
Deficit accumulated
|
|
|
Accumulated other
|
|
|
Total deficit of
|
|
|
|
|
|
|
|
|
|
|
|
|
$0.001 Par
|
|
|
Paid-In
|
|
|
during development
|
|
|
comprehensive
|
|
|
the Company’s
|
|
|
Non-controlling
|
|
|
|
|
|
|
Share
|
|
|
Value
|
|
|
Capital
|
|
|
stage
|
|
|
income (loss)
|
|
|
stockholders
|
|
|
interest
|
|
|
Total deficit
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at August 9, 2006
|
|
|
55,670,000
|
|
|
$
|
55,670
|
|
|
$
|
(55,670
|
)
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
Net (loss)
|
|
|
|
|
|
|
|
|
|
|
-
|
|
|
|
(21,583
|
)
|
|
|
-
|
|
|
|
(21,583
|
)
|
|
|
-
|
|
|
|
(21,583
|
)
|
Foreign currency exchange translation adjustment, net of nil income taxes
|
|
|
|
|
|
|
|
|
|
|
-
|
|
|
|
-
|
|
|
|
884
|
|
|
|
884
|
|
|
|
-
|
|
|
|
884
|
|
Inject paid-in capital
|
|
|
|
|
|
|
|
|
|
|
139,580
|
|
|
|
-
|
|
|
|
-
|
|
|
|
139,580
|
|
|
|
-
|
|
|
|
139,580
|
|
Balance at December 31, 2006
|
|
|
55,670,000
|
|
|
|
55,670
|
|
|
|
83,910
|
|
|
|
(21,583
|
)
|
|
|
884
|
|
|
|
118,881
|
|
|
|
-
|
|
|
|
118,881
|
|
Net (loss)
|
|
|
|
|
|
|
|
|
|
|
-
|
|
|
|
(483,001
|
)
|
|
|
-
|
|
|
|
(483,001
|
)
|
|
|
-
|
|
|
|
(483,001
|
)
|
Foreign currency exchange translation adjustment, net of nil income taxes
|
|
|
|
|
|
|
|
|
|
|
-
|
|
|
|
-
|
|
|
|
10,100
|
|
|
|
10,100
|
|
|
|
-
|
|
|
|
10,100
|
|
Inject paid-in capital
|
|
|
|
|
|
|
|
|
|
|
492,141
|
|
|
|
-
|
|
|
|
-
|
|
|
|
492,141
|
|
|
|
-
|
|
|
|
492,141
|
|
Balance at December 31, 2007
|
|
|
55,670,000
|
|
|
|
55,670
|
|
|
|
576,051
|
|
|
|
(504,584
|
)
|
|
|
10,984
|
|
|
|
138,121
|
|
|
|
-
|
|
|
|
138,121
|
|
Net (loss)
|
|
|
|
|
|
|
|
|
|
|
-
|
|
|
|
(805,983
|
)
|
|
|
-
|
|
|
|
(805,983
|
)
|
|
|
-
|
|
|
|
(805,983
|
)
|
Foreign currency exchange translation adjustment, net of nil income taxes
|
|
|
|
|
|
|
|
|
|
|
-
|
|
|
|
-
|
|
|
|
6,693
|
|
|
|
6,693
|
|
|
|
-
|
|
|
|
6,693
|
|
Inject paid-in capital
|
|
|
|
|
|
|
|
|
|
|
739,775
|
|
|
|
-
|
|
|
|
-
|
|
|
|
739,775
|
|
|
|
-
|
|
|
|
739,775
|
|
Balance at December 31, 2008
|
|
|
55,670,000
|
|
|
|
55,670
|
|
|
|
1,315,826
|
|
|
|
(1,310,567
|
)
|
|
|
17,677
|
|
|
|
78,606
|
|
|
|
-
|
|
|
|
78,606
|
|
Net (loss)
|
|
|
|
|
|
|
|
|
|
|
-
|
|
|
|
(1,937,574
|
)
|
|
|
-
|
|
|
|
(1,937,574
|
)
|
|
|
(333,044
|
)
|
|
|
(2,270,618
|
)
|
Foreign currency exchange translation adjustment, net of nil income taxes
|
|
|
|
|
|
|
|
|
|
|
-
|
|
|
|
-
|
|
|
|
(22
|
)
|
|
|
(22
|
)
|
|
|
-
|
|
|
|
(22
|
)
|
Inject paid-in capital
|
|
|
|
|
|
|
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
437,771
|
|
|
|
437,771
|
|
Balance at December 31, 2009
|
|
|
55,670,000
|
|
|
|
55,670
|
|
|
|
1,315,826
|
|
|
|
(3,248,141
|
)
|
|
|
17,655
|
|
|
|
(1,858,990
|
)
|
|
|
104,727
|
|
|
|
(1,754,263
|
)
|
Net (loss)
|
|
|
|
|
|
|
|
|
|
|
-
|
|
|
|
(2,507,714
|
)
|
|
|
-
|
|
|
|
(2,507,714
|
)
|
|
|
(239,775
|
)
|
|
|
(2,747,489
|
)
|
Foreign currency exchange translation adjustment, net of nil income taxes
|
|
|
|
|
|
|
|
|
|
|
-
|
|
|
|
-
|
|
|
|
(130,863
|
)
|
|
|
(130,863
|
)
|
|
|
-
|
|
|
|
(130,863
|
)
|
Effect of reverse acquisition
|
|
|
11,830,000
|
|
|
|
11,830
|
|
|
|
(112,100
|
)
|
|
|
-
|
|
|
|
-
|
|
|
|
(100,270
|
)
|
|
|
135,048
|
|
|
|
34,778
|
|
Balance as of December 31, 2010
|
|
|
67,500,000
|
|
|
|
67,500
|
|
|
|
1,203,726
|
|
|
|
(5,755,855
|
)
|
|
|
(113,208
|
)
|
|
|
(4,597,837
|
)
|
|
|
-
|
|
|
|
(4,597,837
|
)
|
Net (loss)
|
|
|
|
|
|
|
|
|
|
|
-
|
|
|
|
(3,774,468
|
)
|
|
|
-
|
|
|
|
(3,774,468
|
)
|
|
|
-
|
|
|
|
(3,774,468
|
)
|
Foreign currency exchange translation adjustment, net of nil income taxes
|
|
|
|
|
|
|
|
|
|
|
-
|
|
|
|
-
|
|
|
|
(247,528
|
)
|
|
|
(247,528
|
)
|
|
|
-
|
|
|
|
(247,528
|
)
|
Common stock issued for cash June 27,2011
|
|
|
1,000,000
|
|
|
|
1,000
|
|
|
|
1,999,000
|
|
|
|
-
|
|
|
|
-
|
|
|
|
2,000,000
|
|
|
|
-
|
|
|
|
2,000,000
|
|
Common stock issued for cash August 29, 2011
|
|
|
1,375,000
|
|
|
|
1,375
|
|
|
|
2,748,625
|
|
|
|
-
|
|
|
|
-
|
|
|
|
2,750,000
|
|
|
|
-
|
|
|
|
2,750,000
|
|
Capital contribution
|
|
|
|
|
|
|
|
|
|
|
4,626,818
|
|
|
|
|
|
|
|
|
|
|
|
4,626,818
|
|
|
|
|
|
|
|
4,626,818
|
|
Balance as of December 31, 2011
|
|
|
69,875,000
|
|
|
|
69,875
|
|
|
|
10,578,169
|
|
|
|
(9,530,323
|
)
|
|
|
(360,736
|
)
|
|
|
756,985
|
|
|
|
-
|
|
|
|
756,985
|
|
Net (loss)
|
|
|
|
|
|
|
-
|
|
|
|
-
|
|
|
|
(5,098,131
|
)
|
|
|
-
|
|
|
|
(5,098,131
|
)
|
|
|
-
|
|
|
|
(5,098,131
|
)
|
Foreign currency exchange translation adjustment, net of nil income taxes
|
|
|
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
2,661
|
|
|
|
2,661
|
|
|
|
-
|
|
|
|
2,661
|
|
Balance as of December 31, 2012
|
|
|
69,875,000
|
|
|
$
|
69,875
|
|
|
$
|
10,578,169
|
|
|
$
|
(14,628,454
|
)
|
|
$
|
(358,075
|
)
|
|
$
|
(4,338,485
|
)
|
|
$
