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10-Q
SEVEN STARS CLOUD GROUP, INC. filed this Form 10-Q on 11/13/2017
Entire Document
 

  

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

 

Washington, D.C. 20549

 

FORM 10-Q

 

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended September 30, 2017

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from __________ to __________

 

Commission File Number: 001-35561

 

 

 

 

 

SEVEN STARS CLOUD GROUP, INC.

(Exact name of registrant as specified in its charter)

 

Nevada 20-1778374
(State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.)

 

No.4 Drive-in Movie Theater Park,

No. 21, Liangmaqiao Road, Chaoyang District, Beijing, China 100125

(Address of principal executive offices)

212-206-1216

(Registrant's telephone number, including area code)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes x No ¨

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes x      No ¨

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “larger accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer ¨ Accelerated filer                  ¨
Non-accelerated filer   ¨ Smaller reporting company x
Emerging growth company  ¨  

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes ¨      No x

 

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date: 62,309,492 shares as of November 10, 2017.

 

 

 

 

 

  

QUARTERLY REPORT ON FORM 10-Q

OF SEVEN STARS CLOUD GROUP, INC.

FOR THE PERIOD ENDED SEPTEMBER 30, 2017

 

TABLE OF CONTENTS

 

PART I -FINANCIAL INFORMATION  
     
Item 1.  Financial Statements  3
Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations 33
Item 3  Quantitative and Qualitative Disclosures About Market Risk 44
Item 4.  Controls and Procedures 44
     
PART II -OTHER INFORMATION  
     
Item 1.  Legal Proceedings 46
Item 1A.  Risk Factors 46
Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds 47
Item 3.  Defaults Upon Senior Securities 47
Item 4.  Mine Safety Disclosures 47
Item 5.  Other Information 47
Item 6.  Exhibits 48
Signatures 49

 

References

 

Except as otherwise indicated by the context, references in this report to (i) the “Company,” “Seven Stars Cloud,”, “SSC”, “we,” “us,” and “our” are to Seven Stars Cloud Group, Inc. (formerly known as Wecast Network, Inc.), a Nevada corporation, and its consolidated subsidiaries and variable interest entities; (ii) “CB Cayman” refers to our wholly-owned subsidiary China Broadband, Ltd., a Cayman Islands company; (iii) “YOD Hong Kong” refers to YOU On Demand (Asia) Limited (formerly known as Sinotop Group Limited), a Hong Kong company wholly-owned by CB Cayman; (iv) “YOD WFOE” refers to YOU On Demand (Beijing) Technology Co., Ltd., a PRC company wholly-owned by YOD Hong Kong; (v) “Sinotop Beijing” or “Sinotop” refers to Beijing Sino Top Scope Technology Co., Ltd, a PRC company controlled by YOD Hong Kong through contractual arrangements; (vi) “Zhong Hai Media” refers to Zhong Hai Shi Xun Media Co., Ltd., a PRC company 80% owned by Sinotop Beijing until September 30, 2017; (vii) “SSF” refers to Tianjin Sevenstarflix Network Technology Limited, a PRC company controlled by YOD Hong Kong through contractual arrangements; (viii) “Hua Cheng” refers to Hua Cheng Hu Dong (Beijing) Film and Television Communication Co., Ltd., a PRC company 39% owned by Sinotop Beijing and 20% owner of Zhong Hai Media; (ix) “Wecast Services” refers to our wholly-owned subsidiary Wecast Services Group Limited (formerly known as Sun Video Group Hong Kong Limited) a Hong Kong company; (x) “Wide Angle” refers to Wide Angle Group Limited, a Hong Kong company 55% owned by the Company; (xi) “Wecast SH” refers to Shanghai Wecast Supply Chain Management Limited, a PRC company 51% owned by the Company; (xii)“SEC” refers to the United States Securities and Exchange Commission; (xiii) “Securities Act” refers to Securities Act of 1933, as amended; (xiv) “Exchange Act” refers to the Securities Exchange Act of 1934, as amended; (xv) “PRC” and “China” refer to People’s Republic of China; (xvi) “Renminbi” and “RMB” refer to the legal currency of China; (xvii) “U.S. dollar,” “$” and “US$” refer to United States dollars; and (xviii) “VIEs” refers to our current variable interest entities, Sinotop Beijing, and Tianjin Sevenstarflix Network Technology Limited.

 

 

 

  

PART I — FINANCIAL INFORMATION

 

Item 1. Financial Statements.

 

SEVEN STARS CLOUD GROUP, INC., ITS SUBSIDIARIES AND VARIABLE INTEREST ENTITIES

INDEX TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE PERIOD ENDED SEPTEMBER 30, 2017

 

  Page
Unaudited Consolidated Balance Sheets 4
Unaudited Consolidated Statements of Operations 5
Unaudited Consolidated Statements of Comprehensive Loss 6
Unaudited Consolidated Statements of Cash Flows 7
Unaudited Consolidated Statements of Equity 8
Notes to Unaudited Condensed Consolidated Financial Statements 9

 

 3 

  

Seven Stars Cloud Group, Inc., Its Subsidiaries and Variable Interest Entities
UNAUDITED CONSOLIDATED BALANCE SHEETS

 

   September 30, 2017   December 31, 2016 
         
ASSETS          
Current assets:          
Cash  $1,676,756   $3,761,814 
Accounts receivable, net   42,784,281    9,522,151 
Licensed content, current   883,015    124,319 
Notes receivable   -    1,749,830 
Inventory   375,693    203,697 
Prepaid expenses   370,041    375,944 
Other current assets   2,163,878    3,581,822 
Total current assets   48,253,664    19,319,577 
Property and equipment, net   119,304    4,963,725 
Licensed content, non-current   16,075,134    17,593,528 
Intangible assets, net   151,069    453,242 
Goodwill   -    6,648,911 
Long term investments   6,958,411    6,654,664 
Other non-current assets   -    112,643 
Total assets  $71,557,582   $55,746,290 
LIABILITIES, CONVERTIBLE REDEEMABLE PREFERRED STOCK AND EQUITY          
Current liabilities: (including amounts of consolidated VIEs without recourse to Seven Stars Cloud Group, Inc. See note 3)          
Accounts payable  $43,128,270   $13,341,680 
Deferred revenue   207,112    1,350,054 
Accrued interest due to a related party   397,852    557,918 
Accrued other expenses   118,833    708,987 
Accrued salaries   684,739    766,957 
Payable for purchase of building   -    987,015 
Amounts due to related parties   58,567    1,060,817 
Other current liabilities   168,316    934,480 
Accrued license content fees   -    1,236,661 
Convertible promissory note due to a related party   3,000,000    3,000,000 
Warrant liabilities   -    70,785 
Total current liabilities   47,763,689    24,015,354 
Total liabilities  $47,763,689   $24,015,354 
Commitments and contingencies (Note 17)          
Convertible redeemable preferred stock:          
Series A - 7,000,000 shares issued and outstanding, liquidation and deemed liquidation preference of $3,500,000 as of September 30, 2017 and December 31, 2016, respectively  $1,261,995   $1,261,995 
Equity:          
Series E Preferred Stock - $0.001 par value; 16,500,000 shares authorized, Nil and 7,154,997 shares issued and outstanding, liquidation preference of Nil and $12,521,245 as of September 30, 2017 and December 31, 2016, respectively   -    7,155 
Common stock - $0.001 par value; 1,500,000,000 shares authorized,  62,264,494 and 53,918,523 shares issued and outstanding as of September 30, 2017 and December 31, 2016, respectively   62,264    53,918 
Additional paid-in capital   145,791,961    152,755,919 
Accumulated deficit   (120,521,733)   (115,669,268)
Accumulated other comprehensive loss   (775,512)   (1,353,302)
Total Seven Stars Cloud shareholders’ equity   24,556,980    35,794,422 
Non-controlling interest   (2,025,082)   (5,325,481)
Total equity   22,531,898    30,468,941 
Total liabilities, convertible redeemable preferred stock and equity  $71,557,582   $55,746,290 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

 4 

 

Seven Stars Cloud Group, Inc., Its Subsidiaries and Variable Interest Entities
UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS

 

   Three Months Ended   Nine Months Ended 
   September 30,   September 30,   September 30,   September 30, 
   2017   2016   2017   2016 
                 
Revenue  $30,223,638   $1,626,844   $106,712,428   $4,377,034 
Cost of revenue   28,273,862    893,796    100,888,964    2,609,975 
Gross profit   1,949,776    733,048    5,823,464    1,767,059 
                     
Operating expenses:                    
Selling, general and administrative expense   3,630,949    2,320,247    7,771,561    6,294,206 
Research and development expense   400,040    -    400,040    - 
Professional fees   831,039    326,353    1,845,590    964,290 
Depreciation and amortization   36,508    123,502    293,661    344,308 
Impairment of other intangible assets   152,847    172,064    216,468    172,064 
Total operating expense   5,051,383    2,942,166    10,527,320    7,774,868 
                     
Loss from operations   (3,101,607)   (2,209,118)   (4,703,856)   (6,007,809)
                     
Interest and other income (expense)                    
Interest expense, net   (27,186)   (24,971)   (72,439)   (225,154)
Change in fair value of warrant liabilities   131,357    58,220    (112,642)   201,826 
Equity in loss of equity method investees   (23,632)   17,487    (100,468)   (19,862)
Other   (806)   (3,313)   (111,448)   (8,409)
Loss before income taxes   (3,021,874)   (2,161,695)   (5,100,853)   (6,059,408)
                     
Income tax benefit   -    8,612    -    25,836 
                     
Net loss   (3,021,874)   (2,153,083)   (5,100,853)   (6,033,572)
                     
Net loss (income) attributable to non-controlling interest   (22,723)   105,879    608,910    261,809 
                     
Net loss attributable to Seven Stars Cloud shareholders  $(3,044,597)  $(2,047,204)  $(4,491,943)  $(5,771,763)
                     
Basic loss per share  $(0.05)  $(0.05)  $(0.08)  $(0.18)
Diluted loss per share  $(0.05)  $(0.05)  $(0.08)  $(0.18)
                     
Weighted average shares outstanding:                    
Basic   62,146,168    41,184,037    59,594,289    31,640,230 
Diluted   62,146,168    41,184,037    59,594,289    31,640,230 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

 5 

 

Seven Stars Cloud Group, Inc., Its Subsidiaries and Variable Interest Entities
UNAUDITED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS

 

   Three Months Ended   Nine Months Ended 
   September 30,   September 30,   September 30,   September 30, 
   2017   2016   2017   2016 
                 
Net loss  $(3,021,874)  $(2,153,083)  $(5,100,853)  $(6,033,572)
                     
Other comprehensive income (loss), net of nil tax                    
Foreign currency translation adjustments   60,557    (67,764)   760,363    (269,274)
Comprehensive loss   (2,961,317)   (2,220,847)   (4,340,490)   (6,302,846)
                     
Comprehensive income (loss) attributable to non-controlling interest   17,517    (100,982)   (647,074)   (240,350)
Comprehensive loss attributable to Seven Stars Cloud shareholders  $(2,978,834)  $(2,119,865)  $(3,693,416)  $(6,062,496)

 

The accompanying notes are an integral part of these consolidated financial statements

 

 6 

  

Seven Stars Cloud Group, Inc., Its Subsidiaries and Variable Interest Entities
UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS

 

   Nine Months Ended 
   September 30, 2017   September 30, 2016 
         
Cash flows from operating activities:          
Net loss  $(5,100,853)  $(6,033,572)
Adjustments to reconcile net loss to net cash used in operating activities          
Share-based compensation expense   202,501    286,577 
Provision for doubtful accounts   103,040    366,887 
Depreciation and amortization   293,661    344,308 
Amortization of debt issuance costs   -    122,696 
Income tax benefit   -    (25,836)
Equity in  loss of equity method investees   100,468    19,862 
Loss on disposal of assets   683,195    - 
Change in fair value of warrant liabilities   112,642    (201,826)
Impairment of long-lived assets   216,468    172,064 
Foreign currency exchange losses   -    3,431 
           
Change in assets and liabilities:          
Accounts receivable   (34,582,490)   (2,890,663)
Inventory   (159,240)   - 
Licensed content   759,698    (639,225)
Prepaid expenses and other assets   3,679,359    (799)
Accounts payable   29,792,542    177,354 
Accrued expenses, salary and other current liabilities   (798,209)   250,856 
Deferred revenue   (1,139,357)   (10,359)
Accrued license content fees   -    112,896 
Net cash used in operating activities   (5,836,575)   (7,945,349)
           
Cash flows from investing activities:          
Acquisition of property and equipment   (46,260)   (3,130,862)
Acquisition of leasehold improvements   -    (455,723)
Proceeds from disposal of property and equipment   2,450,044    - 
Disposal of subsidiary, net of cash disposed   (8,753)   - 
Cash paid for the acquisition of subsidiaries   (741,433)   (650,000)
Investments in intangibles   -    (2,811,346)
Investment in long term investments   (250,000)   (3,584,025)
Net cash provided by (used in) investing activities   1,403,598    (10,631,956)
           
Cash flows from financing activities          
Proceeds from private placement   2,529,344    - 
Repayment of amounts due to related parties   (243,503)   - 
Costs associated with financing activities   -    (294,890)
Proceeds from issuance of warrant and shares   -    18,000,000 
Net cash provided by financing activities   2,285,841    17,705,110 
Effect of exchange rate changes on cash   62,078    (57,416)
Net increase (decrease) in cash   (2,085,058)   (929,611)
           
Cash at beginning of period   3,761,814    3,768,897 
           
Cash at end of period  $1,676,756   $2,839,286 

 

Supplemental Cash Flow Information:

          
           
Exchange of Series E Preferred Stock for common stock  $7,155   $100 
Issuance of convertible note for licensed content (Note 12)  $-   $17,717,847 
Issuance of shares for the settlement of liability  $-   $75,000 
Issuance of shares upon conversion of convertible note, including accrued interest and debt issuance cost  $-   $17,733,297 
Payment of interest  $250,000   $- 
Acquisition of long term investment through transfer of Game IP rights  $-   $2,714,441 
Payable for Game IP rights acquired  $-   $93,828 
Payable for workforce acquired  $-   $121,695 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

 7 

 

Seven Stars Cloud Group, Inc., Its Subsidiaries and Variable Interest Entities

UNAUDITED CONSOLIDATED STATEMENTS OF EQUITY

For the Nine Months Ended September 30, 2016

  

   Series E
Preferred
Stock
   Series E
Par
Value
   Common
Stock
   Par
Value
   Additional
Paid-in
Capital
   Accumulated
Deficit
   Accumulated
Other
Comprehensive
Loss
   Seven Stars Cloud
Shareholders'
Equity
   Non-
controlling
Interest
   Total
Equity
 

Balance,

January 1, 2016

   7,254,997   $7,255    24,249,109   $24,249   $97,512,542   $(86,457,840)  $(414,910)  $10,671,296   $(2,388,031)  $8,283,265 
Share-based compensation   -    -    25,000    25    286,552    -    -    286,577    -    286,577 
Common stock issuance   -    -    9,090,909    9,091    17,268,483    -    -    17,277,574    -    17,277,574 
Warrants issued in connection with common stock issuance   -    -    -    -    722,426    -    -    722,426    -    722,426 
Issuance cost in connection with the issuance of common stock and warrants   -    -    -    -    (411,223)   -    -    (411,223)   -    (411,223)
Common stock issued from conversion of  convertible note   -    -    9,208,860    9,209    17,724,088    -    -    17,733,297    -    17,733,297 
Restricted Shares granted in connection with  acquisition   -    -              121,695    -    -    121,695    -    121,695 
Common stock issued for settlement of liability   -    -    41,780    42    74,958    -    -    75,000    -    75,000 
Common stock issued from series E preferred stock   (100,000)   (100)   100,000    100    -    -    -    -    -    - 
Net loss   -    -    -    -    -    (5,771,763)   -    (5,771,763)   (261,809)   (6,033,572)
Foreign currency translation adjustments, net of nil tax   -    -    -    -    -    -    (290,733)   (290,733)   21,459    (269,274)

Balance, 

September 30, 2016

   7,154,997   $7,155    42,715,658   $42,716   $133,299,521   $(92,229,603)  $(705,643)  $40,414,146   $(2,628,381)  $37,785,765 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

 8 

 

Seven Stars Cloud Group, Inc., Its Subsidiaries and Variable Interest Entities
UNAUDITED CONSOLIDATED STATEMENTS OF EQUITY

For the Nine Months Ended September 30, 2017

 

   Series E
Preferred
Stock
   Series E
Par
Value
   Common
Stock
   Par
Value
   Additional
Paid-in
Capital
   Accumulated
Deficit
   Accumulated
Other
Comprehensive
Income (Loss)
   Seven Stars Cloud
Shareholders'
Equity
   Non-
controlling
Interest
   Total
Equity
 

Balance,

January 1, 2017

   7,154,997   $7,155    53,918,523   $53,918   $152,755,919   $(115,669,268)  $(1,353,302)  $35,794,422   $(5,325,481)  $30,468,941 
Share-based compensation   -    -    -    -    202,501    -    -    202,501    -    202,501 
Common stock issuance   -    -    727,273    727    1,999,273    -    -    2,000,000    -    2,000,000 
Common stock issuance for RSU vested   -    -    111,465    112    (112)   -    -    -    -    - 
Common stock issuance for option exercised   -    -    41,131    41    39,862    -    -    39,903    -    39,903 
Common stock issued for warrant exercised   -    -    311,105    311    681,916    -    -    682,227    -    682,227 
Common stock issued from conversion of series E preferred stock   (7,154,997)   (7,155)   7,154,997    7,155    -    -    -    -    -    - 
Disposal of Zhong Hai Shi Xun   -    -    -    -    (9,887,398)   (360,522)   (220,737)   (10,468,657)   3,947,473    (6,521,184)
Net loss   -    -    -    -    -    (4,491,943)   -    (4,491,943)   (608,910)   (5,100,853)
Foreign currency translation adjustments, net of nil tax   -    -    -    -    -    -    798,527    798,527    (38,164)   760,363 

Balance, 

September 30, 2017

   -   $-    62,264,494   $62,264   $145,791,961   $(120,521,733)  $(775,512)  $24,556,980   $(2,025,082)  $22,531,898 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

 9 

 

Seven Stars Cloud Group, Inc., Its Subsidiaries and Variable Interest Entities
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

1.Organization and Principal Activities

 

Seven Stars Cloud Group, Inc., formerly known as Wecast Network, Inc., is a Nevada corporation that primarily operates in China (“PRC”) through its subsidiaries and consolidated variable interest entities (“VIEs”). Seven Stars Cloud Group, Inc., its subsidiaries and consolidated VIEs are collectively referred to as Seven Stars Cloud (“SSC”, “we”, “us”, or “the Company”).