|
-
|
|
|
$
|
(4,338,485
|
)
|
See notes to the consolidated financial
statements
Santaro Interactive Entertainment Company
(A Development Stage Company)
Consolidated Statements of Cash Flows
|
|
Years Ended December 31,
|
|
|
|
|
|
|
2012
|
|
|
2011
|
|
|
August, 2006
(inception of Beijing
Sntaro) through
December 31, 2012
|
|
Cash flows from operating activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss
|
|
$
|
(5,098,131
|
)
|
|
$
|
(3,774,468
|
)
|
|
$
|
(15,201,273
|
)
|
Adjustments to reconcile net loss before non-controlling interests to net cash used by operating activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Depreciation
|
|
|
223,138
|
|
|
|
87,605
|
|
|
|
528,359
|
|
Amortization of intangible assets
|
|
|
9,991
|
|
|
|
7,291
|
|
|
|
17,588
|
|
Gain on deconsolidation of subsidiary
|
|
|
(15,823
|
)
|
|
|
—
|
|
|
|
(15,823
|
)
|
Changes in operating assets and liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Prepaid expenses
|
|
|
319,750
|
|
|
|
(269,305
|
)
|
|
|
5,069
|
|
Other receivables
|
|
|
146,065
|
|
|
|
(94,014
|
)
|
|
|
(88,492
|
)
|
Advance from customers
|
|
|
79,814
|
|
|
|
—
|
|
|
|
79,814
|
|
Taxes payable
|
|
|
737
|
|
|
|
—
|
|
|
|
737
|
|
Deferred revenue
|
|
|
17,450
|
|
|
|
—
|
|
|
|
17,450
|
|
Other payables and accrued expenses
|
|
|
(137,081
|
)
|
|
|
446,373
|
|
|
|
455,220
|
|
Due to related parties
|
|
|
35,376
|
|
|
|
17,818
|
|
|
|
81,437
|
|
Net cash used in operating activities
|
|
|
(4,418,714
|
)
|
|
|
(3,578,700
|
)
|
|
|
(14,119,914
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows from investing activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Purchase of property and equipment
|
|
|
(213,350
|
)
|
|
|
(368,010
|
)
|
|
|
(987,519
|
)
|
Purchase of intangibles
|
|
|
(8,038
|
)
|
|
|
(33,998
|
)
|
|
|
(48,346
|
)
|
Cash effect on deconsolidation of subsidiary
|
|
|
15,823
|
|
|
|
—
|
|
|
|
15,823
|
|
Net cash used in investing activities
|
|
|
(205,565
|
)
|
|
|
(402,008
|
)
|
|
|
(1,020,042
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows from financing activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Proceeds from sale of stock
|
|
|
—
|
|
|
|
4,750,000
|
|
|
|
6,156,274
|
|
Paid-in capital injection
|
|
|
—
|
|
|
|
4,626,818
|
|
|
|
4,626,818
|
|
Capital contributed by non-controlling interest owner
|
|
|
—
|
|
|
|
—
|
|
|
|
428,290
|
|
Loan from a related party
|
|
|
2,631,412
|
|
|
|
1,121,302
|
|
|
|
8,684,406
|
|
Repayment of related parties loan
|
|
|
—
|
|
|
|
(4,786,811
|
)
|
|
|
(4,786,811
|
)
|
Net cash provided by financing activities
|
|
|
2,631,412
|
|
|
|
5,711,309
|
|
|
|
15,108,977
|
|
Effect of exchange rate changes on cash and cash equivalents
|
|
|
13,759
|
|
|
|
(22,076
|
)
|
|
|
80,483
|
|
Net (decrease) increase in cash and cash equivalents
|
|
|
(1,979,108
|
))
|
|
|
1,708,525
|
|
|
|
49,504
|
|
Cash and cash equivalents at the beginning of year
|
|
|
2,028,612
|
|
|
|
320,087
|
|
|
|
—
|
|
Cash and cash equivalents at the end of year
|
|
$
|
49,504
|
|
|
$
|
2,028,612
|
|
|
$
|
49,504
|
|
Supplemental disclosure for cash flow information
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest paid
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
Income taxes paid
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
See notes to the consolidated financial
statements
Santaro
Interactive Entertainment Company
(A
Development Stage Company)
Notes
to Consolidated Financial Statements
1. ORGANIZATION
AND DESCRIPTION OF BUSINESS
Santaro
Interactive Entertainment Company (“the Company”) was incorporated on December 30, 2009 in the State of Nevada. The
Company’s accounting and reporting policies conform to accounting principles generally accepted in the United States of America
(U.S GAAP), and the Company’s fiscal year end is December 31.
The
accompanying consolidated financial statements include the accounts of the following entities, and all significant intercompany
transactions and balances have been eliminated in consolidation as of December 31, 2012 and 2011:
Consolidated entity name:
|
|
|
Percentage of ownership
|
|
Santaro Holdings, Ltd (“SHL”)
|
|
|
100
|
%
|
Santaro Investments, Ltd. (“Santaro HK”)
|
|
|
100
|
%
|
Ningbo Sntaro Network Technology Co., Ltd. (“Ningbo Sntaro”)
|
|
|
100
|
%
|
Beijing Sntaro Technology Co., Ltd. (“Beijing Sntaro”)
|
|
|
Variable Interest Entity
|
|
Beijing Sntaro Freeland Network Co., Ltd. (“FL Network”) (only through December 31, 2012)
|
|
|
100% subsidiary of Beijing Sntaro
|
|
FL Network was a 100% subsidiary of Beijing
Sntaro until December 31, 2012, when we ceased to have the power to direct its activities following a change of ownership. As a
result of such change, FL Network ceased to be our subsidiary starting December 31, 2012.