 

SSC is aiming to become a global leader in providing next-generation Artificial-Intelligent (AI) & Fintech Powered, Supply Chain + Digital Finance Solutions. SSC’s innovative model helps businesses enhance and unlock operational and capital value from both the supply chain and real assets. In addition, SSC offers a closed trade ecosystem for buyers and sellers designed to eliminate transactional middlemen and create a more direct and margin-expanding path for principals. There are three engines that drive our business platform: 1. Intelligent Supply Chain Management; 2. Asset Based Securitization and Tokenization Issuance and Trading Platform and 3. Digital Index and Financial Derivatives Issuance and Trading Platform; All three engines are supported by “ABCD” Technology & Infrastructure (A: Artificial IntelligenceI, B: Blockchain, C: Cloud Computing, D: Data). SSC is also leveraging its legacy operations as a premium content Video On Demand (“VOD”) service provider in China.

 

On January 30, 2017, the Company entered into a Securities Purchase Agreement (the “Sun Video SPA”) with BT Capital Global Limited, a British Virgin Islands company (“BT”) and affiliate of the Company’s Chairman Bruno Wu, for the purchase by the Company of all of the outstanding capital stock of Sun Video Group Hong Kong Limited. On January 31, 2017, the Company entered into another Securities Purchase Agreement (the “Wide Angle SPA”) with BT and Sun Seven Stars Media Group Limited, one of the Company’s largest shareholders, controlled by Mr. Wu, as guarantor, for the purchase by us of 55% of the outstanding capital stock of Wide Angle Group Limited (“Wide Angle”). Details of these two acquisitions are disclosed in Note 4. After acquiring these two entities, other than the Company’s legacy You On Demand (“YOD”) business, the Company became engaged in consumer electronics and smart supply chain management operations.

 

On June 30, 2017, the Company entered into another Securities Purchase Agreement (the “BT SPA”) with BT, pursuant to which the issued and outstanding stock that SSC holds in three separate non-core assets were sold to BT in exchange for RMB100 million (approximately $14.75 million at current exchange rates) in a combination of cash and publicly traded stock to be paid to SSC within one year of closing. A minimum of 20% of the total consideration to SSC will be paid in cash (approximately $2.95 million). A portion of the consideration may be paid in the form of publicly traded stock at the discretion of BT, and in that case, the securities will represent a public company affiliated with BT, in an industry related to SSC’s and with an average daily trading value of at least $146,000. The detail of this transaction has been disclosed in Note 11.

 

In the opinion of management, all adjustments (which include normal recurring adjustments) necessary to present a fair statement of the financial position as of September 30, 2017, results of operations for the three and nine months ended September 30, 2017 and 2016, and cash flows for the nine months ended September 30, 2017 and 2016, have been made. All significant intercompany transactions and balances are eliminated on consolidation.

 

Certain information and footnote disclosures normally included in the annual consolidated financial statements prepared in accordance with U.S. GAAP have been condensed or omitted. These unaudited consolidated financial statements should be read in conjunction with the Company's audited consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016 filed with the Securities and Exchange Commission on March 31, 2017 (“2016 Annual Report”).

 

2.Going Concern and Management’s Plans

 

For the nine months ended September 30, 2017 and 2016, the Company incurred loss from operations of approximately $4.7 million and $6.0 million, respectively, and incurred net loss of $5.1 million and $6.0 million, respectively, and cash used in operations was approximately $5.8 million and $7.9 million, respectively. Further, the Company had accumulated deficit of approximately $120.5 million and $115.7 million as of September 30, 2017 and December 31, 2016, respectively, due to recurring losses since the inception of its business.

 

The Company must continue to rely on proceeds from debt and equity issuances to pay for ongoing operating expenses in order to execute its business plan. On March 28, 2016, the Company completed a common stock financing for $10.0 million. In addition, the Company completed four separate common stock financings with Seven Star Works Co. Ltd. (“SSW”) for $4.0 million on July 19, 2016, with Harvest Alternative Investment Opportunities SPC (“Harvest”) for $4.0 million on August 12, 2016, with Sun Seven Stars Hong Kong Cultural Development Limited (“SSSHK”) for $2.0 million on November 17, 2016 and with certain investors, officers & directors and affiliates in a private placement for $2.0 million on May 19, 2017, respectively. Although the Company believes it has the ability to

 

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Seven Stars Cloud Group, Inc., Its Subsidiaries and Variable Interest Entities
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

  

raise funds by issuing debt or equity instruments, additional financing may not be available to the Company on terms acceptable to the Company or at all or such resources may not be received in a timely manner.

 

These conditions raise substantial doubt about the Company’s ability to continue as a going concern. The consolidated financial statements have been prepared assuming that the Company will continue as a going concern and, accordingly, do not include any adjustments that might result from the outcome of this uncertainty.

 

3.VIE Structure and Arrangements

 

a)Sinotop VIE structure and arrangement

 

In response to PRC laws and regulations that prohibit or restrict foreign ownership of companies that provides value-added telecommunication services, the Company provides its services through Sinotop Beijing. The Company has the ability to control Sinotop Beijing through a series of contractual agreements entered into among YOD WFOE, YOD Hong Kong, Sinotop Beijing and the legal shareholders of Sinotop Beijing.

 

Prior to January 2016, the Company entered into a series of contractual agreements to give it the ability to control Sinotop Beijing with Zhang Yan, the former legal shareholder of Sinotop Beijing (the spouse of its then-CEO). In January 2016, in connection with the appointment of a new CEO and in accordance with its rights under the contractual agreements, (1) the legal ownership of Sinotop Beijing was transferred from Zhang Yan to Bing Wu, the brother of its current Chairman and Yun Zhu, the former Vice President of Beijing Sun Seven Stars Culture Development Limited (“SSS”), (2) the Company terminated the series of contractual arrangements with Zhang Yan, and (3) the Company entered into new contractual agreements with Bing Wu and Yun Zhu (collectively, the “Former Sinotop VIE Agreements”). In October 2016, in accordance with its rights under contractual agreements, (1) the legal ownership of Sinotop Beijing was transferred from Bing Wu to Mei Chen, the former CFO of the Company, (2) the Company terminated the series of contractual arrangements with Bing Wu, and (3) the Company entered into new contractual agreements with Mei Chen (collectively, the “New Sinotop VIE Agreements”). Although the Former Sinotop VIE Agreements and New Sinotop VIE Agreements resulted in changes to the legal shareholders of Sinotop Beijing, there was no change in the Company’s ability to control Sinotop Beijing or the Company’s rights to 100% of the economic benefits of Sinotop Beijing. The Company was the primary beneficiary of Sinotop Beijing prior to the signing of the Former Sinotop VIE Agreements and New Sinotop VIE Agreements and the Company remained the primary beneficiary of Sinotop Beijing after the signing of the former Sinotop VIE Agreements and the New Sinotop VIE Agreements. Accordingly, the change in legal ownership of Sinotop Beijing did not have any impact to the Company’s consolidation of Sinotop Beijing. The key terms of the New Sinotop VIE Agreements are summarized as follows:

 

Equity Pledge Agreement

 

Pursuant to the Equity Pledge Agreement among YOD WFOE, Sinotop Beijing, Mei Chen and Yun Zhu (collectively, the “Nominee Shareholders”), the Nominee Shareholders pledged all of their equity interests in Sinotop Beijing (the “Collateral”) to YOD WFOE as security for the performance of the obligations of Sinotop Beijing to make all the required technical service fee payments pursuant to the Technical Services Agreement and for performance of the Nominee Shareholders’ obligation under the Call Option Agreement. The terms of the Equity Pledge Agreement expire upon satisfaction of all obligations under the Technical Services Agreement and Call Option Agreement.

 

Call Option Agreement

 

Pursuant to the Call Option Agreement among YOD WFOE, Sinotop Beijing and the Nominee Shareholders, the Nominee Shareholders granted an exclusive option to YOD WFOE, or its designee, to purchase, at any time and from time to time, to the extent permitted under PRC law, all or any portion of the Nominee Shareholders’ equity in Sinotop Beijing. The exercise price of the option shall be determined by YOD WFOE at its sole discretion, subject to any restrictions imposed by PRC law. The term of the agreement is until all of the equity interest in Sinotop Beijing held by the Nominee Shareholders are transferred to YOD WFOE, or its designee and may not be terminated by any part to the agreement without consent of the other parties.

 

Power of Attorney

 

Pursuant to the Power of Attorney agreements among YOD WFOE, Sinotop Beijing and each of the respective Nominee Shareholders, each of the Nominee Shareholders granted YOD WFOE the irrevocable right, for the maximum period permitted by law, all of its voting rights as shareholders of Sinotop Beijing. The Nominee Shareholders may not transfer any of its equity interest in Sinotop Beijing to any

 

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Seven Stars Cloud Group, Inc., Its Subsidiaries and Variable Interest Entities
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

party other than YOD WFOE. The Power of Attorney agreements may not be terminated except until all of the equity in Sinotop Beijing has been transferred to YOD WFOE or its designee.

 

Technical Service Agreement

 

Pursuant to the Technical Service Agreement between YOD WFOE and Sinotop Beijing, YOD WFOE has the exclusive right to provide technical service, marketing and management consulting service, financial support service and human resource support services to Sinotop Beijing, and Sinotop Beijing is required to take all commercially reasonable efforts to permit and facilitate the provision of the services by YOD WFOE. As compensation for providing the services, YOD WFOE is entitled to receive service fees from Sinotop Beijing equivalent to YOD WFOE’s cost plus 30% of such costs as calculated on accounting policies generally accepted in the PRC. YOD WFOE and Sinotop Beijing agree to periodically review the service fee and make adjustments as deemed appropriate. The term of the Technical Services Agreement is perpetual, and may only be terminated upon written consent of both parties.

 

Spousal Consent

 

Pursuant to the Spousal Consent, undersigned by the respective spouse of Nominee Shareholders (collectively, the “Spouses”), the Spouses unconditionally and irrevocably agreed to the execution of the Equity Pledge Agreement, Call Option Agreement and Power of Attorney agreement. The Spouses agreed to not make any assertions in connection with the equity interest of Sinotop Beijing and to waived consent on further amendment or termination of the Equity Pledge Agreement, Call Option Agreement and Power of Attorney agreement. The Spouses further pledge to execute all necessary documents and take all necessary actions to ensure appropriate performance under these agreements upon YOD WFOE’s request. In the event the Spouses obtain any equity interests of Sinotop Beijing which are held by the Nominee Shareholders, the Spouses agreed to be bound by the New Sinotop VIE Agreements, including the Technical Services Agreement, and comply with the obligations thereunder, including sign a series of written documents in substantially the same format and content as the New Sinotop VIE Agreements.

 

Letter of Indemnification

 

Pursuant to the Letter of Indemnification among YOD WFOE and Mei Chen and YOD WFOE and Yun Zhu, YOD WFOE agreed to indemnify Nominee Shareholders against any personal, tax or other liabilities incurred in connection with their role in equity transfer to the greatest extent permitted under PRC law. YOD WFOE further waived and released Nominee Shareholders from any claims arising from, or related to, their role as the legal shareholder of Sinotop Beijing, provided that their actions as a nominee shareholder are taken in good faith and are not opposed to YOD WFOE’s best interests. Conversely, the Nominee Shareholders will not be entitled to dividends or other benefits generated therefrom, or receive any compensation in connection with this arrangement. The Letter of Indemnification will remain valid until either Nominee Shareholders or YOD WFOE terminates the agreement by giving the other party hereto 60 days’ prior written notice.

 

In addition to the New Sinotop VIE Agreements, the Management Service Agreement between Sinotop Beijing and YOD Hong Kong continued to remain in effect, the key terms of which are as follows:

 

Management Services Agreement

 

Pursuant to a Management Services Agreement, as of March 9, 2010, YOD Hong Kong has the exclusive right to provide to Sinotop Beijing management, financial and other services related to the operation of Sinotop Beijing’s business, and Sinotop Beijing is required to take all commercially reasonable efforts to permit and facilitate the provision of the services by YOD Hong Kong. As compensation for providing the services, YOD Hong Kong is entitled to receive a fee from Sinotop Beijing, upon demand, equal to 100% of the annual net profits as calculated on accounting policies generally accepted in the PRC of Sinotop Beijing during the term of the Management Services Agreement. YOD Hong Kong may also request ad hoc quarterly payments of the aggregate fee, which payments will be credited against Sinotop Beijing’s future payment obligations.

 

The Management Services Agreement also provides YOD Hong Kong, or its designee, with a right of first refusal to acquire all or any portion of the equity of Sinotop Beijing upon any proposal by the sole shareholder of Sinotop Beijing to transfer such equity. In addition, at the sole discretion of YOD Hong Kong, Sinotop Beijing is obligated to transfer to YOD Hong Kong, or its designee, any part or all of the business, personnel, assets and operations of Sinotop Beijing which may be lawfully conducted, employed, owned or operated by YOD Hong Kong, including:

 

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Seven Stars Cloud Group, Inc., Its Subsidiaries and Variable Interest Entities
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

(a)         business opportunities presented to, or available to Sinotop Beijing may be pursued and contracted for in the name of YOD Hong Kong rather than Sinotop Beijing, and at its discretion, YOD Hong Kong may employ the resources of Sinotop Beijing to secure such opportunities;

 

(b)        any tangible or intangible property of Sinotop Beijing, any contractual rights, any personnel, and any other items or things of value held by Sinotop Beijing may be transferred to YOD Hong Kong at book value;

 

(c)        real property, personal or intangible property, personnel, services, equipment, supplies and any other items useful for the conduct of the business may be obtained by YOD Hong Kong by acquisition, lease, license or otherwise, and made available to Sinotop Beijing on terms to be determined by agreement between YOD Hong Kong and Sinotop Beijing;

 

(d)        contracts entered into in the name of Sinotop Beijing may be transferred to YOD Hong Kong, or the work under such contracts may be subcontracted, in whole or in part, to YOD Hong Kong, on terms to be determined by agreement between YOD Hong Kong and Sinotop Beijing; and

 

(e)        any changes to, or any expansion or contraction of, the business may be carried out at the sole discretion of YOD Hong Kong, and in the name of and at the expense of, YOD Hong Kong; provided, however, that none of the foregoing may cause or have the effect of terminating (without being substantially replaced under the name of YOD Hong Kong) or adversely affecting any license, permit or regulatory status of Sinotop Beijing.

 

The term of the Management Services Agreement is 20 years, and may not be terminated by Sinotop Beijing, except with the consent of, or a material breach by, YOD Hong Kong.

 

Pursuant to the above contractual agreements, YOD WFOE can have the assets transferred freely out of Sinotop Beijing without any restrictions. Therefore, YOD WFOE considers that there is no asset of Sinotop Beijing that can be used only to settle obligations of Sinotop Beijing, except for the registered capital of the entity amounting to RMB10.6 million (approximately $1.6 million) as of September 30, 2017. As Sinotop Beijing is incorporated as limited liability company under PRC Company Law, creditors of this entity do not have recourse to the general credit of other entities of the Company.

 

b)Tianjin Sevenstarflix Network Technology Limited (“SSF”) VIE structure and arrangements

 

In response to PRC laws and regulations that prohibit or restrict foreign ownership of companies that provides value-added telecommunication services, the Company plans to also provide its services through SSF, which is applying to hold the licenses and approvals to provide digital distribution and Internet content services in the PRC. The Company has the ability to control SSF through a series of contractual agreements, as described below, entered into among YOD WFOE, YOD Hong Kong, SSF and the legal shareholders of SSF.

 

On April 5, 2016, YOD WFOE entered into variable interest entity agreements with SSF and its nominee shareholders pursuant to the Amended Tianjin Agreement dated December 21, 2015 (see Note 12(c)) (the “SSF VIE Agreements”). Lan Yang, holder of 99% equity ownership in SSF and a party to certain of the SSF VIE Agreements, is the spouse of Bruno Zheng Wu, the Company’s Chairman. Yun Zhu, holder of 1% equity ownership in SSF and a party to certain of the SSF VIE Agreements, is the Vice President of SSS.

 

The terms of the SSF VIE Agreements are as follows:

 

Equity Pledge Agreement

 

Pursuant to the Equity Pledge Agreement among YOD WFOE, Lan Yang and Yun Zhu (the “Nominee Shareholders”), dated April 5, 2016, the Nominee Shareholders pledged all of their capital contribution rights in SSF to YOD WFOE as security for the performance of the obligations of SSF to make all the required technical service fee payments pursuant to the Technical Services Agreement and for performance of the Nominee Shareholders’ obligation under the Call Option Agreement. The terms of the Equity Pledge Agreement expire upon satisfaction of all obligations under the Technical Services Agreement and Call Option Agreement.

 

Call Option Agreement

 

Pursuant to the Call Option Agreement among YOD WFOE, SSF and the Nominee Shareholders, dated April 5, 2016, the Nominee Shareholders granted an exclusive option to YOD WFOE, or its designee, to purchase, at any time and from time to time, to the extent permitted under PRC law, all or any portion of the Nominee Shareholders’ equity in SSF. The exercise price of the option shall be

 

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Seven Stars Cloud Group, Inc., Its Subsidiaries and Variable Interest Entities
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

determined by YOD WFOE at its sole discretion, subject to any restrictions imposed by PRC law. The term of the agreement is until all of the equity interest in SSF held by the Nominee Shareholders is transferred to YOD WFOE, or its designee and may not be terminated by any party to the agreement without consent of the other parties.

 

Power of Attorney

 

Pursuant to the Power of Attorney agreements among YOD WFOE, SSF and each of the respective Nominee Shareholders, dated April 5, 2016, each of the Nominee Shareholders granted YOD WFOE the irrevocable right, for the maximum period permitted by law, to all of its voting rights as shareholders of SSF. The Nominee Shareholders may not transfer any of their equity interest in SSF to any party other than YOD WFOE. The Power of Attorney agreements may not be terminated except until all of the equity in SSF has been transferred to YOD WFOE or its designee.

 

Technical Service Agreement

 

Pursuant to the Technical Service Agreement, dated April 5, 2016, between YOD WFOE and SSF, YOD WFOE has the exclusive right to provide technical service, marketing and management consulting service, financial support service and human resource support services to SSF, and SSF is required to take all commercially reasonable efforts to permit and facilitate the provision of the services by YOD WFOE. As compensation for providing the services, YOD WFOE is entitled to receive service fees from SSF equivalent to YOD WFOE’s cost plus 20-30% of such costs as calculated on accounting policies generally accepted in the PRC. YOD WFOE and SSF agree to periodically review the service fee and make adjustments as deemed appropriate. The term of the Technical Services Agreement is perpetual, and may only be terminated upon written consent of both parties.

 

Spousal Consent

 

Pursuant to the Spousal Consent, dated April 5, 2016, undersigned by the respective spouse of the Nominee Shareholders (collectively, the “Spouses”), the Spouses unconditionally and irrevocably agreed to the execution of the Equity Pledge Agreement, Call Option Agreement and Power of Attorney agreement. The Spouses agreed to not make any assertions in connection with the equity interest of SSF and to waive consent on further amendment or termination of the Equity Pledge Agreement, Call Option Agreement and Power of Attorney agreement. The Spouses further pledge to execute all necessary documents and take all necessary actions to ensure appropriate performance under these agreements upon YOD WFOE’s request. In the event the Spouses obtain any equity interests of SSF which are held by the Nominee Shareholders, the Spouses agreed to be bound by the SSF VIE Agreements, including the Technical Services Agreement, and comply with the obligations thereunder, including sign a series of written documents in substantially the same format and content as the SSF VIE Agreements.

 

Letter of Indemnification

 

Pursuant to the Letter of Indemnification among YOD WFOE and Lan Yang and YOD WFOE and Yun Zhu, both dated as of April 5, 2016, YOD WFOE agreed to indemnify Nominee Shareholders against any personal, tax or other liabilities incurred in connection with their role in equity transfer to the greatest extent permitted under PRC law. YOD WFOE further waived and released the Nominee Shareholders from any claims arising from, or related to, their role as the legal shareholder of SSF, provided that their actions as a nominee shareholder are taken in good faith and are not opposed to YOD WFOE’s best interests. The Nominee Shareholders will not be entitled to dividends or other benefits generated therefrom, or receive any compensation in connection with this arrangement. The Letter of Indemnification will remain valid until either the Nominee Shareholders or YOD WFOE terminates the agreement by giving the other party hereto 60 days’ prior written notice.

 

Loan Agreement

 

Pursuant to the Loan Agreement among YOD WFOE and the Nominee Shareholders, dated April 5, 2016, YOD WFOE agrees to lend RMB 19.8 million and RMB 0.2 million, respectively, to the Nominee Shareholders for the purpose of establishing SSF and for development of its business. As of December 31, 2016, RMB 27.6 million (US $4.2 million) and RMB nil have been lent to Lan Yang and Yun Zhu, respectively. Lan Yang has contributed all of the RMB 27.6 million (US $4.2 million) in the form of capital contribution. The loan can only be repaid by a transfer by the Nominee Shareholders of their equity interests in SSF to YOD WFOE or YOD WFOE’s designated persons, through (i) YOD WFOE having the right, but not the obligation to at any time purchase, or authorize a designated person to purchase, all or part of the Nominee Shareholders’ equity interests in SSF at such price as YOD WFOE shall determine (the “Transfer Price”), (ii) all monies received by the Nominee Shareholders through the payment of the Transfer Price being used solely to repay YOD WFOE for the loans, and (iii) if the Transfer Price exceeds the principal amount of the loans, the amount in excess of the principal amount of the loans being deemed as interest payable on the loans, and to be payable to YOD WFOE in cash. Otherwise, the

 

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Seven Stars Cloud Group, Inc., Its Subsidiaries and Variable Interest Entities
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

loans shall be deemed to be interest-free. The term of the Loan Agreement is perpetual, and may only be terminated upon the Nominee Shareholders receiving repayment notice, or upon the occurrence of an event of default under the terms of the agreement. The loan extended to the Nominee Shareholders and the capital of SSF are fully eliminated in the consolidated financial statements.

 

Management Services Agreement

 

In addition to the SSF VIE Agreements, the Company’s subsidiary and the parent company of YOD WFOE, YOU On Demand (Asia) Limited, a company incorporated under the laws of Hong Kong (“YOD Hong Kong”) entered into a Management Services Agreement with SSF, dated as of April 6, 2016 (the “Management Services Agreement”). Pursuant to a Management Services Agreement, YOD Hong Kong has the exclusive right to provide to SSF management, financial and other services related to the operation of SSF’s business, and SSF is required to take all commercially reasonable efforts to permit and facilitate the provision of the services by YOD Hong Kong. As compensation for providing the services, YOD Hong Kong is entitled to receive a fee from SSF, upon demand, equal to 100% of the annual net profits as calculated on accounting policies generally accepted in the PRC of SSF during the term of the Management Services Agreement. YOD Hong Kong may also request ad hoc quarterly payments of the aggregate fee, which payments will be credited against SSF’s future payment obligations.

 

In addition, at the sole discretion of YOD Hong Kong, SSF is obligated to transfer to YOD Hong Kong, or its designee, any part or all of the business, personnel, assets and operations of SSF which may be lawfully conducted, employed, owned or operated by YOD Hong Kong, including:

 

(a)        business opportunities presented to, or available to SSF may be pursued and contracted for in the name of YOD Hong Kong rather than SSF, and at its discretion, YOD Hong Kong may employ the resources of SSF to secure such opportunities;

 

(b)        any tangible or intangible property of SSF, any contractual rights, any personnel, and any other items or things of value held by SSF may be transferred to YOD Hong Kong at book value;

 

(c)        real property, personal or intangible property, personnel, services, equipment, supplies and any other items useful for the conduct of the business may be obtained by YOD Hong Kong by acquisition, lease, license or otherwise, and made available to SSF on terms to be determined by agreement between YOD Hong Kong and SSF;

 

(d)        contracts entered into in the name of SSF may be transferred to YOD Hong Kong, or the work under such contracts may be subcontracted, in whole or in part, to YOD Hong Kong, on terms to be determined by agreement between YOD Hong Kong and SSF; and

 

(e)        any changes to, or any expansion or contraction of, the business may be carried out in the exercise of the sole discretion of YOD Hong Kong, and in the name of and at the expense of, YOD Hong Kong;

 

provided, however, that none of the foregoing may cause or have the effect of terminating (without being substantially replaced under the name of YOD Hong Kong) or adversely affecting any license, permit or regulatory status of SSF.

 

The term of the Management Services Agreement is 20 years, and may not be terminated by SSF, except with the consent of, or a material breach by, YOD Hong Kong.

 

Pursuant to the above contractual agreements, YOD WFOE can have the assets transferred freely out of SSF without any restrictions. Therefore, YOD WFOE considers that there is no asset of SSF that can be used only to settle obligation of YOD WFOE, except for the registered capital of SSF amounting to RMB 50.0 million (approximately $7.5 million), among which RMB 27.6 million (approximately $4.1 million) has been injected as of September 30, 2017. As SSF is incorporated as limited liability company under PRC Company Law, creditors of this entity do not have recourse to the general credit of other entities of the Company.

 

Financial Information

 

On June 30, 2017, Company entered into BT SPA, under which Zhong Hai Shi Xun Media, which was formerly 80% owned by Sinotop Beijing, was sold to BT. The details of this transaction are disclosed in Note 11.

 

The following financial information of our VIEs, as applicable for the periods presented, affected the Company's consolidated financial statements.

 

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Seven Stars Cloud Group, Inc., Its Subsidiaries and Variable Interest Entities
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

   September 30,   December 31, 
   2017   2016 
ASSETS          
Current assets:          
Cash  $4,063   $1,519,125 
Accounts receivable, net   -    1,260,529 
Prepaid expenses   2,156    30,455 
Other current assets   1,503    191,427 
Intercompany receivables due from the Company's subsidiaries(i)   2,439,391    150,725 
Total current assets   2,447,113    3,152,261 
Property and equipment, net   -    196,677 
Intangible assets, net   -    2,570 
Long term investments   3,649,042    3,654,664 
Other non-current assets   -    442,782 
Total assets  $6,096,155   $7,448,954 
           
LIABILITIES          
Current liabilities:          
Accounts payable  $-   $5,817 
Deferred revenue   -    824,563 
Accrued expenses   -    268,074 
Other current liabilities   40    394,314 
Accrued license content fees   -    1,236,661 
Intercompany payables due to the Company's subsidiaries(i)   3,518,877    14,752,338 
Total current liabilities   3,518,917    17,481,767 
Total liabilities  $3,518,917   $17,481,767 

 

   Nine Months Ended 
   September 30,   September 30, 
   2017   2016 
Revenue  $794,273   $4,377,034 
Net loss  $(4,293,469)  $(1,182,884)

 

   Nine Months Ended 
   September 30,   September 30, 
   2017   2016 
Net cash used in operating activities  $(1,661,531)  $(3,777,951)
Net cash used in investing activities  $(43,047)  $(3,355,296)
Net cash provided by financing activities(i)  $189,515   $6,555,377 

 

(i)Intercompany receivables and payables are eliminated upon consolidation. The intercompany financing activities include the capital injection of $0.2 million to Sinotop Beijing in the nine months period ended September 30, 2017.

 

After the disposal of Zhong Hai Shi Xun Media as of June 30, 2017, the total assets consisted of receivables and long term investments. The Company expects that a lower percentage of its total revenue will be generated from its VIEs in the foreseeable future.

 

4.Acquisition

 

On January 30, 2017, the Company entered into a Securities Purchase Agreement (the “Sun Video SPA”) with BT Capital Global Limited, a British Virgin Islands company (“BT”) which is controlled by Company’s Chairman Bruno Wu, for the purchase by SSC of all of the outstanding capital stock of Sun Video Group Hong Kong Limited, a Hong Kong corporation (“SVG”), for an aggregate purchase price of $800,000 and a $50 million Promissory Note (the “SVG Note”) with the principal and interest thereon convertible into shares of the Company’s common stock at a conversion rate of $1.50 per share. BT has guaranteed that SVG will achieve certain financial goals within 12 months of the closing. Until receipt of necessary shareholder approvals, the SVG Note is not convertible into shares of our common stock, but once the necessary shareholder approval is received, the unpaid principal and interest thereon will automatically convert. Under the terms of the Sun Video SPA, BT has guaranteed that the business of SVG and its subsidiaries (the “Sun Video Business”) shall achieve revenue of $250 million and $15 million of gross profit (collectively the “Performance Guarantees”) within 12 months of the closing. If the Sun Video Business fails to meet either of the Performance Guarantees within such time, BT shall forfeit back to the Company the shares of the Company’s common stock or the SVG Note, on a pro rata basis based on the Performance Guarantee for which the Sun Video Business achieves the lowest percentage of the respective amount guaranteed.

 

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Seven Stars Cloud Group, Inc., Its Subsidiaries and Variable Interest Entities
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

In addition, if the Sun Video Business achieves more than $50 million in cumulative net income within 3 years of closing, (the “Net Income Threshold”), the Company shall pay BT 50% of the amount of any cumulative net income above the Net Income Threshold. Profit share payments shall be made on an annual basis, in either cash or stock at the discretion of our Board of Directors. If the Board decides to make the payment in stock, the number of our shares of common stock to be awarded shall be calculated based on the market price of such shares.

 

After the acquisition of SVG, the Company changed its name to Wecast Services Group Limited, and is therefore also referred to herein as Wecast Services.

 

On January 31, 2017, the Company entered into a Securities Purchase Agreement (the “Wide Angle SPA”) with BT and Sun Seven Stars Media Group Limited, a Hong Kong company (“SSS”), one of the Company’s largest shareholders, controlled by our Chairman Bruno Wu, as guarantor, for the purchase by the Company of 55% of the outstanding capital stock of Wide Angle for the sole consideration of the Company adding Wide Angle to the Sun Video Business acquired by the Company under the Sun Video SPA and thereby including 100% of the revenue and gross profit from Wide Angle in the calculation of the SVG Performance Guarantees set forth in the Sun Video SPA considering the Company has consolidated Wide Angle.

 

Since the Company, Wecast Services and Wide Angle were controlled by our Chairman Bruno Wu since November 10, 2016, as well as both before and after the acquisition, this transaction was accounted for as a business combination between entities under common control by Mr. Wu. Therefore, in accordance with ASC Subtopic 805-50, the consolidated financial statements of the Company include the acquired assets and liabilities of the SVG and Wide Angle at their historical carrying amounts. In addition, the Company’s consolidated financial statements as of December 31, 2016 have been prepared as if the Wecast Services and Wide Angle had been owned by the Company since November 10, 2016 presented and the Company’s consolidated financial statements as of December 31, 2016 has been retrospectively adjusted accordingly.

 

As of September 30, 2017, the Company recorded the $50 million SVG Note as additional paid in capital, as the Company believes that the Performance Guarantees can be met within 12 months of the closing. Considering the proceeds transferred were larger than carrying amounts of the net assets received, such $50 million was then recognized as a reduction to the Company’s additional paid in capital. The Company has not begun accruing any reserves relating to potential Net Income Threshold earnout payments, since the Sun Video Business is currently not close to exceeding this threshold.

 

5.Accounts Receivable

 

Accounts receivable consists of the following:

 

   September 30,   December 31, 
   2017   2016 
Accounts receivable, gross:  $42,787,928   $12,350,947 
Less: allowance for doubtful accounts   (3,647)   (2,828,796)
Accounts receivable, net  $42,784,281   $9,522,151 

 

The movement of the allowance for doubtful accounts is as follows:

 

   September 30,
2017
   December 31,
2016
 
Balance at the beginning of the period  $(2,828,796)  $(3,672)
Additions charged to bad debt expense   (103,040)   (2,825,124)
Write-off of bad debt allowance   47,378    - 
Disposal of Zhong Hai Shi Xun   2,880,811    - 
Balance at the end of the period  $(3,647)  $(2,828,796)

 

6.Property and Equipment

 

The following is a breakdown of the Company’s property and equipment:

 

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Seven Stars Cloud Group, Inc., Its Subsidiaries and Variable Interest Entities
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

  

   September 30,   December 31, 
   2017   2016 
Furniture and office equipment  $296,161   $1,063,481 
Vehicle   146,466    267,023 
Office Building   -    3,948,058 
Leasehold improvements   -    939,844 
Total property and equipment   442,627    6,218,406 
Less: accumulated depreciation   (323,323)   (1,254,681)
Property and Equipment, net  $119,304   $4,963,725 

 

The Company recorded depreciation expense of approximately $8,508 and $209,139 for the three and nine months ended September 30, 2017 and $33,000 and $101,000 for the three and nine months ended September 30, 2016, respectively.

 

7.Intangible Assets

 

As of September 30, 2017 and December 31, 2016, the Company’s amortizing and indefinite lived intangible assets consisted of the following:

 

   September 30, 2017   December 31, 2016 
 Amortizing Intangible   Gross
Carrying
   Accumulated   Impairment   Net   Gross
Carrying
   Accumulated   Impairment   Net 
Assets  Amount   Amortization   Loss   Balance   Amount   Amortization   Loss   Balance 
                                        
Charter/Cooperation agreements (iii)  $-   $-   $-   $-   $2,755,821   $(909,257)  $(1,846,564)  $- 
Software and licenses   211,939    (195,160)   -    16,779    267,991    (241,932)   -    26,059 
Patent and trademark (iv)   92,965    (39,943)   (53,022)   -    92,965    (39,943)   -    53,022 
Website and mobile app development (ii)   -    -    -    -    593,193    (421,129)   (172,064)   - 
Workforce (i)   305,694    (152,847)   (152,847)   -    305,694    (76,422)   -    229,272 
Total amortizing intangible assets  $610,598   $(387,950)  $(205,869)  $16,779   $4,015,664   $(1,688,683)  $(2,018,628)  $308,353 
Indefinite lived intangible assets                                        
Website name   134,290    -    -    134,290    134,290    -    -    134,290 
Patent (iv)   10,599    -    (10,599)   -    10,599    -    -    10,599 
Total intangible assets  $755,487   $(387,950)  $(216,468)  $151,069   $4,160,553   $(1,688,683)  $(2,018,628)  $453,242 

 

(i) On April 1, 2016, the Company entered into an agreement with Mr. Changsheng Liu, under which SSC agreed to pay Mr. Changsheng Liu cash consideration of $187,653 and 66,500 shares of restricted shares with a six month restriction period and a fair value of $121,695 in exchange for a workforce of 10 personnel experienced in programing content mobile apps. All 10 personnel entered into three year employment contracts with SSC effective April 1, 2016. The Company also acquired certain laptop and desktop computers with fair value of $3,655. According to the agreement, 30% of the cash consideration is due upon the signing of the agreement, 20% is due 2 months after the signing of the agreement and 50% is due 6 months after the signing of the agreement. All cash consideration has been paid. If any of 3 key staff, as defined, terminated their employment with SSC during the first 12 months of employment, SSC has the right to forfeit the unpaid cash consideration. In addition, Mr. Changsheng Liu would be required to pay a default penalty at minimal of $129,180. SSC has accounted for the transaction as an asset acquisition in which SSC mainly acquired a workforce, which is recognized as an intangible asset at cost. Subsequently, the workforce intangible is amortized over the employment term of three years.

 

The Company recorded amortization expense related to our amortizing intangible assets of approximately $28,000 and $84,522 for the three and nine months ended September 30, 2017 and $90,000 and $243,000 for the three and nine months ended September 30, 2016 respectively, which included the amortization expense of the workforce acquired as stated above.