On
October 12, 2010, the Company entered into a Share Exchange Agreement (the “Exchange Agreement”), with Santaro Holdings,
Ltd., a limited liability company organized under the laws of British Virgin Islands, (“SHL”), and the shareholders
of SHL (collectively the “SHL Shareholders”). Pursuant to the terms of the Exchange Agreement, the SHL Shareholders
transferred to the Company 100% of the outstanding shares of SHL in exchange for the newly issued 55,670,000 restricted shares
of the common stock of the Company. SHL is a holding company which has a 100% ownership interest in Santaro Investments, Ltd.,
a Hong Kong company which in turn has a 100% ownership interest in Ningbo Sntaro Network Technology Co., Ltd, a Wholly Foreign
Owned Enterprise (“WFOE”) established in the People’s Republic of China. Through control of the WFOE, the Company
controls Beijing Sntaro Technology Co., Ltd, a company organized under the laws of the People’s Republic of China and engaged
in the development and operation of online games. As a result of the transactions described above, the Company became the record
and beneficial owner of 100% of the share capital of SHL and therefore owns 100% of the share capital of its subsidiaries and Variable
Interest Entities indirectly.
Santaro
Holdings, Ltd. (“SHL”) is a limited liability company organized under the laws of British Virgin Islands incorporated
on December 2, 2009.100 shares with par value $1.00 were issued and outstanding, although no capital was paid in as of December
31, 2012.
As
a holding company, SHL has one wholly owned subsidiary, Santaro Investments, Ltd. (“Santaro HK”), a Hong Kong corporation
set up by SHL on January 27, 2010. On July 13, 2010, Santaro HK set up a wholly owned subsidiary, Ningbo Sntaro Network Technology
Co., Ltd. (“Ningbo Sntaro”), a Wholly Foreign Owned Enterprise (WFOE) organized under the laws of the People’s
Republic of China (“PRC”). Ningbo Sntaro exercises control through a series of agreements over Beijing Sntaro Technology
Co., Ltd. (“Beijing Sntaro”), an operating company organized under the laws of the PRC, and principally engaged in
the development and operation of online games. Beijing Sntaro has 100% ownership interest in Beijing Sntaro Freeland Network Co.,
Ltd. (the “FL Network”)
until December 31, 2012
, a company organized under
the laws of the PRC. The beneficial controlling stockholders of the Company own all the outstanding shares of Beijing Sntaro. In
addition, SHL is the indirect parent of Ningbo Sntaro and controls this entity through its ownership of Santaro HK.
On July 18, 2011, Santaro HK established
Outlets Internet Sale Limited jointly with New Select Group Limited (BVI), each party holds 50% shares of this newly established
entity. The primary objective of this JV establishment is for the further extension and development of on-line business of “Outlet”
in PRC China.
Beijing
Sntaro was organized under the laws of People’s Republic of China (the “PRC”) on August 9, 2006 with paid-in
capital of $139,580, which was 80% owned by Mr. Zhilian Chen, Beijing Sntaro’s chairman; the other 20% of the equity was
held by Mr. Wenjie Lu. Beijing Sntaro is engaged in the development and operation of online games, investment in online games project.
As of the end of fiscal 2012, Beijing Sntaro has been in development stage and does not conduct any substantive sale of its online
games.
Beijing
Sntaro completed a series of changes in ownership which were necessary to comply with its development. In April, 2007, pursuant
to a Board of Directors’ resolution, Beijing Sntaro changed its equity ownership as follows; Mr. Zhilian Chen, Mr. Xiaobo
Li and Mr. Wenjie Lu became the owners of Beijing Sntaro, with the percentage of ownership of 60%, 20%, and 20% respectively, and
paid-in capital of $379,033, $126,344, and $126,344, respectively.
In
May 2008, Beijing Sntaro entered into its second change of equity ownership. According to the equity agreement in May 2008, Mr.
Zhilian Chen, Mr. Xiaobo Li, Mr. Xianhua Shen and Miss Yingnv Sun became the owners of Beijing Sntaro, with the percentage of ownership
of 60%, 20%, 10%, and 10%, respectively, and paid in capital of $822,897, $274,299, $137, 150, and $137,150, respectively.
On
March 9, 2009, Beijing Sntaro established FL Network (only through December 31, 2012), a subsidiary that is engaged in the business
of online games development and operation, mainly focuses on technology research, FL Network is 70% owned by Beijing Sntaro, and
30% owned by Beijing East Free Land Media & Film Co., Ltd (the “FL Media”).
In
April 2010, Beijing Sntaro entered into its third change of equity ownership. According to an amended equity agreement in December
2009, Mr. Xiaobo Li transferred his ownership in Beijing Sntaro to Mr. Zhilian Chen, another owner of Beijing Sntaro, and increased
Mr. Chen’s percentage of ownership to 80%, with paid-in of capital $1,097,196. Mr. Xianhua Shen’s and Ms. Yingnv Sun’s
equity remained unchanged, with their percentage of ownership at 10%, and 10%, respectively, and paid-in capital of $137,150, and
$137,150, respectively.
In
December 2011, Beijing Sntaro entered into its fourth change of equity ownership. According to the shareholders resolutions and
amendments to the articles of association of Beijing Sntaro dated December 5, 2011, Mr. Zhilian Chen subscribed for $4,626,818
of the increased registered capital of Beijing Sntaro. After this newly capital injection, Mr. Zhilian Chen’s, Mr. Xianhua
Shen’s and Ms. Yingnv Sun’s equity in Beijing Sntaro changed, with their percentage of ownership at 95.4%, 2.3%, and
2.3%, respectively, and paid-in capital of $5,724,014, $137,150, and $137,150, respectively.
On
June 20, 2010, the FL Network (only through December 31, 2012), the subsidiary of Beijing Sntaro, also completed a change in its
ownership. Ms. Yu Bai was transferred 2.5% ownership by Beijing Sntaro and 2.5% shares by FL Media for free. And Ms. Yu Bai became
ownership percentage from 70% and 30% to 67.5% and 27.5%, respectively.
On
October 12, 2010, within the Exchange Agreement described above, the Company used 8,400,000 shares out of the newly issued 55,670,000
shares to exchange the 32.5% noncontrolling interests in FL Network from FL Media and Ms. Yu Bai and gave the interests to Beijing
Sntaro, who had 67.5% ownership interest in FL Network. As of December 31, 2010, Beijing Sntaro has 100% ownership interest in
the FL Network
until December 31, 2012
.
The
Company is principally engaged in the development and operation of online games, and has a core product development team that is
responsible for developing new games. Three Kingdoms Online and 108 Warriors are the two Massive Multiplayer Online Role Playing
Game (“MMORPG”) games. 108 Warriors was launched in the third quarter of 2012 . UU World is another MMORPG of the Company,
which was also under development, but this game has been suspended right now, because the management considered this game is not
suitable for current customer’s needs. In order to better meet the market demand, the company decided to search a proper
opportunity to transfer this game into another kind of product.
2. GOING CONCERN
AND LIQUIDITY
The
accompanying financial statements are presented on a going concern basis. The Company is in a development stage and only generated
an insignificant amount of revenue during the period from its inception (August 9, 2006) to December 31, 2012. The Company has
recurring net losses and negative cash flows from operations and has been dependent on debt and equity financing. The Company has
an accumulated deficit of $
14,628,454 as of December 31, 2012
. These conditions raise
substantial doubt about the Company’s ability to continue as a going concern. During the year ended December 31, 2011, the
Company obtained a funding in the aggregate $4,750,000 from the issuance of 2,375,000 shares of our common stock, and warrants
to purchase a total of 1,187,500 shares of our common stock. On December 5, 2011, Mr. Zhilian Chen converted parts of the loan
provided by CixiYide, a related party (Note 13), to Beijing Sntaro, i.e., $4,626,818 (RMB 29,260,000), into the registered capital
of Beijing Sntaro by the way of subscribing for the increased capital of Beijing Sntaro and then let Beijing Sntaro to pay back
the increased capital to CixiYide. There can be no assurance that the Company will be able to obtain additional debt or equity
financing on terms acceptable to it, or if at all. Management plans to fund continuing operations through new financing from related
parties and equity financing arrangements.