 

In September, 2017, after evaluating the cost and benefit, Company decided to terminate the service contract with this entire team and therefore Company recognize impairement in the amount of $152,847.

 

(ii) Considering a new mobile app has been developed to be put into market in October 2016, the Company determined that the future cash flows generated from the old mobile app was nil. In accordance with ASC 350, Intangibles – Goodwill and Other, recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to the estimated undiscounted future cash flows expected to be generated by the asset. The Company estimated the fair value of this intangible asset to be nil as of December 31, 2016. Fair value was determined using unobservable (Level 3) inputs. In June, 2017, this intangible asset has been disposed of along with other net assets in Zhong Hai Shi Xun.

 

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Seven Stars Cloud Group, Inc., Its Subsidiaries and Variable Interest Entities
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

(iii) During the fourth quarter of 2016, the Company determined that the Charter/Cooperation agreements will not serve the business or generate future cash flow. As no future cash flows will be generated from the Charter/Cooperation agreements, the Company estimated the fair value of the Charter/Cooperation agreements to be nil as of December 31, 2016. Fair value was determined using unobservable (Level 3) inputs. Impairment loss from Charter/Cooperation agreements of $1,846,000 was recognized in 2016 to write off the entire book value of the Charter/Cooperation agreements. In June, 2017, this intangible asset has been disposed of along with other net assets in Zhong Hai Shi Xun.

 

(iv) During the second quarter of 2017, the Company determined that one of its subsidiaries in the US will not serve the non-core business or generate future cash flow. As no future cash flows will be generated from using the patent owned by this subsidiary, the Company estimated the fair value of those patent to be nil as of June 30, 2017. Fair value was determined using unobservable (Level 3) inputs. Impairment loss from patent of $63,621 was recognized in 2017 to write off the entire book value of the patent.

 

The following table outlines the amortization expense for the next three years and thereafter:

 

   Amortization to be 
Years ending December 31,  Recognized 
2017 (3 months)  $2,517 
2018   10,067 
2019   4,195 
Total amortization to be recognized  $16,779 

 

8.Long Term Investments

 

Cost method investments

 

Cost method investments as of the period ended September 30, 2017 and December 31, 2016 are as follow:

 

   September 30,   December 31, 
   2017   2016 
Topsgame (i)  $3,291,600   $3,156,985 
Frequency (ii)   3,000,000    3,000,000 
DBOT (iii)   250,000     - 
Total  $6,541,600   $6,156,985 

 

(i)Investment in Topsgame

 

On April 13, 2016, SSF entered into a Game Right Assignment Agreement with SSS for the acquisition of certain game IP rights (“Game IP Rights”) for approximately $2.7 million (RMB18 million) in cash. On April 15, 2016, SSF entered into a Capital Increase Agreement with Nanjing Tops Game Co., Ltd. (“Topsgame”) and its shareholders whereby SSF transferred the Game IP Rights acquired from SSS to Topsgame in exchange for 13% of Topsgame’s equity ownership. Topsgame is a PRC company that specializes in the independent development and operation of online, stand-alone and other games as well as the distribution of domestic and overseas games. The Company’s 13% ownership interest does not provide the Company with the right to nor does the Company have representation on the board of directors of Topsgame.

 

The Company has recognized the cost of the investment in Topsgame, which is a private company with no readily determinable fair value, based on the acquisition cost of Game IP Rights of approximately $2.7 million and accounts for the investment by the cost method.

 

On September 14, 2016, SSF increased its investment in Topsgame by RMB3,900,000 (approximately $584,000) and maintained its 13% equity ownership of Topsgame. The investment continued to be accounted for using the cost method.

 

On June 30, 2017, the Company entered into the BT SPA, pursuant to which, Topsgame has been agreed to be sold to BT in the consideration of the fair value of Topsgame which approximates to its carrying book value (appraised by an independent third party). However, considering the payment term is in one year, its collectability is uncertain and required legal transfer process was not completed as of September 30, 2017, Company did not account for this transaction as of September 30, 2017.

 

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Seven Stars Cloud Group, Inc., Its Subsidiaries and Variable Interest Entities
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

(ii)Investment in Frequency

 

In April 2016, the Company and Frequency Networks Inc. (“Frequency”) entered into a Series A Preferred Stock Purchase Agreement (the “SPA”) for the purchase of 8,566,271 shares of Series A Preferred Stock, Frequency (the “Frequency Preferred Stock”) for a total purchase price of $3 million. The 8,566,271 Series A Preferred Stock represent 9% ownership and voting interest on an as converted basis and does not provide the Company with the right to nor does the Company have representation on the board of directors of Frequency.

 

The Frequency Preferred Stock is entitled to non-cumulative dividends at the rate of $0.02548 per share per annum, declared at the discretion of Frequency’s board of directors. The Frequency Preferred Stock is also convertible into shares of Frequency common stock at the Company’s election any time after issuance on a 1:1 basis, subject to certain adjustment. Each share of Frequency Preferred Stock also has a liquidation preference of $0.42467 per share, plus any declared but unpaid dividends.

 

The Company has recognized the cost of the investment in Frequency, which is a private company with no readily determinable fair value, at its cost of $3 million and accounts for the investment by the cost method.

 

There were no identified events or changes in circumstances that may have had a significant adverse effect on the fair value of our cost method investments, accordingly the fair value of our cost method investments are not estimated.

 

(iii)Investment in DBOT

 

In August, 2017, Company made a strategic investment of US$250,000 in the Delaware Board of Trade Holdings, Inc. (“DBOT”) to acquire 187,970 common shares. DBOT is an approved and licensed FINRA- and SEC-regulated electronic trading platform with operations in Delaware. One of our subsidiaries is powered by DBOT’s platform, trading system and technology. The Company accounts for this investment using the cost method, as the Company owns less than 4% of the common shares and the Company has no significant influence over DBOT.

 

Equity method investments

 

Equity method investment movement for the nine months ended on September 30, 2017 is as follow:

 

      September 30, 2017 
      December 31,
2016
   Capital increase   Loss on
investment
   Impairment loss   Foreign currency
translation adjustments
   September 30,
2017
 
Wecast Internet  (i)   132,782    -    (77,210)   -    3,797    59,369 
Hua Cheng  (ii)   364,897    -    (23,258)   -    15,803    357,442 
Shandong Media  (iii)   -    -    -    -    -    - 
Total     $497,679    -   $(100,468)   -   $19,600   $416,811 

 

(i)Investment in Wecast Internet

 

In October 2016, the Company’s subsidiary, YOU On Demand (Asia) Ltd., invested RMB1,000,000 (approximately $149,750) in Wecast Internet Limited (“Wecast Internet”) and held its 50% equity ownership.

 

(ii)Investment in Hua Cheng

 

As of the period ended September 30, 2017 and December 31, 2016, the Company held 39% equity ownership in Hua Cheng, and accounted for the investment by the equity method.

 

(iii)Investment in Shandong Media

 

As of the period ended September 30, 2017 and December 31, 2016, the Company held 30% equity ownership in Shandong Media, and accounts for the investment by the equity method. The investment was fully impaired as of September 30, 2017 and December 31, 2016.

 

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Seven Stars Cloud Group, Inc., Its Subsidiaries and Variable Interest Entities
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

  

9.Stockholders’ Equity

 

On July 6, 2016, the Company entered into a Common Stock Purchase Agreement (the “SSW SPA”) with Seven Stars Works Co., Ltd., a Korea company (“SSW”) and an affiliate of SSS. Pursuant to the terms of the SSW SPA, the Company has agreed to sell and issue 2,272,727 shares of the Company’s common stock for $1.76 per share, or a total purchase price of $4.0 million to SSW. A total of $4.0 million was received and 2,272,727 shares were issued on July 19, 2016.

 

On August 11, 2016, the Company entered into Common Stock Purchase Agreement (the “Harvest SPA”) with Harvest Alternative Investment Opportunities SPC (“Harvest”), a Cayman Islands company. Pursuant to the terms of the Harvest SPA, the Company has agreed to sell and issue 2,272,727 shares of the Company’s common stock, for $1.76 per share, or a total purchase price of $4.0 million to Harvest. A total of $4.0 million was received and 2,272,727 shares were issued on August 12, 2016.

 

On November 11, 2016, the Company entered into Common Stock Purchase Agreement (the “SSSHKCD SPA”) with Sun Seven Stars Hong Kong Cultural Development Limited, a Hong Kong company (“SSSHKCD”) and an affiliate of SSS. Pursuant to the terms of the SSSHKCD SPA, the Company has agreed to sell and issue 1,136,365 shares of the Company’s common stock for $1.76 per share, or a total purchase price of $2.0 million to SSSHKCD. A total of $2.0 million was received and 1,136,365 shares were issued on November 17, 2016.

 

As described in Note 12, the Company and SSS entered into a series of agreements, including an agreement pursuant to which the Company agreed to sell and issue 4,545,455 shares of the Company's common stock and warrants to acquire an additional 1,818,182 shares (at an exercise price of $2.75 per share) for an aggregate purchase price of $10 million to SSS.

 

On May 19, 2017, the Company entered into a subscription agreement with certain investors, including officers, directors and other affiliates of the Company, pursuant to which the Company issued and sold to such investors, in a private placement, an aggregate of 727,273 shares of the common stock of the Company, for $2.75 per share, or a total purchase price of $2.0 million. Investors in the private placement included Lan Yang, the wife of the Company’s Chairman Bruno Wu, and China Telenet Ventures Limited, an entity owned and controlled by Sean Wang, a member of the Company’s Board of Directors. As of July 18, 2017, all subscription amounts have been received by the Company.

 

10.Fair Value Measurements

 

Accounting standards require the categorization of financial assets and liabilities, based on the inputs to the valuation technique, into a three-level fair value hierarchy. The various levels of the fair value hierarchy are described as follows:

 

·Level 1 — Financial assets and liabilities whose values are based on unadjusted quoted market prices for identical assets and liabilities in an active market that we have the ability to access.

 

·Level 2 — Financial assets and liabilities whose values are based on quoted prices in markets that are not active or model inputs that are observable for substantially the full term of the asset or liability.

 

·Level 3 — Financial assets and liabilities whose values are based on prices or valuation techniques that require inputs that are both unobservable and significant to the overall fair value measurement.

 

Accounting standards require the use of observable market data, when available, in making fair value measurements. When inputs used to measure fair value fall within different levels of the hierarchy, the level within which the fair value measurement is categorized is based on the lowest level input that is significant to the fair value measurement.

 

The Company reviews the valuation techniques used to determine if the fair value measurements are still appropriate on an annual basis, and evaluate and adjust the unobservable inputs used in the fair value measurements based on current market conditions and third party information.

 

Common stock is valued at closing price reported on the active market on which the individual securities are traded.

 

The fair value of the warrant liabilities was valued using Monte Carlo Simulation method at the year ended December 31, 2016. All the remaining warrant liabilities have been expired as of August 30, 2017. The following assumptions were incorporated:

 

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Seven Stars Cloud Group, Inc., Its Subsidiaries and Variable Interest Entities
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

   Monte Carlo 
   December 31, 
   2016 
Risk-free interest rate   0.70%
Expected volatility   55%
Expected term   0.67 year 
Expected dividend yield   0%

 

The following tables present the fair value hierarchy for those assets and liabilities measured at fair value on a recurring basis as of December 31, 2016:

 

   December 31, 2016     
   Fair Value Measurements     
   Level 1   Level 2   Level 3   Total Fair Value 
Liabilities                
Warrant liabilities (see Note 13)  $-   $-   $70,785   $70,785 

 

The table below reflects the components effecting the change in fair value for the nine months ended September 30, 2017:

 

   Level 3 Assets and Liabilities     
   For the Nine  Months Ended September 30 , 2017     
    January 1,       Change in   September 30, 
   2017   Settlements   Fair Value   2017 
Liabilities:                
Warrant liabilities (see Note 13)  $70,785   $(183,427)  $112,642   $- 

 

The significant unobservable inputs used in the fair value measurement of the Company’s warrant includes the risk free interest rate, expected volatility, expected term and expected dividend yield. Significant increases or decreases in any of those inputs in isolation would result in a significantly different fair value measurement.

 

The carrying amount of cash, accounts receivable, notes receivable, accounts payable, accrued other expenses, other current liabilities and convertible promissory note as of September 30, 2017 and December 31, 2016, approximate fair value because of the short maturity of these instruments.

 

11.Related Party Transactions

 

(a)$3.0 Million Convertible Note

 

On May 10, 2012, the Executive Chairman and Principal Executive Officer, Mr. Shane McMahon, made a loan to the Company in the amount of $3,000,000. In consideration for the loan, the Company issued a convertible note to Mr. McMahon in the aggregate principal amount of $3,000,000 (the “Note”) at a 4% interest rate computed on the basis of a 365 day year. Upon issuance, the conversion price of the Note was equal to the price per share paid for securities by investors in the most recent financing (as of the date of conversion) of equity or equity-linked securities of the Company.

 

Effective on January 31, 2014, the Company and Mr. McMahon entered into Amendment No. 4 to the Note pursuant to which the Note is at Mr. McMahon’s option, payable on demand or convertible on demand into shares of Series E Preferred Stock of the Company (the “Series E Preferred Stock”) at a conversion price of $1.75, until December 31, 2015. As a result, in 2014, the Company recognized a beneficial conversion feature discount calculated as the difference between the Series E Preferred Stock at its intrinsic value, which was the fair value of the common stock at the commitment date for the Series E Preferred Stock investment and the effective conversion price. As such, we recognized a beneficial conversion feature of approximately $2,126,000 in 2014 which was reflected as interest expense and additional paid-in capital since the note was payable upon demand.

 

Effective December 30, 2014, the Company and Mr. McMahon entered into Amendment No. 5 pursuant to which the maturity date of the Note was extended to December 31, 2016. The Note remains payable on demand or convertible on demand into shares of Series E Preferred Stock at a conversion price of $1.75 at Mr. McMahon’s option.

 

On December 31, 2016, the Company and Mr. McMahon entered into an amendment pursuant to which the Note will be at Mr. McMahon’s option, payable on demand or convertible on demand into shares of the Company’s Series E Preferred Stock, provided that the Note will no longer be convertible into Series E Preferred Stock upon the conversion of the Series E Preferred stock owned by C

 

 22 

 

Seven Stars Cloud Group, Inc., Its Subsidiaries and Variable Interest Entities
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

Media into the Company’s Common Stock (pursuant to which all Series E Preferred Stock will be automatically converted) but then convertible only into Common Stock at a conversion price of $1.50, until December 31, 2018.

 

For the three and nine months ended September 30, 2017, the Company recorded interest expense of $30,247 and $89,753, respectively, related to the Note; For the three and nine months ended September 30, 2016, the Company recorded interest expense of $30,000 and $90,000, respectively, related to the Note. In August, 2017, Company has paid $250,000 interest related to the Note.

 

(b)Cost of Revenue

 

Hua Cheng, in which the Company holds 39% of the equity shares, charged the Company licensed content fees of approximately Nil and $55,000 for the three months ended September 30, 2017 and 2016, and approximately Nil and $148,000 for the nine months ended September 30, 2017 and 2016, respectively.

 

(c)Purchase of Game IP Rights

 

On April 13, 2016, SSF entered into a Game Right Assignment Agreement with SSS for the acquisition of certain Game IP Rights for cash of $2.7 million (RMB 18 million), which was paid in full in 2016. The Game IP Rights was recorded at cost and then subsequently transferred in exchange for the investment in Topsgame as disclosed in Note 8 above.

 

(d)Deposit for Investment in MYP

 

On September 19, 2016, the Company signed a non-binding term sheet with Sun Video Group HK Limited ("SVG") in purchase for its 51% ownership of M.Y. Products, LLC ("MYP"), a video commerce and supply chain management operator, in exchange for $50 million worth of Wecast Network common stock and $800,000 cash.

 

In accordance with the Term Sheet, the Company wired $800,000 (or its RMB equivalent) to MYP upon signing the term sheet as Good Faith Deposit. The transaction has already been closed, and all of the deposit paid to MYP has been transferred into liability due to BT, which is the former shareholder of SVG, and as of September 30, 2017, Company still owed to BT in the amount of $58,567.

 

(e)Assets Disposal to BT

 

On June 30, 2017, the Company entered into a Securities Purchase Agreement (the BT SPA) with BT, pursuant to which the issued and outstanding stock that SSC holds in three separate non-core assets were sold to BT in exchange for RMB100 million (approximately $14.75 million at current exchange rate) in a combination of cash and publicly traded stock to be paid to SSC within one year of closing. A minimum of 20% of the total consideration to SSC will be paid in cash (approximately $2.95 million). A portion of the consideration may be paid in the form of publicly traded stock at the discretion of BT, and in that case the securities will represent a public company affiliated with BT, in an industry related to SSC’s and with an average daily trading value of at least $146,000.

 

These three separate non-core assets that sold to BT included 80% equity interest in Zhong Hai Shi Xun Media for zero, 13% equity interest in Nanjing Tops Game and 25% share capital investment right in Pantaflix JV in consideration of RMB100 million. As Zhong Hai Shi Xun Media is the Company’s subsidiary, sale of a subsidiary to a related party under common control would cause the Company to derecognize the net assets transferred at its carrying amounts and recognize no gains or losses. The difference between proceeds received and the carrying amount of the net assets transferred is recognized in additional paid in capital. At the same time, the Goodwill in the amount of $6.6 million has been pushed down to Zhong Hai Shi Xun Media along with the disposal.

 

Meanwhile, considering the payment term is one year, there is uncertainty with respect to collectability and required legal transfer process of Nanjing Tops Game was not completed, Company did not account for the transaction of disposal of 13% equity interest in Nanjing Tops Game and 25% share capital investment right in Pantaflix JV as of September 30, 2017 until the collectability is reasonably assured.

 

12.SSS Agreements

 

On November 23, 2015, the Company entered into a series of agreements for a strategic investment by SSS, a PRC company in the media and entertainment industry that is controlled by the Company’s Chairman, Bruno Wu. The strategic investment by SSS included a private placement of equity securities of the Company, a content licensing agreement, and the potential for Tianjin Enternet Network Technology Limited (“Tianjin Enternet”), an affiliate of SSS, to earn additional shares of the Company’s common stock contingent on

 

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Seven Stars Cloud Group, Inc., Its Subsidiaries and Variable Interest Entities
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

the performance of SSF. SSF intends to provide a branded pay content service, consumer payments and behavior data analysis service, customer management and data-based service and mobile social TV-based customer management service.

 

On December 21, 2015, the Company entered into an Amended and Restated Securities Purchase Agreement (the “Amended SSS Purchase Agreement”) and a Revised Content License Agreement (the “Revised Content Agreement”) with SSS which amended certain terms of the original agreements dated November 23, 2015. In addition, the Company also entered into an Amended and Restated Share Purchase Agreement (the “Amended Tianjin Agreement”) with Tianjin Enternet.

 

On July 6, 2016, the Company entered into a Common Stock Purchase Agreement with Seven Stars Works Co., Ltd., a Korea company (“SSW”) and an affiliate of SSS for the purchase by SSW of 2,272,727 shares of the Company’s common stock, for $1.76 per share, or a total purchase price of $4.0 million.

 

On November 11, 2016, the Company entered into a Common Stock Purchase Agreement with Sun Seven Stars Hong Kong Cultural Development Limited, a Hong Kong company (“SSSHKCD”) and an affiliate of SSS. Pursuant to the terms of the SPA, the Company has agreed to sell and issue 1,136,365 shares of the Company’s common stock, for $1.76 per share, or a total purchase price of $2.0 million to SSSHKCD.

 

(a)Amended SSS Purchase Agreement

 

On March 28, 2016, pursuant to the Amended SSS Purchase Agreement, the Company sold, and SSS purchased, 4,545,455 shares of the Company’s common stock for a purchase price of $2.20 per share, or an aggregate of $10.0 million. In addition, SSS received a two-year warrant to acquire an additional 1,818,182 shares of the Company’s common stock at an exercise price of $2.75 per share (the “SSS Warrant”). Until receipt of necessary shareholder approvals, the SSS Warrant may not be exercised to the extent that such exercise would result in SSS and its affiliates beneficially owning more than 19.99% of the Company’s outstanding common stock. On June 27, 2016, shareholder approval was obtained.

 

Since the SSS Warrant does not embody any future obligation for the Company to repurchase its own shares, is indexed to the Company’s own stock, may only be settled by the physical delivery of shares, and no conditions exist in which net cash settlement could be forced upon the Company by SSS in any other circumstances, the SSS Warrant is considered an equity classified instrument. The proceeds of $10.0 million, net of issuance cost of approximately $411,000, was allocated to common stock and SSS Warrant based on their relative fair value as of March 28, 2016 of approximately $8,227,000 and $673,000, respectively. Accordingly, the Company recorded approximately $725,000 in additional paid-in capital for the SSS Warrant.

 

(b)Revised Content Agreement

 

On March 28, 2016, pursuant to the Amended and Restated SSS Purchase Agreement, SSS granted the Company non-exclusive royalty-free distribution rights for certain video content value in exchange for a convertible promissory note (the “SSS Note”). The SSS Note has a stated principal amount of approximately $17,718,000, was originally due to mature on May 21, 2016. On May 12, 2016, the Company and SSS entered into an amendment agreement to extend the maturity date of the SSS Note to July 31, 2016. The SSS Note beard an interest at the rate of 0.56% per annum. Immediately upon the receipt of the required shareholder approval to allow SSS to beneficially own more than 19.99% of the Company’s outstanding common stock, which was obtained on June 27, 2016, the SSS Note was converted into 9,208,860 shares of the Company’s common stock.

 

In connection with the issuance of the SSS Note, the Company recorded debt issuance costs of approximately $131,000 which was to be amortized over the period of the SSS Note’s maturity date, of which approximately $123,000 was recognized during the year ended December 31, 2016.

 

The Company measured the effective conversion price of the SSS Note using its carrying value on March 28, 2016 and compared it to the fair value of the Company’s common stock on that date. As the effective conversion price of the SSS Note of $1.91 exceeded the fair value of the Company’s common stock of $1.81, no beneficial conversion feature was recognized.

 

The carrying value of the SSS Note as of June 27, 2016, which included the unamortized issuance costs of $8,000 and, pursuant to the terms of SSS Note, accrued interest expense of $25,000 has been recorded into the common shares issued on June 27, 2016.

 

 24 

  

Seven Stars Cloud Group, Inc., Its Subsidiaries and Variable Interest Entities
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

(c)Amended Tianjin Agreement

 

Pursuant to the Amended Tianjin Agreement dated December 21, 2015, Tianjin Enternet was to contribute 100% of the equity ownership of SSF, a newly-formed subsidiary of Tianjin Enternet to the Company. Contingent on the performance of SSF, Tianjin Enternet was to receive shares of the Company’s common stock over three years, with the exact number not exceeding 5.0 million per year, provided the earn-out provisions for each of the 2016, 2017 and 2018 annual periods (the “Earn-Out Share Award”) was achieved. The earn-out provision for 2016, 2017 and 2018 are either 50.0 million homes/users passed or $4.0 million net income, 100.0 million homes/users passed or $6.0 million net income and 150.0 million homes/users passed or $8.0 million net income, respectively. In the event that the Company has not obtained the required vote from shareholders to issue the earn-out shares to Tianjin Enternet, the Company was required to issue a promissory note with a principal amount equal to the quotient by multiplying 5.0 million by the applicable stock price defined in the agreement.

 

On April 5, 2016, in lieu of Tianjin Enternet contributing 100% of the equity ownership of SSF to the Company, YOD WFOE entered into VIE agreements with SSF and its legal shareholders in order to comply with PRC regulatory requirements on certain industries. SSF is 99% owned by Lan Yang, the spouse of Bruno Zheng Wu, the Company’s Chairman, and 1% owned by Yun Zhu, a Vice President of Wecast Network. By virtue of these VIE agreements; YOD WFOE obtained financial controlling interest in SSF, including the power to direct the activities of SSF, and therefore is the primary beneficiary of SSF. As the control of SSF was transferred to YOD WFOE through both the VIE agreements and physical handover of company documents on April 5, 2016, the transaction was determined to be completed on that date.

 

At the time YOD WFOE obtained control over SSF, SSF had no assets, liabilities, employees or operating activities, nor did it hold any licenses, trade names or other intellectual properties. The Company also did not receive any assets, employees, contracts, sales or distribution systems or intellectual property from Tianjin Enternet in connection with the transaction. Since the acquisition of SSF did not include any input or processes, as defined under ASC 805-10-20, the transaction was not considered a business combination under ASC 805.

 

The earn-out provision was originally based on either the number of home/user pass or the net income of SSF. While the net income was to be measured based on the operations of SSF, the number of home/user pass is measured based on number of home/user pass of SSF’s distributors. Such earn-out provision is based on an index that is not calculated solely by reference to the operations of SSF, which is not considered indexed to the Company’s own shares. Also the earn-out provisions permit cash settlement if the Company cannot issue the earn-out shares. Therefore, the earn-out provision is classified as a liability and measured initially and subsequently at fair value with changes in fair value recognized in earnings at each reporting periods.

 

On June 27, 2016, the Company held its 2016 annual meeting of stockholders and received approval from its stockholders to allow SSS to beneficially own more than 19.99% of the Company’s outstanding common stock. Accordingly, the Earn-Out Share Award became issuable at the time when the earn-out provisions are considered to have been met pursuant to the Amended Tianjin Agreement.

 

On November 10, 2016, the Board of Directors (the “Board”) of SSC held a special meeting. At the recommendation of the Company’s audit committee, the Board determined that it is in the best interests of the Company and the Company’s shareholders to amend the terms of the Earn-Out Share Award to (1) reduce the total Earn-Out Share Award from 15,000,000 shares of Common Stock to 10,000,000 shares of Common Stock and (2) measure the achievement of the earn-out provisions based on the Companywide achievement of homes passed in lieu of the measurement being measured by SFF’s stand-alone achievement of homes passed. Based on evidence provided to the Board, the requisite thresholds necessary to trigger issuance of all shares of Common Stock subject to the Earn-Out Share Award have been achieved. Accordingly, on November 10, 2016, the Board approved the issuance of 10,000,000 shares of its common stock, par value $0.001 per share (“Common Stock to SSS”) and the shares were issued on November 11, 2016.

 

The Company recognized the fair value of the Common Stock to SSS of approximately $13,700,000, based on the market price of the Company’s Common Stock, as Earn-out share award expense in the consolidated statement of operations for the year ended December 31, 2016.

 

13.Warrant Liabilities

 

In connection with our August 30, 2012 private financing, the Company issued 977,063 warrants to investors and the broker. In accordance with ASC 815-40, Contracts in Entity’s Own Equity, the warrants have been accounted as derivative liabilities to be re- measured at the end of every reporting period with the change in fair value reported in the consolidated statement of operations. On August 30, 2012, such warrants were valued at $1,525,000 utilizing a valuation model and were initially recorded as a liability. The fair value of the warrants is remeasured at each reporting period based on the Monte Carlo valuation.

 

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Seven Stars Cloud Group, Inc., Its Subsidiaries and Variable Interest Entities
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

As of December 31, 2016, the warrant liability was revalued as disclosed in Note 10, and recorded at its fair value of approximately $70,785.

 

In 2017, there were 182,534 warrants exercised during nine months ended September 30, 2017, all the remaining 353,716 warrants were expired as of August 30, 2017.

 

14.Share-Based Payments

 

As of September 30, 2017, the Company had 1,845,010 options, 422,085 restricted shares and 3,118,181 warrants outstanding (including the 1,818,182 warrants issued to SSS as disclosed in Note 12 (a) to purchase shares of our common stock.

 

The Company awards common stock and stock options to employees and directors as compensation for their services, and accounts for its stock option awards to employees and directors pursuant to the provisions of ASC 718, Stock Compensation. The fair value of each option award is estimated on the date of grant using the Black-Scholes Merton valuation model. The Company recognizes the fair value of each option as compensation expense ratably using the straight-line attribution method over the service period, which is generally the vesting period.

 

Total share-based payments expense recorded by the Company during the three months and nine months ended September 30, 2017 and 2016 is as follows:

 

   Three Months Ended   Nine Months Ended 
   September 30,   September 30,   September 30,   September 30, 
   2017   2016   2017   2016 
Employees and directors share-based payments  $54,846   $75,000   $202,501   $287,000 

 

Effective as of December 3, 2010, our Board of Directors approved the SSC 2010 Stock Incentive Plan (“the 2010 Plan”) pursuant to which options or other similar securities may be granted. The maximum aggregate number of shares of our common stock that may be issued under the Plan is 4,000,000 shares. As of September 30, 2017, options available for issuance are 1,415,003 shares.

 

(a)Stock Options

 

Stock option activity for the nine months ended September 30, 2017 is summarized as follows:

 

           Weighted Average     
           Remaining   Aggregated 
   Options   Weighted Average   Contractual Life   Intrinsic 
   Outstanding   Exercise Price   (Years)   Value 
Outstanding at January 1, 2017   2,101,425   $2.42    4.59   $- 
Granted   170,000    1.57           
Exercised   (78,211)   1.63           
Expired   (45,662)   2.90           
Forfeited   (302,542)   1.50           
Outstanding at September 30, 2017   1,845,010    2.67    4.46    0.39 
Vested and expected to vest as of September 30, 2017   1,845,010    2.67    4.46    0.39 
Options exercisable at September 30, 2017 (vested)   1,609,196    2.82    3.80    0.36 

  

On January 4, March 1 and March 16, 2017, 90,000, 45,000 and 35,000 shares stock options, respectively, were issued to certain employees for services provided to us. The fair value of the stock options granted were valued using the Black-Scholes Merton method on the grant date, amounting to $61,200, $45,443 and $36,750, respectively.

 

As of September 30, 2017, approximately $220,777 of total unrecognized compensation expense related to non-vested share options is expected to be recognized over a weighted average period of approximately 1.98 years. The total fair value of shares vested during the nine months ended September 30, 2017 and 2016 was approximately $56,765 and $12,000,  respectively. 

 

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Seven Stars Cloud Group, Inc., Its Subsidiaries and Variable Interest Entities
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

(b) Warrants

 

In connection with the Company’s financings, the Warner Brother Agreement and the service agreements, the Company issued warrants to service providers to purchase common stock of the Company.

 

As of September 30, 2017, the weighted average exercise price of the warrants was $2.33 and the weighted average remaining life was 0.81 years. The following table outlines the warrants outstanding and exercisable as of September 30, 2017 and December 31, 2016:

 

   September 30,   December 31,         
   2017   2016         
   Number of   Number of         
   Warrants   Warrants       
Warrants Outstanding  Outstanding and
Exercisable
   Outstanding and
Exercisable
   Exercise
Price
   Expiration
Date
 
                 
2012 August Financing Warrants  (i)   -    536,250   $1.50    08/30/17 
2013 Broker Warrants (Series D Financing)   100,000    228,571    1.75    07/05/18 
2013 Broker Warrants (Convertible Note)   114,285    114,285    1.75    11/04/18 
2014 Broker Warrants (Series E Financing)   1,085,714    1,085,714    1.75    01/31/19 
2016 Warrants to SSS (Note 12)   1,818,182    1,818,182   $2.75    03/28/18 
    3,118,181    3,783,002           

 

(i)The warrants are classified as derivative liabilities as disclosed in Note 13.

 

(c) Restricted Shares

 

In January, 2017, the Company granted 35,000 restricted shares to one employee under the “2010 Plan”. The restricted shares have a vesting period of four years with the first one-fourth vesting on the first anniversary from grant date and the remaining three-fourth vesting ratably over twelve quarters. The grant date fair value of the restricted shares was $43,750. As this employee left the Company in February, no expense was recorded.

 

In March and April, 2017, the Company granted 365,000 restricted shares to certain employees under the “2010 Plan”. The restricted shares have a vesting period of four years with the first one-fourth vesting on the first anniversary from grant date and the remaining three-fourth vesting ratably over twelve quarters. The grant date fair value of the restricted shares was $778,200.

 

A summary of the restricted shares is as follows:

 

   Shares   Weighted-average 
 fair value
 
Restricted shares outstanding at January 1, 2017   228,550   $1.75 
Granted   400,000    2.05 
Forfeited   (95,000)   1.65 
Vested   (111,465)   1.73 
Restricted shares outstanding at September 30, 2017   422,085   $2.07 

 

15.Loss Per Common Share

 

   Three Months Ended   Nine Months Ended 
   September 30,   September 30,   September 30,   September 30, 
   2017   2016   2017   2016 
Net loss attributable to common stockholders  $(3,044,597)  $(2,047,204)  $(4,491,943)  $(5,771,763)
Basic                    
Basic weighted average shares outstanding   62,146,168    41,184,037    59,594,289    31,640,230 
                     
Diluted                    
Diluted weighted average common shares outstanding   62,146,168    41,184,037    59,594,289    31,640,230 
                     
Net loss per share:                    
Basic  $(0.05)  $(0.05)  $(0.08)  $(0.18)
Diluted  $(0.05)  $(0.05)  $(0.08)  $(0.18)

 

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Seven Stars Cloud Group, Inc., Its Subsidiaries and Variable Interest Entities
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

Basic loss per common share attributable to Seven Stars Cloud shareholders is calculated by dividing the net loss attributable to Seven Stars Cloud shareholders by the weighted average number of outstanding common shares during the applicable period.

 

Diluted loss per share is calculated by taking net loss, divided by the diluted weighted average common shares outstanding. Diluted loss per share for the three and nine months ended September 30, 2017 and 2016 both equal to basic loss per share for respective periods because the effect of securities convertible into common shares is anti-dilutive.

 

The following table includes the number of shares that may be dilutive potential common shares in the future. These shares were not included in the computation of diluted loss per share because the effect was either antidilutive or the performance condition was not met.

 

   Three Months Ended   Nine Months Ended 
   September 30,   September 30,   September 30,   September 30, 
   2017   2016   2017   2016 
Warrants   3,118,181    3,783,002    3,118,181    3,783,002 
Options   2,267,095    2,151,428    2,267,095    2,151,428 
Series A Preferred Stock   933,333    933,333    933,333    933,333 
Series E Preferred Stock   -    7,154,997    -    7,154,997 
Convertible promissory note and interest   35,598,447    2,015,812    35,598,447    2,015,812 
Total   41,917,056    16,038,572    41,917,056    16,038,572 

  

16.Income Taxes

 

As of September 30, 2017, the Company had approximately $34.4 million of the U.S domestic cumulative tax loss carryforwards and approximately $15.0 million of the foreign cumulative tax loss carryforwards, which may be available to reduce future income tax liabilities in certain jurisdictions. These U.S. and foreign tax loss carryforwards will expire beginning in 2028 through 2036, and 2018 to 2022, respectively.

 

The income tax expense for the nine months ended September 30, 2017 is nil because of net operating loss and deferred tax assets related to the net operating loss carryovers utilized had been offset by a valuations allowance. Company had established a 100% valuation allowance against its net deferred tax assets due to its history of pre-tax losses and the likelihood that the deferred tax assets will not be realized. The valuation allowance was increased approximately $1.0 million during the nine months ended September 30, 2017.

 

As of September 30, 2017, there are no unrecorded tax benefits which would impact our financial position or our results of operations.

 

17.Contingencies and Commitments

 

(a)Operating Lease Commitment

 

The Company is committed to paying leased property costs related to our offices as follows:

 

   Leased Property 
Years ending December 31,  Costs 
2017(3 months)  $19,711 
2018   70,211 
2019   36,269 
2020   37,147 
Thereafter   18,575 
Total  $181,913 

 

(b)Lawsuits and Legal Proceedings

 

From time to time, we may become involved in various lawsuits and legal proceedings which arise in the ordinary course of business. However, litigation is subject to inherent uncertainties, and an adverse result in these or other matters may arise from time to time that may harm our business. As of September 30, 2017, there are no such legal proceedings or claims that we believe will have a material adverse effect on our business, financial condition or operating results.