3. VARIABLE INTEREST
ENTITIES (VIES)
Regulations
of the People’s Republic of China (“PRC”) prohibit direct foreign ownership of business entities providing internet
content, or ICP, services in the PRC such as the business of providing online games. In September 2010, a series of contractual
arrangements were entered between Ningbo Sntaro and Beijing Sntaro and its individual owners. Pursuant to the agreements, Ningbo
Sntaro provides exclusive technical consulting and management services to Beijing Sntaro. A summary of the major terms of the agreements
is as follows:
|
(1)
|
Ningbo Sntaro has a decisive right to determine the amount of the fees it will receive and it intends
to transfer substantially all of the economic benefits of Beijing Sntaro to Ningbo Sntaro;
|
|
(2)
|
The equity owners of Beijing Sntaro irrevocably granted the Ningbo Sntaro the right to make all
operating and business decisions for Beijing Sntaro on behalf of the equity owners;
|
|
(3)
|
All equity owned by the three equity owners of Beijing Sntaro shall be pledged to Ningbo Sntaro as a collateral
against the service fee payable to Ningbo Sntaro; and
|
|
(4)
|
The equity owners of Beijing Sntaro may not dispose of or enter into any other agreements involving all
and any of the equity interest of Beijing Sntaro without prior agreement by Ningbo Sntaro.
|
Pursuant
to the above arrangements, all of the equity owners' rights and obligations of Beijing Sntaro were assigned to Ningbo Sntaro, which
resulted in the equity owners of Beijing Sntaro lacking the ability to make decisions that have a significant effect on Beijing
Sntaro's operations, and enable Ningbo Sntaro to extract the profits from the operation of Beijing Sntaro, and assume the Beijing
Sntaro's residual benefits. Because the Ningbo Sntaro and its indirect parent are the sole interest holders of Beijing Sntaro,
the Company consolidates Beijing Sntaro from its inception consistent with the provisions of FASB Accounting Standards Codification
("ASC") 810.
In
addition, as all of these contractual arrangements are governed by PRC law and provide for the resolution of disputes through either
arbitration or litigation in the PRC, they would be interpreted in accordance with PRC law and any disputes would be resolved in
accordance with PRC legal procedures. The legal environment in the PRC is not as developed as in other jurisdictions, such as the
United States. As a result, uncertainties in the PRC legal system could further limit the Company’s ability to enforce these
contractual arrangements. Furthermore, these contracts may not be enforceable in China if PRC government authorities or courts
take a view that such contracts contravene PRC laws and regulations or are otherwise not enforceable for public policy reasons.
In the event the Company is unable to enforce these contractual arrangements, it may not be able to exert effective control over
the VIEs, and its ability to conduct its business may be materially and adversely affected.
None
of the assets of the variable interest entities (the “VIEs”) can be used only to settle obligations of the consolidated VIEs.
Conversely, liabilities recognized as a result of consolidating these VIEs do not represent additional claims on the Company’s
general assets.
Most
of our operations are conducted through our affiliated companies which the Company controls through contractual agreements in the
form of VIEs. Current regulations in China permit our PRC subsidiaries to pay dividends to us only out of its accumulated distributable
profits, if any, determined in accordance with their articles of association and PRC accounting standards and regulations. The
ability of these Chinese affiliates to make dividends and other payments to us may be restricted by factors that include changes
in applicable foreign exchange and other laws and regulations.
|
A.
|
Under PRC law, our subsidiary may only pay dividends after
10% of its after-tax profits have been set aside as reserve funds, unless such reserves have reached at least 50% of its registered
capital. Such cash reserve may not be distributed as cash dividends.
|
|
B.
|
The PRC Income Tax Law also imposes a 10% withholding income
tax on dividends generated on or after January 1, 2008 and distributed by a resident enterprise to its foreign investors, if such
foreign investors are considered as non-resident enterprise without any establishment or place within China or if the received
dividends have no connection with such foreign investors’ establishment or place within China, unless such foreign investors’
jurisdiction of incorporation has a tax treaty with China that provides for a different withholding arrangement.
|
As
of December 31, 2012, there were no such retained earnings available for distribution.
The
following financial statement amounts and balances of the VIEs were included in the accompanying consolidated financial statements
as of and for the year ended December 31:
|
|
December 31,
|
|
|
December 31,
|
|
|
|
2012
|
|
|
2011
|
|
Total assets
|
|
$
|
123,052
|
|
|
$
|
198,095
|
|
|
|
|
|
|
|
|
|
|
Total liabilities
|
|
$
|
2,682,517
|
|
|
$
|
1,927,064
|
|
|
|
Year Ended December 31,
|
|
|
|
2012
|
|
|
2011
|
|
Revenues
|
|
$
|
27,571
|
|
|
$
|
-
|
|
|
|
|
|
|
|
|
|
|
Net loss
|
|
$
|
256,072
|
|
|
$
|
1,541,019
|
|
All
of our current revenue is generated in PRC currency Renminbi (“RMB”). Any future restrictions on currency exchanges
may limit our ability to use net revenues generated in Renminbi to make dividends or other payments in U.S. dollars or fund possible
business activities outside China.
Foreign
currency exchange regulation in China is primarily governed by the following rules:
|
·
|
Foreign Exchange Administration Rules (1996), as amended in August 2008, or the Exchange Rules;
|
|
·
|
Administration Rules of the Settlement, Sale and Payment of Foreign Exchange (1996), or the Administration
Rules.
|
Under
the Administration Rules, RMB is freely convertible for current account items, including the distribution of dividends, interest
payments, trade and service related foreign exchange transactions, but not for capital account items, such as direct investments,
loans, repatriation of investments and investments in securities outside of China, unless the prior approval of the SAFE is obtained
and prior registration with the SAFE is made. Foreign-invested enterprises like ours that need foreign exchange for the distribution
of profits to their shareholders may affect payment from their foreign exchange accounts or purchase and pay foreign exchange rates
at the designated foreign exchange banks to their foreign shareholders by producing board resolutions for such profit distribution.
Based on their needs, foreign-invested enterprises are permitted to open foreign exchange settlement accounts for current account
receipts and payments of foreign exchange along with specialized accounts for capital account receipts and payments of foreign
exchange at certain designated foreign exchange banks.
4. SUMMARY OF SIGNIFICANT
ACCOUNTING POLICIES
Principles
of consolidation and basis of presentation
The
accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in
the United States of America (“U.S. GAAP”). In the opinion of management, all adjustments (which include normal recurring
adjustments) necessary to present a fair statement of the financial position as of December 31, 2012 and 2011, and the results
of operations and cash flows for the years ended December 31, 2012 and 2011, have been made. The Company is considered to be in
the development stage as defined in Accounting Standards Codification (ASC) 915 “Development Stage Entities”. The Company
is devoting substantially all of its efforts on the development and operation of online games.
The
accompanying consolidated financial statements as of December 31, 2012 and 2011, and for the years then ended include the Companies,
SHL, Santaro HK, Ningbo Sntaro, Beijing Sntaro and FL Network
(only through December 31, 2012)
.
All inter-company transactions and balances have been eliminated in consolidation.
Use
of Estimates
The
preparation of consolidated financial statements in conformity with the U.S. GAAP requires management to make estimates and assumptions
that affect the reported amounts of assets, liabilities and disclosures of contingent assets and liabilities at the date of the
consolidated financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results
could differ from those estimates. Significant items subject to such estimates and assumptions include the useful lives of fixed
assets; the fair value determination of financial and equity instruments, the realization of deferred tax assets and; the recoverability
of intangible assets and property and equipment; and accruals for income tax uncertainties and other contingencies. The current
economic environment has increased the degree of uncertainty inherent in those estimates and assumptions.
Foreign Currency Translation
and transaction
The
Company maintains its books and accounting records in RMB, which is determined as the functional currency. The Company’s
financial statements are translated into the reporting currency, the United States Dollar (“USD”). Assets and liabilities
of the Company are translated at the prevailing exchange rate at each reporting period end. Contributed capital accounts are translated
using the historical rate of exchange when capital is injected. Income and expense accounts are translated at the average rate
of exchange during the reporting period. Translation adjustments resulting from translation of these financial statements are reflected
as accumulated other comprehensive income (loss) in stockholders’ equity (deficit).
Translation
adjustments resulting from this process are included in accumulated other comprehensive loss in the consolidated statement of operations
and comprehensive loss and amounted $358,075 as of December 31, 2012, and $360,736 as of December 31, 2011. The balance sheet
amounts with the exception of equity at December 31, 2012 were translated at 6.3161 RMB to $1.00 USD as compared to 6.3647 RMB
at December 31, 2011. The equity accounts were stated at their historical rate. The average translation rates applied to income
statement accounts for the years ended December 31, 2012 and 2011 were 6.3198 RMB and 6.4739 RMB, respectively.
Statement of Cash Flows
In
accordance with FASB guidance, “Statement of Cash Flows,” cash flows from the Company’s operations is calculated
based upon the functional currency. As a result, amounts related to assets and liabilities reported on the statement of cash flows
may not necessarily agree with changes in the corresponding balances on the balance sheet.
Fair Value of Measurements
ASC
820 establishes a common definition for fair value to be applied to existing generally accepted accounting principles that require
the use of fair value measurements, establishes a framework for measuring fair value and expands disclosure about such fair value
measurements.
ASC 820 defines fair value as the price
that would be received upon sale of an asset or paid to transfer a liability in an orderly transaction between market participants
at the measurement date. Additionally, ASC 820 requires the use of valuation techniques that maximize the use of observable inputs
and minimize the use of unobservable inputs. These inputs are prioritized below:
Level 1:
|
Inputs are unadjusted quoted prices in active markets for identical assets or liabilities available at the measurement date.
|
Level 2:
|
Inputs are unadjusted quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets and liabilities in markets that are not active, inputs other then quoted prices that are observable, and inputs derived from or corroborated by observable market data.
|
Level 3:
|
Inputs are unobservable inputs which reflect the reporting entity’s own assumptions on what assumptions the market participants would use in pricing the asset or liability based on the best available information.
|
There were no transfers between level 1,
level 2 or level 3 measurements for the year ended December 31, 2012.
As of December 31, 2012, none of the Company’s
nonfinancial assets or liabilities was measured at fair value on a nonrecurring basis.
Cash
and cash equivalents, accounts due from and to related parties, other payables and accrued expenses are carried at cost on
the balance sheets and the carrying amount approximates their fair value because of the short-term nature of these financial instruments.
Cash and Cash Equivalents
Cash
and cash equivalents include cash on hand, deposits in banks with maturities of three months or less, and all highly liquid investments
which are unrestricted as to withdrawal or use, and which have original maturities of three months or less at the time of purchase.
The
Company maintains cash deposits in financial institutions or state-owned banks within the PRC that are not covered by insurance.
Non-performance by these institutions could expose the Company to losses. To date, the Company has not experienced any losses in
such accounts.
Property and equipment
Property
and equipment are stated at cost less accumulated depreciation. Depreciation is computed using the straight-line method over the
following estimated useful lives:
Computer equipment
|
3-5 years
|
Leasehold improvements
|
3 years
|
Furniture and fixtures
|
3-5 years
|
Expenditures
for maintenance and repairs are expensed as incurred. Gain or loss on the disposal of property and equipment is the difference
between the net sales proceeds and the carrying amount of the relevant assets and is recognized in the consolidated statements
of operations and comprehensive income.
Revenue recognition
The Company currently provides online game
services in the PRC and recognizes revenue in accordance to the criteria of ASC subtopic 605 (“ASC 605”), Revenue Recognition
when persuasive evidence of an arrangement exists, the service has been rendered, the sales price is fixed or determinable, and
collectability is reasonably assured. Online game revenues include our MMOG operations and Co-operation Web-based game revenues.
MMOG operations
The Company operates Massively Multiplayer
Online Role-Playing Games (“MMORPG”) under a free-to-play model. The online game revenue derives from the sale of in-game
virtual items and revenue was recognized pursuant to the item-based revenue model.
Under the item-based model, players are
able to play the basic features of the game for free. We generate revenues when players purchase virtual items that enhance their
playing experience, such as weapons, clothing, accessories and pets. The item-based revenue model allows us to introduce new virtual
items or change the features or properties of virtual items to enhance game player interaction and create a better game community.
The Company sells prepaid cards, in both
virtual and physical forms, to third party distributors who in turn sell the prepaid cards to end customers. The prepaid cards
provide customers with a pre-specified number of game points for consumption. All prepaid cards sold to distributors require upfront
advance cash payments. The prepaid game cards entitle end users to purchase virtual items in the Company’s online games.
Prepaid cards will expire two years after the date of card production if they have never been activated. The proceeds from the
expired game cards are recognized as revenue upon expiration of cards. In contrast, once the prepaid cards are activated and credited
to a player’s personal game account, they will not expire as long as the personal game account remains active. The personal
game account will always remain active before the game stop operating.
The end users also could choose bank recharge
method directly to exchange Santaro currency (“Long Bi”) or game currency of 108 warriors (“Silver”) through
third-party payment platforms.
All proceeds received from distributors
or through direct online payment systems are deferred when received, revenues are recognized over estimated life of the virtual
items that game players purchase or as the virtual items are consumed. The below description are the detailed revenue recognition
method adopted by the company.
Instant
consumption mode is used when users purchase instant services or items with Silver. And as that service or item will be immediately
consumed right after the Silver is paid by the user, therefore the reflected RMB value (from equivalent Silver) can be confirmed
and recorded as revenue after the completion of the purchase (exchange Long Bi for Silver) by the user.
Limited
consumption mode is used when users purchase the items or services with limited effective time. This type of items or services
will be fully consumed by the end of the effective time. Therefore the reflected RMB value of that purchase will be confirmed as
revenue after the item or service has been fully consumed (expired).