 

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Seven Stars Cloud Group, Inc., Its Subsidiaries and Variable Interest Entities
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

18.Concentration, Credit and Other Risks

 

(a)PRC Regulations

 

The PRC market in which the Company operates poses certain macro-economic and regulatory risks and uncertainties. These uncertainties extend to the ability of the Company to conduct wireless telecommunication services through contractual arrangements in the PRC since the industry remains highly regulated. The Company conducts legacy YOD business in China through Zhong Hai Media, which the Company controls as a result of a series of contractual arrangements entered among YOD WFOE, Sinotop Beijing as the parent company of Zhong Hai Media, SSF and the respective legal shareholders of Sinotop Beijing and SSF. The Company believes that these contractual arrangements are in compliance with PRC law and are legally enforceable. If Sinotop Beijing, SSF or their respective legal shareholders fail to perform the obligations under the contractual arrangements or any dispute relating to these contracts remains unresolved, YOD WFOE or YOD HK can enforce its rights under the VIE contracts through PRC law and courts. However, uncertainties in the PRC legal system could limit the Company’s ability to enforce these contractual arrangements. In particular, the interpretation and enforcement of these laws, rules and regulations involve uncertainties. If YOD WFOE had direct ownership of Sinotop Beijing and SSF, it would be able to exercise its rights as a shareholder to effect changes in the board of directors of Sinotop Beijing or SSF, which in turn could effect changes at the management level, subject to any applicable fiduciary obligations. However, under the current contractual arrangements, the Company relies on Sinotop Beijing, SSF and their respective legal shareholders to perform their contractual obligations to exercise effective control. The Company also gives no assurance that PRC government authorities will not take a view in the future that is contrary to the opinion of the Company. If the current ownership structure of the Company and its contractual arrangements with the VIEs and their equity holders were found to be in violation of any existing or future PRC laws or regulations, the Company's ability to conduct its business could be affected and the Company may be required to restructure its ownership structure and operations in the PRC to comply with the changes in the PRC laws which may result in deconsolidation of the VIEs.

 

In addition, the telecommunications, information and media industries remain highly regulated. Restrictions are currently in place and are unclear with respect to which segments of these industries foreign owned entities, like YOD WFOE, may operate. The PRC government may issue from time to time new laws or new interpretations on existing laws to regulate areas such as telecommunications, information and media, some of which are not published on a timely basis or may have retroactive effect. For example, there is substantial uncertainty regarding the Draft Foreign Investment Law, including, among others, what the actual content of the law will be as well as the adoption and effective date of the final form of the law. Administrative and court proceedings in China may also be protracted, resulting in substantial costs and diversion of resources and management attention. While such uncertainty exists, the Company cannot assure that the new laws, when it is adopted and becomes effective, and potential related administrative proceedings will not have a material and adverse effect on the Company's ability to control the affiliated entities through the contractual arrangements. Regulatory risk also encompasses the interpretation by the tax authorities of current tax laws, and the Company’s legal structure and scope of operations in the PRC, which could be subject to further restrictions resulting in limitations on the Company’s ability to conduct business in the PRC.

 

(b)Major Customers

 

Legacy YOD business

 

The Company has agreements with distribution partners, including digital cable operators, IPTV operators, OTT streaming operators and mobile smartphone manufacturers and operator. A distribution partner that individually generates more than 10% of the Company’s revenue is considered a major customer.

 

On October 8, 2016, the Company signed an agreement to form a partnership with Zhejiang Yanhua ("Yanhua Agreement"), where Yanhua will act as the exclusive distribution operator (within the territory of the People's Republic of China) of SSC's licensed library of major studio films. According to the Yanhua Agreement, the existing legacy Hollywood studio paid contents as well as other IP contents specified in the agreement, along with the corresponding authorized rights letter that SSC is entitled to, will be turned over to Yanhua as a whole package, which was agreed to be priced at RMB13,000,000. In addition to the above-mentioned minimal guarantee fee of RMB13,000,000 specified, there is a provision in the Yanhua Agreement which states that once the revenue recognized from the existing contents transferred from SSC to Yanhua reaches the amount of RMB13,000,000, the revenue above RMB13,000,000 will be shared with SSC from the date when this revenue threshold is reached based on certain revenue-sharing mechanism stipulated in the Yanhua Agreement.

 

Pursuant to ASC Subtopic 926-605, Entertainment-Films - Revenue Recognition, for certain contracts that involve sub-licensing content within the specified license period, revenue is recognized upon delivery of films when the arrangement includes a nonrefundable minimum guarantee, delivery is complete and there are no substantive future obligations to provide future additional services.

 

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Seven Stars Cloud Group, Inc., Its Subsidiaries and Variable Interest Entities
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

According to the Yanhua Agreement, the total price of the Existing Contents to be transferred is RMB13,000,000. The payment is agreed to be paid in two installments, the first half of RMB6,500,000 was received on December 30, 2016. The remaining RMB6,500,000 will be paid under the scenario that the license content fees due to Studios for the existing legacy Hollywood paid contents will be settled. Due to the fact that the second installment will depend upon some future events and is contingent in nature, we deem this portion of the fee is not fixed or determinable and therefore, this portion of the revenue did not meet the revenue recognition criteria to be recognized accordingly.

 

Pursuant to the Yanhua Agreement, RMB6,500,000 was recognized as revenue in the first three months ended March 31, 2017 based on the relative fair value of licensed content delivered to Yanhua.

 

In terms of the additional revenue-sharing fee over the above-mentioned RMB13,000,000 fee specified, considering that this part of arrangement fee is not fixed or determinable at the time point as of September 30, 2017, it has not met the criteria for revenue recognition, management will recognize it once it becomes determinable and meet the other revenue recognition criteria in the future.

  

For the nine months ended September 30, 2016, three customers individually accounted for 31%, 16% and 13% of the Company’s revenue. Three customers individually accounted for 33%, 14% and 12% of the Company’s net accounts receivables as of September 30, 2016.

 

Wecast Services

 

The holdings and businesses from Company’s two acquisitions in January 2017 (Note 4) now reside under “Wecast Services”, our wholly-owned subsidiary Wecast Services Group Limited. Wecast Services (which resides under the Product Sales Cloud) is currently primarily engaged with consumer electronics and smart supply chain management operations. The Company’s ending customers include British Telecom, Micromax and about 15 to 20 other corporations across the world.

 

For the nine months ended September 30, 2017, three customers individually accounted for more than 10% of the Company’s revenue. Three customers individually accounted for more than 10% of the Company’s net accounts receivables as of September 30, 2017, respectively.

 

(c) Major Suppliers

 

Legacy YOD business

 

The Company relies on agreements with studio content partners to acquire video contents. A content partner that accounts for more than 10% of the Company’s cost of revenues is considered a major supplier.

 

As of December 31, 2016, all licensed contents have been recognized as cost of revenues other than the ones that acquired from SSS in the amount of $17.7 million (note 12).

 

For the nine months ended September 30, 2016, four suppliers individually accounted for more than 10% of the Company’s cost of revenues. Two suppliers individually accounted for 10% of the Company’s accounts payable as of September 30, 2016.

 

Wecast Services

 

The Company relies on agreements with consumer electronics manufacturers to provide integrated circuit, printed circuit board assembly and other necessary assembly.

 

For the nine months ended September 30, 2017, five suppliers individually accounted for more than 10% of the Company’s cost of revenues. Three suppliers individually accounted for more than 10% of the Company’s accounts payable as of September 30, 2017.

 

(d)Concentration of Credit Risks

 

Financial instruments that potentially subject the Company to significant concentration of credit risk primarily consist of cash and accounts receivable. As of September 30, 2017 and December 31, 2016, the Company’s cash was held by financial institutions located in the PRC, Hong Kong and the United States that management believes have acceptable credit. Accounts receivable are typically unsecured and are mainly derived from revenues from the Company’s VOD content distribution partners, and smart sales products to

 

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Seven Stars Cloud Group, Inc., Its Subsidiaries and Variable Interest Entities
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

customers. The risk with respect to accounts receivable is mitigated by regular credit evaluations that the Company performs on its distribution partners and its ongoing monitoring of outstanding balances.

 

(e) Foreign Currency Risks

 

A majority of the Company’s operating transactions are denominated in RMB and a significant portion of the Company’s assets and liabilities is denominated in RMB. RMB is not freely convertible into foreign currencies. The value of the RMB is subject to changes in the central government policies and to international economic and political developments. In the PRC, certain foreign exchange transactions are required by laws to be transacted only by authorized financial institutions at exchange rates set by the People’s Bank of China (“PBOC”). Remittances in currencies other than RMB by the Company in China must be processed through PBOC or other China foreign exchange regulatory bodies which require certain supporting documentation in order to complete the remittance.

 

Cash consist of cash on hand and demand deposits at banks, which are unrestricted as to withdrawal.

 

Time deposits, which mature within one year as of the balance sheet date, represent interest-bearing certificates of deposit with an initial term of greater than three months when purchased. Time deposits which mature over one year as of the balance sheet date are included in non-current assets.

 

Cash and time deposits maintained at banks consist of the following:

 

   September 30,   December 31, 
    2017     2016 
RMB denominated bank deposits with financial institutions in the PRC  $1,431,601    1,566,107 
US dollar denominated bank deposits with financial institutions in the PRC  $19,227    670,951 
HKD denominated bank deposits with financial institutions in Hong Kong Special Administrative Region (“HK SAR”)  $47,723    14,151 
US dollar denominated bank deposits with financial institutions in Hong Kong Special Administrative Region (“HK SAR”)  $117,528    1,402,842 
US dollar denominated bank deposits with financial institutions in The United States of America (“USA”)  $56,975    95,030 

 

As of September 30, 2017 and December 31, 2016 deposits of $407,903 and $384,545 were insured, respectively. To limit exposure to credit risk relating to bank deposits, the Company primarily places bank deposits only with large financial institutions in the PRC, HK SAR, USA and Cayman with acceptable credit rating.

 

19.Defined Contribution Plan

 

For our U.S. employees, during 2011, the Company began sponsoring a 401(k) defined contribution plan ("401(k) Plan") that provides for a 100% employer matching contribution of the first 3% and a 50% employer matching contribution of each additional percent contributed by an employee up to 4% of each employee’s pay. Employees become fully vested in employer matching contributions after six months of employment. Company 401(k) matching contributions were approximately approximately $3,980 and $6,526 for the three and nine months ended September 30, 2017 respectively and $1,000 and $3,000 for the three and nine months ended September 30, 2016 respectively.

 

Full time employees in the PRC participate in a government-mandated defined contribution plan pursuant to which certain pension benefits, medical care, unemployment insurance, employee housing fund and other welfare benefits are provided to employees. PRC labor regulations require the Company to make contributions based on certain percentages of the employees’ basic salaries. Other than such contributions, there is no further obligation under these plans. The total contribution for such PRC employee benefits was $274,049 and $387,560 for the nine months ended September 30, 2017 and 2016, respectively.

 

20.Segment Reporting

 

The Company’s chief operating decision maker has been identified as the chief executive officer, who reviews consolidated results when making decisions about allocating resources and assessing performance of the Company. In fiscal year 2016, the Company operated and reported its performance in one segment. However, starting from fiscal year 2017, since Company has acquired Wecast Services Limited and Wide Angle Group Limited in January (see note 4), the Company has operated two segments based on different clouds that major business resides in, including Legacy YOD segment and Wecast Service segment. Therefore, there are two reportable segments for the nine months ended September 30, 2017. The two reportable segments are: 

 

Legacy YOD - Provides premium content and integrated value-added service solutions for the delivery of VOD and paid video programming to digital cable providers, Internet Protocol Television (“IPTV”) providers. The core revenues are being generated from

 

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Seven Stars Cloud Group, Inc., Its Subsidiaries and Variable Interest Entities
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

both minimum guarantee payments and revenue sharing arrangements with distribution partners as well as subscription or transactional fees from subscribers.

 

Wecast Services - Wecast Services (which resides under the Product Sales Cloud) is currently primarily engaged with consumer electronics and smart supply chain management operations.

 

Segment disclosures are on a performance basis consistent with internal management reporting. The Company does not allocate expenses below segment gross profit since these segments share the same executive team, office space, occupancy expenses, information technology infrastructures, human resources and finance department. The following tables summarized the Company’s revenue and cost generated from different revenue streams.

 

   Nine Months Ended 
   September 30,   September 30, 
   2017   2016 
NET SALES TO EXTERNAL CUSTOMERS          
-Legacy YOD  $794,273   $4,377,034 
-Wecast Services   105,918,155    - 
Net sales   106,712,428    4,377,034 
GROSS PROFIT          
-Legacy YOD   31,659    1,767,059 
-Wecast Services   5,791,805    - 
Gross profit   5,823,464    1,767,059 

 

   September 30,   December 31, 
   2017   2016 
TOTAL ASSETS          
-Legacy YOD  $26,377,184   $36,975,911 
-Wecast Services   46,125,371    14,448,702 
-Unallocated assets   4,036,369    4,321,677 
-Intersegment elimination   (4,981,342)   - 
Total   71,557,582    55,746,290 

 

21.Subsequent Event

 

On October 17, 2017, Wecast Services Group Limited (“Wecast”), a wholly owned subsidiary of the Company, entered into a Technical License Agreement with Guangxi Dragon Coin Network Technology Co., Ltd. (“Guangxi”), pursuant to which Wecast has agreed to provide Guangxi with a non-exclusive agreement to license the technology platform from Wecast’s Red Coin Chain. Pursuant to the terms of the License Agreement, Guangxi, a subsidiary of Courage Investment Group Limited (1145.HK) (“Courage Investment Group”), will be granted a non-exclusive license from Wecast and the Red Coin Chain (“Red Coin”), to use Red Coin’s technology platform specifically and exclusively for real estate based securitization. In exchange and in consideration for, the non-exclusive rights to the technology, the Company will receive 17.9% of the existing total equity of Courage Investment Group, which is Guangxi’s Hong Kong listed parent company.

 

On October 23, 2017, the Company entered into a Securities Purchase Agreement with Hong Kong Guo Yuan Group Capital Holdings Limited. Pursuant to the terms of the agreement, the Company has agreed to sell and issue 5,494,505 shares of the Company’s common stock to the Hong Kong Guo Yuan Group Capital Holdings Limited for $1.82 per share, or a total purchase price of $10.0 million.

 

On November 9, 2017, the Board of Directors approved Amendment No. 7 to $3.0 million Convertible Promissory Notes (“Note”) issued to Mr. Shane McMahon, our Vice Chairman, pursuant to which the maturity date of the Note was extended to December 31, 2019. The Note remains payable on demand or convertible on demand into Common Stock at a conversion price of $1.50.

 

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Cautionary Note Regarding Forward Looking Statements

 

This Form 10-Q contains “forward-looking” statements that involve risks and uncertainties. You can identify these statements by the use of forward-looking words such as "may", "will", "expect", "anticipate", "estimate", "believe", "continue", or other similar words. You should read statements that contain these words carefully because they discuss our future expectations, contain projections of our future results of operations or financial condition or state other "forward-looking" information. We believe that it is important to communicate our future expectations to our investors. These forward-looking statements are not, however, guarantees of future performance and actual results may differ materially from the expectations that are expressed, implied or forecasted in any such forward-looking statements. There may be events in the future that we are unable to accurately predict or control, including weather conditions and other natural disasters which may affect demand for our products, and the product–development and marketing efforts of our competitors. Examples of these events are more fully described in the Company’s 2016 Annual Report under Part I. Item 1A. Risk Factors.

 

Unless required by law, the Company undertakes no obligation to update publicly any forward-looking statements, whether as a result of new information, future events or otherwise. Readers should carefully review the reports and documents the Company files from time to time with the SEC, particularly its Quarterly Reports on Form 10-Q, Annual Report on Form 10-K , Current Reports on Form 8-K and all amendments to those reports.

 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

 

The following management’s discussion and analysis should be read in conjunction with our financial statements and the notes thereto and the other financial information appearing elsewhere in this report. In addition to historical information, the following discussion contains certain forward-looking information. See “Cautionary Note Regarding Forward Looking Statements” above for certain information concerning those forward-looking statements.

 

Overview

 

Seven Stars Cloud Group, Inc. (NASDAQ: SSC) is aiming to become a global leader in providing next-generation Artificial-Intelligent (AI) & Fintech Powered, Supply Chain + Digital Finance Solutions. SSC’s innovative model helps businesses enhance and unlock operational and capital value from both the supply chain and real assets. In addition, SSC offers a closed trade ecosystem for buyers and sellers designed to eliminate transactional middlemen and create a more direct and margin-expanding path for principals. There are three engines that drive our business platform: 1. Intelligent Supply Chain Management; 2. Asset Based Securitization and Tokenization Issuance and Trading Platform and 3. Digital Index and Financial Derivatives Issuance and Trading Platform; All three engines are supported by “ABCD” Technology & Infrastructure (A: Artificial IntelligenceI, B: Blockchain, C: Cloud Computing, D: Data).

 

SSC launched its legacy VOD service through the acquisition of YOD Hong Kong (formerly Sinotop Group Limited) on July 30, 2010, through its subsidiary China CB Cayman. Through a series of contractual arrangements, YOD WFOE, the subsidiary of YOD Hong Kong, controls Sinotop Beijing, a corporation established in the PRC. Sinotop Beijing was the 80% owner of Zhong Hai Media until June 30, 2017, through which we provided: 1) integrated value–added business–to–business (“B2B”) service solutions for the delivery of VOD and enhanced premium content for digital cable; 2) integrated value–added business–to–business–to–customer (“B2B2C”) service solutions for the delivery of VOD and enhanced premium content for IPTV and OTT providers and; 3) a direct to user, or B2C, mobile video service app. The detail of the disposal of Zhong Hai Media has been disclosed in Note 11.