Apportioned
consumption mode is used for perpetual virtual items and services, which can be used unlimited times through their estimated life
spans. The delivery criterion for perpetual virtual items is generally met ratably over the expected delivery obligation period,
which, in this case, is the estimated life of the perpetual virtual items purchased. Revenue is recognized proportionately over
the estimated life spans which are based on data related to paying game player usage patterns for each category of virtual item.
The game log, which records the whole process of a specific item or service being purchased and consumed, will be used periodically
to readjust the estimation on perpetual virtual items’ life spans.
Co-operation Web-based game
As the operator, the Company signed distribution
agreements with third-party developers to offer the games to users on its websites or platforms. Although the company is the party
that signs the user agreement with its users and is responsible for its users’ experience on its Websites or platforms, its
remaining obligation is deemed to be inconsequential and perfunctory after the end users recharge to exchange the game coins of
these web-based games. Besides, the third party developers obliged to provide on-going services to users, so a proportion of the
full revenue received from end users is recorded as revenue according to the distribution agreements.
Cost of revenue
Cost
of revenue consists primarily of service fee, depreciation, salary and social insurance and other expenses incurred by the Company
and are recorded on an accrual basis.
Costs
incurred for maintenance after the online games are available for marketing are expensed when incurred and are included in product
cost of revenues.
Cost
of revenue also includes business tax and surcharges with 5.60% tax rate. Business tax and surcharges for the year ended December
31, 2012 and 2011 were $1,717 and $0, respectively.
Research and development
expenses
For
software development costs, including online games, to be sold or marketed to customers, the Company expenses software development
costs incurred prior to reaching technological feasibility. Once a software product has reached technological feasibility, all
subsequent software costs for that product are capitalized until that product is released for marketing. After an online game is
released, the capitalized product development costs are amortized over the estimated product life. To date, the Company has essentially
completed its software development concurrently with the establishment of technological feasibility. As of December 31, 2012, no
costs have been capitalized.
Research
and development expenses consist primarily of outsourced research and development expenses, payroll, depreciation charge and other
overhead expenses for the development of the Company’s proprietary games, and are recorded on an accrual basis.
Sales and marketing
expenses
Sales
and marketing expenses consist primarily of salary, advertising and promotion fee, and other expense incurred by the Company’s
sales and marketing personnel. Sales and marketing expenses are recorded on an accrual basis. Sales and marketing expenses for
the year ended December 31, 2012 and 2011 were $362,145 and $ 21,280, respectively.
Gain on deconsolidation of subsidiary
The
Company accounts for deconsolidation of subsidiaries in accordance with ASC Topic 810 “Consolidation”. In accordance
with ASC Topic 810, the parent shall account for the deconsolidation of a subsidiary by recognizing a gain or loss in net income
attributable to the parent, measured as the difference between:
a.
The aggregate of all of the following:
1.
The fair value of any consideration received;
2.
The fair value of any retained non-controlling investment in the former subsidiary at the date the subsidiary is deconsolidated;
3.
The carrying amount of any non-controlling interest in the former subsidiary (including any accumulated other comprehensive income
attributable to the non-controlling interest) at the date the subsidiary is deconsolidated.
b.
The carrying amount of the former subsidiary’s assets and liabilities.
Income
taxes
Income
taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future
tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities
and their respective tax bases and tax loss and tax credit carry forwards. Deferred tax assets and liabilities are measured using
enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered
or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the consolidated statements
of income in the period that includes the enactment date. A valuation allowance is provided to reduce the amount of deferred tax
assets if it is considered more likely than not that some portion or all of the deferred tax assets will not be realized.
ASC
740 clarifies the accounting for uncertain tax positions and requires that an entity recognizes in the consolidated financial statements
the impact of a tax position, if that position is more likely than not of being sustained upon examination, based on the technical
merits of the position. Recognized income tax positions are measured at the largest amount that is greater than 50% likely of being
realized. Changes in recognition or measurement are reflected in the period in which the change in judgment occurs. The Company
has elected to classify interest and penalties related to unrecognized tax benefits, if and when required, as a component of income
tax expense in the consolidated statements of income.
Recent
issued accounting pronouncements
The
Company does not believe any recently issued but not yet effective accounting standards, if currently adopted, would have a material
effect of the consolidated financial position, results of operation and cash flows.
5. EARNINGS (LOSS)
PER SHARE
The
FASB’s accounting standard for
earnings (loss)
per share requires presentation
of basic and diluted
earnings (loss)
per share in conjunction with the disclosure
of the methodology used in computing such
earnings (loss)
per share. Basic
earnings
(loss)
per share excludes dilution and is computed by dividing income available to common
stockholders by the weighted average common shares outstanding during the period. Diluted
earnings (loss)
per
share takes into account the potential dilution that could occur if securities or other contracts to issue common stock were exercised
and converted into common stock. Warrants issued on June 27, 2011 and August 29, 2011 to purchase a total of 1,187,500 shares of
common stock of the Company were not included in the diluted calculation since our common stock’s average market price did
not exceed the warrant exercise price. In addition, the Company had a net loss during current period so dilutive securities would
decrease negative EPS and have an anti-dilutive effect.
The
following is a reconciliation of the basic and diluted
earnings (loss)
per share computations
for the years ended December 31, 2012 and 2011:
|
|
2012
|
|
|
2011
|
|
|
|
|
|
|
|
|
Net loss for basic and diluted earnings (loss) per share
|
|
$
|
(5,098,131
|
)
|
|
$
|
(3,774,468
|
)
|
|
|
|
|
|
|
|
|
|
Weighted average shares used in basic and diluted computation
|
|
|
69,875,000
|
|
|
|
68,470,959
|
|
Earnings (loss) per share:
|
|
|
|
|
|
|
|
|
Basic and diluted
|
|
$
|
(0.07
|
)
|
|
$
|
(0.06
|
)
|
6. OTHER RECEIVABLES
Other receivables of $10,592 and $156,268 as
of December 31, 2012 and 2011 consisted of cash advances given to certain employees for use during business operations and are
recognized as general and administration expenses when expenses are incurred. It also includes certain rental deposit.
7. PROPERTY AND
EQUIPMENT
Property
and equipment are summarized as follows:
|
|
December 31,
|
|
|
December 31,
|
|
|
|
2012
|
|
|
2011
|
|
|
|
|
|
|
|
|
Computer equipment
|
|
$
|
670,268
|
|
|
$
|
414,922
|
|
Furniture and fixtures
|
|
|
221,666
|
|
|
|
190,417
|
|
Leasehold improvement
|
|
|
216,373
|
|
|
|
214,721
|
|
|
|
|
1,108,307
|
|
|
|
820,060
|
|
Less: Accumulated depreciation
|
|
|
(551,423
|
)
|
|
|
(325,648
|
)
|
|
|
|
|
|
|
|
|
|
Property and equipment, net
|
|
$
|
556,884
|
|
|
$
|
494,412
|
|
Depreciation
expenses for the years ended December 31, 2012 and 2011 were $223,138 and $87,605 respectively.
8. LONG TERM INVESTMENT
On July 18, 2011, Santaro HK and a non-related
company, New Select Group Limited (BVI), established a legal entity named Outlets Internet Sale Limited. Each party holds a 50%
interest in Outlets Internet Sale Limited that was formed for the purpose of the development of an online outlet business. Management
has classified the investment as a joint venture and will account for the investment under the equity-method of accounting since
each investor may participate, directly or indirectly, in the overall management of the joint venture and has joint control in
accordance with the provisions of Accounting Standards Codification (ASC) 323 “Investments - Equity Method and Joint Ventures”.
There was no activity during the year ended December 31, 2012.
9. DECONSOLIDATION
OF FL NETWORK
FL
network was incorporated on March 9, 2009 by Beijing Santaro and a third party FL media where Beijing Santaro held 70% ownership
interest. On October 12, 2010, Beijing Santaro completed purchasing the rest 30% interest of FL Network who became the Company’s
wholly held subsidiary through December 31, 2012. On December 31, 2012, an independent third party bought 100% equity interest
of FL network with a cash consideration of approximately US$15,800 (RMB100,000). The deconsolidation of FL network was accounted
for in accordance with ASC Topic 810 “Consolidation”. The Company recognized a gain of approximately $15,800 upon deconsolidation
of FL network, which has been recorded as a gain on deconsolidation of subsidiaries in the Company’s consolidated statements
of income and comprehensive income. This gain represents the difference between the fair value of consideration received and the
carrying amount of the former subsidiary's assets and liabilities as of the date of deconsolidation. The operating activities of
FL network in 2012 are insignificant.
10. OTHER PAYABLES
AND ACCRUED EXPENSES
Other
payables and accrued expenses consist of the following:
|
|
December 31,
|
|
|
December 31,
|
|
|
|
2012
|
|
|
2011
|
|
|
|
|
|
|
|
|
Other payables
|
|
$
|
447,147
|
|
|
$
|
454,117
|
|
Accrued salaries
|
|
|
20,829
|
|
|
|
78,917
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
467,976
|
|
|
$
|
533,034
|
|
Other
Payable of $
447,147
as of December 31, 2012 consisted of the interest-free loan of
$237,488 from Ningbo Jufeng Textile Co., Ltd, a third party of the Company. Other Payable of $454,117 as of December 31, 2011 consisted
of the interest-free loan of $235,675 from Ningbo Jufeng Textile Co., Ltd. The loan is unsecured, payable on demand, and is outstanding.
11. INCOME TAX EXPENSES
The
Company and its subsidiaries file income tax returns separately.
The
United States of America
Santaro
Interactive Entertainment Company is incorporated in the State of Nevada in the U.S., and is subject to a gradual U.S. federal
corporate income tax of 15% to 35%. The State of Nevada does not impose any corporate state income tax.
British
Virgin Islands
Santaro
holdings Ltd (the “SHL”) was incorporated in the British Virgin Islands on December 2, 2009 (“SHL”). Under
the current laws of the British Virgin Islands, SHL is not subject to tax on income or capital gains. In addition, upon payments
of dividends by SHL, no British Virgin Islands withholding tax is imposed.
Hong
Kong
Santaro
Investments, Ltd., was incorporated in Hong Kong on January 27, 2010. Santaro HK did not earn any income that was derived in Hong
Kong for the year ended December 31, 2012 and therefore was not subject to Hong Kong Profits Tax. The payments of dividends by
Hong Kong companies are not subject to any Hong Kong withholding tax.
PRC
Ningbo
Sntaro, Beijing Sntaro and FL Network (only through December 31, 2012) were all organized under the laws of the People’s
Republic of China (“PRC”) which are subject to Enterprise Income Tax (“EIT”) on the taxable income as reported
in their respective statutory financial statements adjusted in accordance with the Enterprise Income Tax Law. Pursuant to the PRC
Income Tax Laws, the Company and subsidiary are subject to EIT at a statutory rate of 25%.
Deferred
Tax Assets
In
assessing the realization of deferred tax assets, the Company considers projected future taxable income and tax planning strategies
in making its assessment, as of December 31, 2012 and 2011, for PRC income tax purposes.
Ningbo
Sntaro had deferred tax assets of approximately $1,666,526 and $519,763 as of December 31, 2012 and 2011, which consisted of a
tax loss carry-forward of $6,630,454 and $2,046,088, respectively. Ningbo Sntaro had no other temporary differences as of December
31, 2012 and 2011. Management determines it is more likely than not that all deferred tax asset could not be recognized, so full
allowances were provided as of December 31, 2012 and 2011. The deferred tax assets begin to expire in 2016.
Beijing
Sntaro had deferred tax assets of approximately $2,006,076 and $1,155,274 as of December 31, 2012 and 2011, which consisted of
a tax loss carry-forward of $8,133,000 and $4,731,783, respectively. Beijing Sntaro had no other temporary differences as of December
31, 2012 and 2011. Management determines it is more likely than not that all deferred tax asset could not be recognized, so full
allowances were provided as of December 31, 2012 and 2011.
The
deferred tax assets begin to expire in 2012. The deferred tax assets of approximately $6,751 began to expire in 2012, which consisted
of a tax loss of $27,002 in year 2006.
FL
Network had deferred tax assets of approximately $759,661 as of December 31, 2011, which consisted of tax loss carry-forwards of
$3,034,520. It had no other temporary differences as of December 31, 2011. Management determines it is more likely than not that
all deferred tax asset could not be recognized, so full allowances were provided as of December 31, 2011. Since the FL network
was deconsolidated on December 31, 2012, deferred tax asset was $0 as of December 31, 2012.
As
of December 31, 2012 and 2011, an aggregated valuation allowance of $3,672,602 and $2,434,698 was provided since management determines
it is more likely than not that all deferred tax asset could not be recognized. As a result of the 100% reserve of the deferred
tax assets, the effective tax rate differs from the statutory tax rate.
12. EMPLOYEE BENEFITS
The
full-time employees of the Company and its subsidiary that are incorporated in the PRC are entitled to staff welfare benefits,
including medical care, unemployment insurance and pension benefits. The Company is required to accrue for these benefits based
on percentages of 10%, 1% and 12% of the local employees’ average salaries in accordance with the relevant regulations, and
to conduct contributions to the state-sponsored medical plans, unemployment insurance and pension benefits. For the years ended
December 31, 2012 and 2011, total amounts expensed for such employee benefits amounted to $198,687 and $195,513, respectively.
The PRC government is responsible for the medical benefits and ultimate pension liability to these employees.
13. RELATED PARTY
TRANSACTIONS AND BALANCES
The
Company is in a development stage and only has an insignificant amount of revenue to date during the period from its inception
(August 9, 2006) to December 31, 2012. CixiYide is a company 100% beneficially owned by Mr. Zhilian Chen, the Company’s Chairman
and major stockholder. CixiYide provides continuous financial support for Beijing Sntaro’s business and operation. By the
end of 2011, CixiYide had provided loans to Beijing Sntaro in the aggregate amount of $1,577,639.
During the year ended
December 31, 2012, CixiYide made an additional loan of $957,343 to Beijing Sntaro. The total amount due to CixiYide from Beijing
Sntaro is $2,534,982 as of December 31, 2012.