 

On October 8, 2016, the Company signed an agreement to form a partnership with Zhejiang Yanhua ("Yanhua Agreement"), where Yanhua will act as the exclusive distribution operator (within the territory of the PRC) of the Company's licensed library of major studio films. According to the Yanhua Agreement, the existing legacy Hollywood pay-per-view contents as well as other IP contents specified in the agreement, along with the corresponding authorized rights letter that the Company is entitled to, will be transferred to Yanhua as a whole package for a minimum guarantee fee of RMB 13,000,000. In addition to the minimal guarantee fee of RMB 13,000,000, a provision in the Yanhua Agreement states that revenue recognized from the existing content transferred from the Company to Yanhua in excess of RMB 13,000,000, will be shared with the Company from the date when this revenue threshold is reached based on a certain revenue-sharing mechanism stipulated in the Yanhua Agreement.

 

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On January 30, 2017, the Company entered into a Securities Purchase Agreement (the “Sun Video SPA”) with BT Capital Global Limited which has been controlled by Company’s chairman Bruno Wu, for the purchase by us of all of the outstanding capital stock of Sun Video Group Hong Kong Limited. On January 31, 2017, the Company entered into another Securities Purchase Agreement (the “Wide Angle SPA”) with BT and Sun Seven Stars Media Group Limited, one of the Company’s largest shareholders, controlled by Mr. Wu, as guarantor, for the purchase by us of 55% of the outstanding capital stock of Wide Angle. After acquiring these two entities, other than our legacy YOD business, we are also engaged with consumer electronics and smart hand held device design and supply chain management business.

 

On June 30, 2017, Company entered into another Securities Purchase Agreement (the “BT SPA”) with BT, pursuant to which the issued and outstanding stock that SSC holds in three separate non-core assets were sold to BT in exchange for RMB100 million (approximately $14.75 million at current exchange rate) in a combination of cash and publicly traded stock to be paid to SSC within one year of closing. A minimum of 20% of the total consideration to SSC will be paid in cash (approximately $2.95 million). A portion of the consideration may be paid in the form of publicly traded stock at the discretion of BT, and in that case the securities will represent a public company affiliated with BT, in an industry related to SSC’s and with an average daily trading value of at least $146,000.

 

Principal Factors Affecting Our Financial Performance

 

The Company is in the process of transforming its business model and aims to be be a leading Intelligent Industrial Internet (3I) platform, creating a fintech-powered, supply chain solution simplified for commercial enterprises. There are two engines that drive its business platform; (1) VPaaS + TPaaS - Supply Chain Management for key industry sectors and leaders including but not limited to Big Commodities, Cross-Border Trade, Consumer Electronics & Energy; and (2) Digital Finance Solutions - Supply Chain Finance underwritten by its Global Cornerstone Funds and ABS, Tokenization and Exchange Platforms, which include FINRA and SEC-regulated: Index Exchanges, Initial Coin Offering / Tokenization, ETFs and Derivatives. Both Engines and their various arms will run on 'BASE' technology and infrastructure (Blockchain, Artificial Intelligence, Supply Chain & Exchanges) to power a closed trade ecosystem for buyers and sellers designed to eliminate transactional middlemen and create a more direct and margin-expanding path for principals. In connection with this transformation, the Company has recently assembled a new experienced management team, stabilized the foundation, capitalized and rebranded the Company, reconfigured the business structure, expanded the Company’s mission and business lines, made several key investments and finally, injected several privately held and revenue producing assets into the corporation. It is uncertain whether these efforts will prove beneficial or whether we will be able to develop the necessary business models, infrastructure and systems to support the business. This includes having or hiring the right talent to execute our business strategy. Market acceptance of new product and service offerings will be dependent in part on our ability to include functionality and usability that address customer requirements, and optimally price our products and services to meet customer demand and cover our costs.

 

Taxation

 

United States

 

Seven Stars Cloud Group, Inc. and M. Y. Products, LLC are subject to United States tax. No provision for income taxes in the United States has been made as neither company had taxable profit in the United States since inception.

 

Cayman Islands and the British Virgin Islands

 

Under current laws of the Cayman Islands and the British Virgin Islands, we are not subject to tax on our income or capital gains. In addition, dividend payments are not subject to withholding tax in the Cayman Islands or British Virgin Islands.

 

Hong Kong

 

Our subsidiaries incorporated in Hong Kong are under the current laws of Hong Kong, are subject to Profits Tax of 16.5%. No provision for Hong Kong Profits Tax has been made as net operating loss carryovers offset current taxable income.

 

The People’s Republic of China (“PRC”)

 

Under the PRC’s Enterprise Income Tax Law, our Chinese subsidiaries and VIEs are subject to an earned income tax of 25.0%.

 

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Our future effective income tax rate depends on various factors, such as tax legislation, the geographic composition of our pre-tax income and non-tax deductible expenses incurred. Our management carefully monitors these legislative developments to determine if there will be any change in the statutory income tax rate.

 

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Consolidated Results of Operations

 

Comparison of Three Months Ended September 30, 2017 and 2016

 

   Three Months Ended         
   September 30, 2017   September 30, 2016   Amount Change   % Change 
Revenue  $30,223,638   $1,626,844   $28,596,794    1758%
Cost of revenue   28,273,862    893,796    27,380,066    3063%
Gross profit   1,949,776    733,048    1,216,728    166%
                     
Operating expense:                    
Selling, general and administrative expenses expenses   3,630,949    2,320,247    1,310,702    56%
Research and development expenses   400,040    -    400,040    100%
Professional fees   831,039    326,353    504,686    155%
Impairment of other intangible assets   152,847    172,064    (19,217)   (11%)
Depreciation and amortization   36,508    123,502    (86,994)   (70%)
                     
Total operating expense   5,051,383    2,942,166    2,109,217    72%
                     
Loss from operations   (3,101,607)   (2,209,118)   (892,489)   40%
Interest expense, net   (27,186)   (24,971)   (2,215)   9%
Change in fair value of warrant liabilities   131,357    58,220    73,137    126%
Equity in loss of equity method investees   (23,632)   17,487    (41,119)   (235%)
Others   (806)   (3,313)   2,507    (76%)
                     
Loss before income taxes   (3,021,874)   (2,161,695)   (860,179)   40%
                     
Income tax benefit   -    8,612    (8,612)   (100%)
                     
Net loss   (3,021,874)   (2,153,083)   (868,791)   40%
                     
Net loss (income) attributable to non-controlling interest   (22,723)   105,879    (128,602)   (121%)
                     
Net loss attributable to Seven Stars Cloud Group, Inc. shareholders  $(3,044,597)  $(2,047,204)  $(997,393)   49%

 

Revenues

 

1>OTT, Mobile App, IPTV and Digital Cable VOD Businesses (Legacy YOD)

Provides premium content and integrated value-added service solutions for the delivery of VOD and paid video programming to digital cable providers, Internet Protocol Television (“IPTV”) providers. The core revenues are being generated from both minimum guarantee payments and revenue sharing arrangements with distribution partners as well as subscription or transactional fees from subscribers.

 

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2> Wecast Services

On January 30, 2017, the Company completed the acquisition of Sun Video Group HK Limited ("SVG"), which has a 51% ownership stake in Shanghai Wecast Supply Chain Management Limited ("Wecast SH"). On January 31, 2017, the Company acquired 55% of the outstanding capital stock of Wide Angle Group Limited (“Wide Angle”). The holdings and businesses from both these acquisitions now reside under “Wecast Services”, our wholly-owned subsidiary Wecast Services Limited. Wecast Services (which resides under the Product Sales Cloud) business unit, is currently primarily engaged with consumer electronics and smart supply chain management operations. Our end customers include British Telecom, Micromax and about 15 to 20 other corporations across the world.

 

   2017Q3   2016Q3   Difference 
   USD   USD   USD   % 
Legacy YOD   -    1,626,844    (1,626,844)   (100%)
Wecast Services   30,223,638    -    30,223,638    100%
Total   30,223,638    1,626,844    28,596,794    1758%

 

Revenue for the three months ended September 30, 2017 was $30.2 million as compared to $1.6 million for the same period in 2016, an increase of approximately $28.6 million, or 1,758%. The increase was mainly due to our new business line acquired in January 2017. This increase was partially offset by a decrease of our legacy YOD business in the amount of $1.6 million, as the legacy YOD business shifts to a new exclusive distribution agreement with Zhejiang Yanhua Culture Media Co., Ltd. ("Yanhua ") which was announced in Q4 2016. As revenue generated by Yanhua did not exceed the revenue sharing threshold, no additional revenue was recorded in the quarter ended September 30, 2017.

 

Cost of revenues

 

   2017Q3    2016Q3   Difference 
    USD     USD    USD    % 
 Legacy YOD   -     893,796    (893,796)   (100%)
Wecast Services   28,273,862     -    28,273,862    100%
 Total   28,273,862     893,796    27,380,066    3063%

 

Cost of revenues was approximately $28.3 million for the three months ended September 30, 2017, as compared to $0.9 million for the three months ended September 30, 2016. Our cost of revenues increased by $27.4 million which is in line with our increase in revenues. Our cost of revenues is primarily comprised of cost to purchase electronics products from suppliers.

 

Gross profit

 

    2017 Q3     2016Q3   Difference 
    USD     USD    USD    % 
 Legacy YOD   -     733,048    (733,048)   (100%)
Wecast Services   1,949,776     -    1,949,776    100%
 Total   1,949,776     733,048    1,216,728    166%

 

Gross profit ratio for the three months ended September 30, 2017 decreased by 38.61% from 45.06% to 6.45%, as the Wecast Services business, which currently is engaged mostly in lower margin electronics, is still in its relative infancy and the business service offerings as well as profit-sharing arrangements with a growing range of suppliers are in transition.

 

Selling, general and administrative expenses

 

Selling, general and administrative expense for the three months ended September 30, 2017 was $3.6 million as compared to $2.3 million for the same period in 2016, an increase of approximately $1.3 million or 56%. The majority of the increase was due to 1) the increase of our sales and marketing expense to introduce and promote our business models to various potential investors and business partners, as well as promote Wecast Services, which was acquired in January, 2017; and 2) financial advisory expenses that were paid to independent professional financial advisory companies to assist us being able to contact and negotiate with more business partners. The Company is also continuing to focus on more cost saving activities to reduce daily operating expenses. 

 

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Professional fees

 

Professional fees for the three months ended September 30, 2017 were $0.8 million as compared to $0.3 million for the same period in 2016, an increase of approximately $0.5 million. The increase in professional fees was mainly caused by the legal, valuation and auditing service fees incurred for three months ended September 30, 2017 in relation to the acquisitions in January 2017 and increased audit service fees charged by our external auditor for the opening audit due to our auditor change in 2017.

 

Change in fair value of warrant liabilities

 

Certain of our warrants are recognized as derivative liabilities and re-measured at the end of every reporting period and upon settlement, with the change in value reported in the statement of operations. We reported a gain of approximately $0.13 million and a gain of approximately $0.06 million for the three months ended September 30, 2017 and 2016, respectively. The changes are primarily due to expiration of all remaining warrant liability in August, 2017.

 

Income tax expenses

 

The income tax expense for the three months ended September 30, 2017 is nil because net operating loss carryovers offset current taxable income and deferred tax assets related to the net operating loss carryovers utilized had been offset by a valuation allowance.

 

Net loss attributable to non-controlling interest

 

Hua Cheng previously had a 20% non-controlling interest in Zhong Hai Media and accounting for that interest under the equity method by recording 20% of the operating losses of Zhong Hai Media. For the three months ended September 30, 2016, operating loss attributable to Hua Cheng was approximately $0.1 million. The Company sold Zhong Hai Media on June 30, 2017 and no more such allocation since then.

 

Dillon Yu has a 49% non-controlling interest in Shanghai Wecast Supply Chain Management Limited (“Wecast SH”) and as such we allocate 49% of the operating loss of Wecast SH to Dillon Yu. During the three months ended September 30, 2017, approximately $0.01 million of our operating loss from Wecast SH was allocated to Dillon Yu, which was nil in the same period in 2016.

 

Swiss Guorong Limited has a 45% non-controlling interest in Wide Angle and as such we allocate 45% of the operating profit of Wide Angle to Swiss Guorong Limited. During the three months ended September 30, 2017, approximately $0.03 million of our operating income from Wide Angle was allocated to Swiss Guorong Limited, which was nil for the same period in 2016.

 

Comparison of Nine Months Ended September 30, 2017 and 2016

 

   Nine Months Ended         
   September 30, 2017   September 30, 2016   Amount Change   % Change 
Revenue  $106,712,428   $4,377,034   $102,335,394    2338%
Cost of revenue   100,888,964    2,609,975    98,278,989    3766%
Gross profit   5,823,464    1,767,059    4,056,405    230%
                     
Operating expense:                    
Selling, general and administrative expenses expenses   7,771,561    6,294,206    1,477,355    23%
Research and development expenses   400,040    -    400,040    100%
Professional fees   1,845,590    964,290    881,300    91%
Impairment of other intangible assets   216,468    172,064    44,404    26%
Depreciation and amortization   293,661    344,308    (50,647)   (15%)
                     
Total operating expense   10,527,320    7,774,868    2,752,452    35%
                     
Loss from operations   (4,703,856)   (6,007,809)   1,303,953    (22%)
Interest expense, net   (72,439)   (225,154)   152,715    (68%)
Change in fair value of warrant liabilities   (112,642)   201,826    (314,468)   (156%)
Equity in loss of equity method investees   (100,468)   (19,862)   (80,606)   406%
Others   (111,448)   (8,409)   (103,039)   1225%
                     
Loss before income taxes   (5,100,853)   (6,059,408)   958,555    (16%)
                     
Income tax benefit   -    25,836    (25,836)   (100%)
                     
Net loss   (5,100,853)   (6,033,572)   932,719    (15%)
                     
Net loss attributable to non-controlling interest   608,910    261,809    347,101    133%
                     
Net loss attributable to Seven Stars Cloud Group, Inc. shareholders  $(4,491,943)  $(5,771,763)  $1,279,820    (22%)

 

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Revenues

   YTD 2017Q3   YTD 2016Q3   Difference 
   USD   USD   USD   % 
Legacy YOD   794,273    4,377,034    (3,582,761)   (82%)
Wecast Services   105,918,155    -    105,918,155    100%
Total   106,712,428    4,377,034    102,335,394    2338%

 

Revenue for the nine months ended September 30, 2017 was approximately $106.7 million, as compared to $4.4 million for the same period in 2016. The increase in revenue of approximately $102.3 million was attributable to the new consumer electronics business line acquired in January 2017, and to a lesser extent, one-time consulting services that we provided to certain customers. These revenues were partially offset by the decrease of our legacy YOD business, which is in line with our business strategy transition.

 

Gross profit

 

   2017 1-9   2016 1-9   Diff 
   USD   USD   USD   % 
Legacy YOD   31,659    1,767,059    (1,735,400)   (98%)
Wecast Services   5,791,805    -    5,791,805    100%
Total   5,823,464    1,767,059    4,056,405    230%

 

Our gross profit for the nine months ended September 30, 2017 was approximately $5.8 million, as compared to $1.8 million during the same period in 2016. Gross profit ratio for the six months ended September 30, 2017 was 5.5%, a decrease from 40.4%, as the Wecast Services business, which currently is engaged mostly in lower margin electronics, is still in its relative infancy and the business service offerings as well as profit-sharing arrangements with a growing range of suppliers are in transition.

 

Selling, general and administrative expenses

 

Our selling, general and administrative expenses for the nine months ended September 30, 2017 increased approximately $1.5 million, or 23%, as compared with the amount for the nine months ended September 30, 2016.

 

The  majority of the increase was due to 1) the increase of our sales and marketing expense to introduce and promote of our business models to various potential investors and business partners, as well as to promote Wecast Services business; and 2) financial advisory expenses that were paid to independent professional companies to assist us in being able to contact and negotiate with more business partners.

 

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Professional fees

 

Professional fees are generally related to public company reporting and governance expenses as well as legal fees related to business transition and expansion. Our costs for professional fees increased approximately $0.9 million, or 91%, to $1.8 million for the nine months ended September 30, 2017, for the same period in 2016. The increase in professional fees was mainly caused by the legal, valuation and auditing service fees incurred in relation to the acquisitions in January 2017.

 

Change in fair value of warrant liabilities

 

Certain of our warrants are recognized as derivative liabilities and re-measured at the end of every reporting period and upon settlement, with the change in value reported in the statement of operations. We reported a loss of approximately $0.1 million but a gain of approximately $0.2 million for the nine months ended September 30, 2017 and 2016, respectively. The changes are primarily due to fluctuations in our closing stock price.

 

Net loss attributable to non-controlling interest

 

Hua Cheng previously had a 20% non-controlling interest in Zhong Hai Media and accounting for that interest under the equity method by recording 20% of the operating losses of Zhong Hai Media. For the nine months ended September 30, 2016, operating loss attributable to Hua Cheng was approximately $0.3 million. The Compnay sold Zhong Hai Media on June 30, 2017 and only $0.03 million operating loss were attributable to Hua Cheng for the same period in 2017.

 

Dillon Yu has a 49% non-controlling interest in Shanghai Wecast Supply Chain Management Limited (“Wecast SH”) and as such we allocate 49% of the operating loss of Wecast SH to Dillon Yu. During the nine months ended September 30, 2017, approximately $0.6 million of our operating loss from Wecast SH was allocated to Dillon Yu, which was nil in the same period in 2016.

 

Swiss Guorong Limited has a 45% non-controlling interest in Wide Angle and as such we allocate 45% of the operating profit of Wide Angle to Swiss Guorong Limited. During the nine months ended September 30, 2017, approximately $0.003 million of our operating loss from Wide Angle was allocated to Swiss Guorong Limited, which was nil for the same period in 2016.

 

Liquidity and Capital Resources

 

As of September 30, 2017, the Company had cash of approximately $1.7 million and had accumulated deficits of approximately $120.5 million and $115.7 million as of September 30, 2017 and December 31, 2016, respectively, due to recurring losses since our inception. These factors could raise substantial doubt about the Company’s ability to continue as a going concern.

 

We continue to rely on debt and equity financing to pay for ongoing operating expenses and execution of our business plan. On March 28, 2016, we completed a common stock financing for $10.0 million. On July 19, 2016, we completed a stock financing with SSW for $4.0 million. On August 12, 2016, we completed another common stock financing with Harvest Alternative Investment Opportunities SPC for $4.0 million. On November 17, 2016, we completed another common stock financing with SSSHK for $2.0 million. On May 19, 2017, we completed another common stock financing with certain investors, including officers, directors and other affiliates of the Company for $2.0 million.