Santaro
HK entered into a loan agreement with Mr. Zhilian Chen on August 2, 2010 for $310,000 for the payment of Ningbo Sntaro’s
registered paid-in-capital in accordance with Chinese legal requirements. Santaro HK received the loan in September 2010. At December
31, 2012, the carrying amount of the loan was $150,007.
By
the end of 2011, Mr. Zhilian Chen has provided loans in the amount of
$4,713 to Ningbo Sntaro. During the year ended December 31, 2012, Mr. Zhilian Chen
made an additional loan of $15,869 to Ningbo Sntaro. The total amount due to Mr. Zhilian Chen from Ningbo Sntaro was
$20,582 as of December 31, 2012.
During the year ended December 31, 2012, CixiYide
made an additional loan in the amount of $1,687,750 to Ningbo Sntaro. The total amount due to CixiYide from Ningbo Sntaro was $1,687,750
as of December 31, 2012.
As
of December 31, 2012, the total balance of loans due to CixiYide and Mr. Zhilian Chen from the company was $4,393,321. The loans
are unsecured and interest free, payable on demand, and are outstanding.
During
the year ended December 31, 2011, Mr. Mingyang Li, the Company’s CEO, provided a loan in the amount of $7,856 to Beijing
Sntaro and a loan in the amount of $5,554 to Ningbo Sntaro. These loans increased by $8,689 and $10,980 during the year ended December
31, 2012, respectively. As of December 31, 2012, the total balance of loans from Mr. Mingyang Li was $33,079. The loans are unsecured
and interest free, payable on demand, and are outstanding.
14. LEASE COMMITMENTS
The
Company has entered into operating lease arrangements mainly relating to its office premises which will end on December 26, 2014.
Future minimum lease payments for non-cancelable operating leases as of December 31,
2012 are as follows:
|
|
Rental
|
|
Fiscal Year
|
|
Commitments
|
|
|
|
|
|
2013
|
|
$
|
519,421
|
|
2014
|
|
|
513,650
|
|
|
|
|
|
|
Total
|
|
$
|
1,033,071
|
|
Total rental expenses
are $565,695 and $264,445 for the years ended December 31, 2012 and 2011, respectively.
15. SALE OF COMMON
STOCK AND WARRANTS
On
June 27, 2011, the Company entered into subscription agreements with certain institutional investors to sell an aggregate of one
million (1,000,000) shares of its common stock, and warrants to purchase a total of five hundred thousand (500,000) shares of its
common stock to the buyers for gross proceeds of $2,000,000 before deducting fees and expenses. The warrants mature in three years
and have a strike price of $5.00 per share.
On
August 29, 2011, the Company entered into subscription agreements with certain institutional investors to sell an aggregate of
one million three hundred seventy five thousand (1,375,000) shares of its common stock, and warrants to purchase a total of six
hundred eighty seven thousand five hundred (687,500) shares of its common stock to the buyers for gross proceeds of $2,750,000
before deducting fees and expenses and excluding the proceeds, if any, from the exercise of the warrants. The warrants mature in
three years and have a strike price of $5.00 per share.
All
warrants were evaluated for liability treatment and were determined to be equity instruments.
Above
two transactions have been completed as of December 31, 2011.
16. CONTINGENCIES
In
July 2006, the Ministry of Industry and Information Technology of the PRC, or MIIT, issued the Circular on Strengthening the Administration
of Foreign Investment in and Operation of Value-added Telecommunications Business, or the MIIT Circular. The MIIT Circular reiterated
the regulations on foreign investment in telecommunications businesses, which require foreign investors to set up foreign-invested
enterprises and obtain a business operating license for Internet content provision to conduct any value-added telecommunications
business in China. Under the MIIT Circular, a domestic company that holds an Internet content provision license is prohibited from
leasing, transferring or selling the license to foreign investors in any form, and from providing any assistance, including providing
resources, sites or facilities, to foreign investors that conduct value-added telecommunications business illegally in China. Furthermore,
the relevant trademarks and domain names that are used in the value-added telecommunications business must be owned by the local
Internet content provision license holder. Due to a lack of interpretative materials from the regulator, it is unclear what impact
the MIIT Circular will have on us or the other Chinese Internet companies that have adopted the same or similar corporate and contractual
structures as ours.
On
September 28, 2009, the General Administration of Press and Publications, or the GAPP, the National Copyright Administration (hereinafter
referred to as “NCA”), and National Office of Combating Pornography and Illegal Publications (hereinafter referred
to as “NOCPIP”) jointly published the “Stipulations on ‘Three Provisions’ ” of the State Council
and the Relevant Interpretations of the State Commission Office for Public Sector Reform and the Further Strengthening of the Administration
of Pre-examination and Approval of Online games and the Examination and Approval of Imported Online games (Xin Chu Lian [2009]
No. 13), or Circular 13. Circular 13 restates the general principle espoused in recently promulgated regulations that foreign investment
is not permitted in online game operating businesses in China. According to the Article IV of Circular 13, foreign investors are
prohibited from participating in online game operating businesses via wholly owned, equity joint venture or cooperative joint venture
investments in China, and from controlling and participating in such businesses directly or indirectly through contractual or technical
support arrangements. In the event of a violation of these provisions, GAPP shall, in conjunction with the relevant government
authorities of the PRC, investigate and handle the same in accordance with the law. In serious cases, the relevant licenses and
registrations shall be revoked. However, due to the lack of a detailed interpretation of Circular 13, it is not yet clear how it
will be implemented. Moreover, Circular 13 was issued solely by GAPP, NCA and NOCPIP, instead of being jointly issued by the publication
administration authorities and other government authorities which are in charge of the related business operations, like the Ministry
of Commerce, or the MOFCOM, and the MIIT, and the scope, implementation and enforcement of Circular 13 from the views of the above
mentioned other authorities remain uncertain.
In
the opinion of Han Kun Law Offices, our PRC legal counsel, subject to the interpretation and implementation of the MIIT Circular
and Circular 13, the ownership structure of Ningbo Sntaro and Beijing Sntaro and our contractual arrangements with Beijing Sntaro
and its shareholders comply with all existing PRC laws, rules and regulations. However, in the opinion of our PRC legal counsel,
there are substantial uncertainties regarding the interpretation and application of current or future PRC laws and regulations
and there may be changes and other developments in the PRC laws and regulations or their interpretations. Accordingly, we cannot
give assurance that the Chinese government authorities will ultimately take a view that is consistent with the opinion of our PRC
legal counsel.
If
the past or current ownership structures, contractual arrangements and businesses of our company Beijing Sntaro is found to be
in violation of any existing or future PRC laws or regulations, including the MIIT Circular and Circular 13, the relevant supervisory
authorities would have broad discretion in dealing with such violations, including but not limited to: revoking our business and
operating licenses; levying fines; confiscating our income or the income of Beijing Sntaro; shutting down our servers or blocking
our website; imposing conditions or requirements with which we may not be able to comply; requiring us to restructure the relevant
ownership structure, operations or contractual arrangements; restricting or prohibiting our use of the proceeds from our public
offering to finance our business and operations in China; and taking other regulatory or enforcement actions that could be harmful
to our business.
17. SUBSEQUENT EVENT
Management
has considered all events occurring through the date the financial statements have been issued, and has determined that there are
no such events that are material to the financial statements, or all such material events have been fully disclosed.