 

The consolidated financial statements included in this report have been prepared assuming that the Company will continue as a going concern and, accordingly, do not include any adjustment that might result from the outcome of this uncertainty.

 

The following table provides a summary of our net cash flows from operating, investing and financing activities.

 

   Nine  Months Ended 
   September 30,   September 30, 
   2017   2016 
Net cash used in operating activities  $(5,836,575)  $(7,945,349)
Net cash provided by (used in) investing activities   1,403,598    (10,631,956)
Net cash provided by financing activities   2,285,841    17,705,110 
Effect of exchange rate changes on cash   62,078    (57,416)
Net decrease in cash   (2,085,058)   (929,611)
           
Cash at beginning of period   3,761,814    3,768,897 
           
Cash at end of period  $1,676,756   $2,839,286 

 

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Operating Activities

 

Cash used in operating activities decreased for the nine months ended September 30, 2017 compared to 2016, primarily due to a decrease in our loss from operation from $6.0 million to $5.1 million.

 

Financing Activities

 

During the nine months ended on September 30, 2017, we entered into a subscription agreement with certain investors, including officers, directors and other affiliates, pursuant to which we issued and sold to such investors, in a private placement, an aggregate of 727,273 shares of the common stock of the Company, for $2.75 per share, or a total purchase price of $2.0 million. While in the same period in 2016, we received $10 million investment proceeds from the sales of 4,545,455 shares of our common stock and issuance of a two-year warrant to acquire an additional 1,818,182 shares of our common stock at an exercise price of $2.75 per share to SSS.

 

Effects of Inflation

 

Inflation and changing prices have had an effect on our business and we expect that inflation or changing prices could materially affect our business in the foreseeable future. Our management will closely monitor price changes and make efforts to maintain effective cost control in operations.

 

Off Balance Sheet Arrangements

 

We do not have any off balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity or capital expenditures or capital resources that is material to an investor in our securities.

 

Seasonality

 

Our operating results and operating cash flows historically for our legacy YOD business have not been subject to seasonal variations. However, we expect a disproportionate amount of our revenues generated from Wecast Services quarter over quarter due to the customers’ seasonal demand, as normally holiday demand or new model of product introduction would increase our revenue. This pattern may change, however, as a result of new market opportunities or new product introductions. 

 

Critical Accounting Policies

 

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires our management to make assumptions, estimates, and judgments that affect the amounts reported, including the notes thereto, and related disclosures of commitments and contingencies, if any. We have identified certain accounting policies that are significant to the preparation of our financial statements. These accounting policies are important for an understanding of our financial condition and results of operations. Critical accounting policies are those that are most important to the portrayal of our financial condition and results of operations and require management’s difficult, subjective, or complex judgment, often as a result of the need to make estimates about the effect of matters that are inherently uncertain and may change in subsequent periods. Certain accounting estimates are particularly sensitive because of their significance to financial statements and because of the possibility that future events affecting the estimate may differ significantly from management’s current judgments. We believe the following critical accounting policies involve the most significant estimates and judgments used in the preparation of our financial statements.

 

Variable Interest Entities

 

We account for entities qualifying as variable interest entities (“VIEs”) in accordance with Financial Accounting Standards Boards (“FASB”) Accounting Standards Codification (“ASC”) Topic 810, Consolidation. For our consolidated VIEs, management has made evaluations of the relationships between our VIEs and the economic benefit flow of contractual arrangement with VIEs. In connection with such evaluation, management also took into account the fact that, as a result of such contractual arrangements, we control the legal shareholders’ voting interests and have power of attorney in the VIEs, and therefore we are able to direct all business activities of the VIEs. As a result of such evaluation, management concluded that we are the primary beneficiary of our consolidated VIEs.

 

We have concluded that we can control our PRC VIEs after consulting with our in-house PRC legal counsel. Enforecement of PRC laws and regulations that affect our ability to control our PRC VIEs may preclude us from consolidating these companies in the future.

 

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Revenue Recognition

 

When persuasive evidence of an arrangement exists, the sales price is fixed or determinable and collectability is reasonably assured, we recognize revenue as services are performed. For certain contracts that involve sub-licensing content within the specified license period, revenue is recognized in accordance with ASC Subtopic 926-605, Entertainment-Films - Revenue Recognition, whereby revenue is recognized upon delivery of films when the arrangement includes a nonrefundable minimum guarantee, delivery is complete and we have no substantive future obligations to provide future additional services. Payments received from customers for the performance of future services are recognized as deferred revenue, and subsequently recognized as revenue in the period that the service obligations are completed.

 

In accordance with ASC 605-25, Revenue Recognition - Multiple Element Arrangements, contracts with multiple element deliverables are separated into individual units for accounting purposes when the unit determined to have standalone value to the customer. Since the contract price is for all deliverables, we allocated the arrangement consideration to all deliverables at the inception of the arrangement based on their relative selling price. We use (a) vendor-specific objective evidence of selling price, if it exists, or, (b) the management’s best estimate of the selling price for that deliverable to determine the relative selling price of each individual unit.

 

We also generate revenue from sales of goods. Sales orders are confirmed after negotiation on price between customers and us. Purchase orders are confirmed after careful selection of suppliers and negotiation on price. We purchase finished goods from suppliers in accordance with sales orders from customers. Our suppliers then deliver goods to our customers directly. We are required to bear the direct risk of damage to the goods that the direct default risk that cannot be delivered to the customer. When the delivery is completed, we recognize revenue and the related cost at the same time. According to purchase orders with suppliers, we, as the owner of the goods, become the first responsible party for the goods.

 

In accordance with ASC 605-45, Revenue Recognition – Principal Agent Consideration, we account for revenue from sales of goods on a gross basis. We are the primary obligor in the arrangements, as we have the ability to establish prices, and have discretion in selecting the independent suppliers and other third-party that will perform the delivery service, we are responsible for the defective products and we bear credit risk with customer payments. Accordingly, all such revenue billed to customers is classified as revenue and all corresponding payments to suppliers are classified as cost of revenues.

 

The recognition of revenue involves certain judgments and changes in our assumptions, judgments or estimations may have a material impact on the amount and timing of our revenue recognition.

 

Licensed Content

 

We obtain content through content licensing agreements with studios and distributors. We recognize licensed content when the license fee and the specified content titles are known or reasonably determinable. Prepaid license fees are classified as an asset on the consolidated balance sheets as licensed content and accrued license content fees payable are classified as a liability on the consolidated balance sheets.

 

We amortize licensed content in cost of revenues over the contents contractual window of availability based on the expected revenue derived from the licensed content, beginning with the month of first availability, such that our revenues bear a representative amount of the cost of the licensed content. We review factors that impact the amortization of licensed content on a regular basis, including factors that may bear direct impact on expected revenue from specific content titles. We estimate expected revenue by reviewing relevant factors, including marketing considerations, programming efforts, relationship with our channel partners, expected customer renewals and content offered by other distributors on the same platform. Changes in our expected revenue from licensed content could have a significant impact on our amortization pattern.

 

Intangible Assets and Goodwill

 

We account for intangible assets and goodwill, in accordance with ASC 350, Intangibles – Goodwill and Other. ASC 350 requires that goodwill and intangible assets with indefinite useful lives no longer be amortized, but instead be evaluated for impairment at least annually. ASC 350 also requires that intangible assets with estimable useful lives be amortized over their respective estimated useful lives and reviewed for impairment whenever events indicate the carrying amount may not be recoverable. In accordance with ASC 350, goodwill is allocated to reporting units, which are either the operating segment or one reporting level below the operating segment. On an annual basis, we review goodwill for impairment by first assessing qualitative factors to determine whether the existence of events or circumstances makes it more-likely-than-not that the fair value of a reporting unit is less than its carrying amount. If we determine that it is more-likely-than-not that the fair value of a reporting unit is less than its carrying amount, goodwill is further tested for impairment by comparing the carrying value to the estimated fair value of its reporting units, determined using externally quoted prices (if available) or a discounted cash flow model and, when deemed necessary, a market approach.

 

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Application of goodwill impairment tests requires significant management judgment, including the identification of reporting units, assigning assets, liabilities and goodwill to reporting units and determination of fair value of each reporting unit. Judgment applied when performing the qualitative analysis includes consideration of macroeconomic, industry and market conditions, overall financial performance of the reporting unit, composition, personnel or strategy changes affecting the reporting unit and recoverability of asset groups within a reporting unit. Judgments applied when performing the quantitative analysis includes estimating future cash flows, determining appropriate discount rates and making other assumptions. Changes in these judgments, estimates and assumptions could materially affect the determination of fair value for each reporting unit.

 

Standards Issued and Not Yet Implemented

 

In February 2016, the Financial Accounting Standards Board issued Accounting Standards Update (ASU) No. 2016-02, Leases (Topic 842). The new standard is effective for reporting periods beginning after December 15, 2018 and early adoption is permitted. The standard will require lessees to report most leases as assets and liabilities on the balance sheet, while lessor accounting will remain substantially unchanged. The standard requires a modified retrospective transition approach for existing leases, whereby the new rules will be applied to the earliest year presented. We do not expect the new lease standard to have a material effect on our financial position, results of operations or cash flows.

 

In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers, or ASU 2014-09, a standard that will supersede virtually all of the existing revenue recognition guidance in U.S. GAAP. The standard establishes a five-step model that will apply to revenue earned from a contract with a customer. Extensive disclosures will be required, including disaggregation of total revenue, information about performance obligations, changes in contract asset and liability account balances between periods and key judgments and estimates. The FASB has issued several amendments to the standard, including clarification on accounting for licenses of intellectual property and identifying performance obligations.

 

The guidance permits two methods of adoption: retrospectively to each prior reporting period presented (the full retrospective method), or retrospectively with the cumulative effect of initially applying the guidance recognized at the date of initial application (the modified retrospective method). We currently anticipate adopting the standard using the modified retrospective method. The new standard will be effective for us beginning January 1, 2018.

 

We are undertaking a comprehensive approach to assess the impact of the guidance on our business by reviewing our current accounting policies and practices to identify any potential differences that may result from applying the new requirements to our consolidated financial statements. We do not anticipate that this standard will have a material impact to revenue recognition in both of our legacy YOD business and Wecast Service business. Especially for Wecast Service business, we will continue to recognize revenue as principal for these contracts at the point in time when the products are delivered. The new standard requires to disclose more information about revenue activities and related transactions including quantitative and qualitative information about performance obligations, significant judgements and estimates, contract assets and liabilities and disaggregation of revenue, which we are continuing to assess in the first quarter of 2018. We are also identifying and implementing changes to the Company’s business processes, systems and controls to support adoption of the new standard in 2018. We continue to make significant progress on our review of the standard. Our initial assessment may change as we continue to refine these assumptions.

 

In May 2016, the FASB issued ASU 2016-12 Revenue from Contracts with Customers (Topic 606): Narrow-Scope Improvements and Practical Expedients. The amendments in this Update do not change the core principle of the guidance in Topic 606. Rather, the amendments in this Update affect only the narrow aspects of Topic 606. The areas improved include: (1) Assessing the Collectability Criterion in Paragraph 606-10-25-1(e) and Accounting for Contracts That Do Not Meet the Criteria for Step 1; (2) Presentation of Sales Taxes and Other Similar Taxes Collected from Customers; (3) Noncash Consideration; (4) Contract Modifications at Transition; (5) Completed Contracts at Transition; and (6) Technical Correction. The effective date and transition requirements for the amendments in this Update are the same as the effective date and transition requirements for Topic 606 (and any other Topic amended by Update 2014-09). We are planning to adopt the above standards on January 1, 2018. We may use either a full retrospective or a modified retrospective approach to adopt this standard. We are currently evaluating this standard and the related updates, including which transition approach to use as well as the impact of adoption on policies, practices and systems. The standard also requires us to evaluate whether our businesses promise to transfer services to the customer itself (as a principal) or to arrange for services to be provided by another party (as an agent). To make that determination, the standard uses a control model rather than the risks-and-rewards model in current U.S. GAAP. At this stage in the evaluation, we do not anticipate that the new guidance will have a material impact on our revenue recognition policies, practices or systems. We are currently evaluating the impact of this standard to its consolidated financial statements upon adoption.

 

In June 2016, the FASB issued ASU 2016-13, “Financial Instruments—Credit Losses (Topic 326)”. The pronouncement changes the impairment model for most financial assets, and will require the use of an “expected loss” model for instruments measured at amortized cost. Under this model, entities will be required to estimate the lifetime expected credit loss on such instruments and record an allowance to offset the amortized cost basis of the financial asset, resulting in a net presentation of the amount expected to be collected on the financial asset. This pronouncement is effective for fiscal years, and for interim periods within those fiscal years, beginning after December 15, 2019. We do not expect a material impact to its consolidated financial statement upon adoption of this ASU.

 

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In November 2016, the FASB issued ASU 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash, which requires companies to include amounts generally described as restricted cash and restricted cash equivalents in cash and cash equivalents when reconciling beginning-of-period and end-of-period total amounts shown on the statement of cash flows. This guidance will be effective in the first quarter of 2018 and early adoption is permitted. Management is still evaluating the effect that this guidance will have on the consolidated financial statements and related disclosures.

 

In January 2017, FASB issued ASU 2017-01, “Business Combinations (Topic 805): Clarifying the Definition of a Business”. The update affects all companies and other reporting organizations that must determine whether they have acquired or sold a business. The definition of a business affects many areas of accounting including acquisitions, disposals, goodwill, and consolidation. The update is intended to help companies and other organizations evaluate whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. The update provides a more robust framework to use in determining when a set of assets and activities is a business, and also provides more consistency in applying the guidance, reduce the costs of application, and make the definition of a business more operable. For public companies, the update is effective for annual periods beginning after December 15, 2017, including interim periods within those periods. The guidance should be applied prospectively upon its effective date. The effect of ASU 2017-01 on the consolidated financial statements will be dependent on any future acquisitions.

 

Item 3. Quantitative and Qualitative Disclosures about Market Risk

 

We are a smaller reporting company as defined by Rule 12b-2 of the Securities Exchange Act of 1934 and are not required to provide the information under this item.

 

Item 4. Controls and Procedures

 

Evaluation of Disclosure Controls and Procedures

 

We maintain disclosure controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act) that are designed to ensure that information that would be required to be disclosed in Exchange Act reports is recorded, processed, summarized and reported within the time period specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including to our Chief Executive Officer and Chief Financial Officer , as appropriate, to allow timely decisions regarding required disclosure.

 

As required by Rule 13a-15 under the Exchange Act, our management, including our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of September 30, 2017. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that as of September 30, 2017, and as of the date that the evaluation of the effectiveness of our disclosure controls and procedures was completed, our disclosure controls and procedures were not effective to satisfy the objectives for which they are intended, as a result of one material weakness described below.

 

Changes in Internal Control Over Financial Reporting

 

On February 4, 2017, Ms. Mei Chen resigned from her position as Chief Financial Officer of the Company and was replaced by Mr. Simon Wang, as the Chief Financial Officer and principal financial officer and principal accounting officer.

 

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In 2016, a material weakness identified in the internal control of financial reporting related to the design, documentation and implementation of effective internal controls over the review of the cash  flow forecasts used in the accounting for licensed content recoverability. Specifically, the Company did not design and maintain effective internal controls related to management’s review of the data inputs and assumptions used in its cash flow forecasts for licensed content recoverability.

 

Other than the changes stated above, there have been no other significant changes in internal control for the nine months ended September 30, 2017, which have materially affected or would likely materially affect our internal control over financial reporting. The Company continues to invest resources in order to upgrade internal controls.

 

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PART II – OTHER INFORMATION

 

Item 1. Legal Proceedings

 

There are no material pending legal proceedings to which we are a party or to which any of our property is subject. To the best of our knowledge, no such actions against us are contemplated or threatened.

 

Item 1A. Risk Factors

 

In addition to the other information set forth in this report, you should carefully consider the factors discussed in Part I, "Item 1A. Risk Factors" in our 2016 Annual Report which could materially affect our business, financial condition or future results. The risks described in our Annual Report on Form 10-K are not the only risks facing our Company. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition or future results. Other than as noted below, there have been no material changes in the risk factors from those disclosed in the Annual Report on Form 10-K for the year ended December 31, 2016.

 

The Company is in the process of transforming its business model and this transformation may not be successful.

 

The Company is in the process of transforming its business model and is aiming to become a global leader in providing next-generation Artificial-Intelligent (AI) & Fintech Powered, Supply Chain + Digital Finance Solutions. SSC’s innovative model helps businesses enhance and unlock operational and capital value from both the supply chain and real assets. In addition, SSC offers a closed trade ecosystem for buyers and sellers designed to eliminate transactional middlemen and create a more direct and margin-expanding path for principals. There are three engines that drive our business platform: 1. Intelligent Supply Chain Management; 2. Asset Based Securitization and Tokenization Issuance and Trading Platform and 3. Digital Index and Financial Derivatives Issuance and Trading Platform; All three engines are supported by “ABCD” Technology & Infrastructure (A: Artificial IntelligenceI, B: Blockchain, C: Cloud Computing, D: Data). In connection with this transformation, the Company has recently assembled a new experienced management team, stabilized the foundation, capitalized and rebranded the Company, reconfigured the business structure, expanded the Company’s mission and business lines, made several key investments and finally, injected several privately held and revenue producing assets into the corporation. It is uncertain whether these efforts will prove beneficial or whether we will be able to develop the necessary business models, infrastructure and systems to support the business. This includes having or hiring the right talent to execute our business strategy. Market acceptance of new product and service offerings will be dependent in part on our ability to include functionality and usability that address customer requirements, and optimally price our products and services to meet customer demand and cover our costs.

 

Any failure to implement this plan in accordance with our expectations could have a material adverse effect on our financial results. Even if the anticipated benefits and savings are substantially realized, there may be consequences, internal control issues, or business impacts that were not expected. Additionally, as a result of our restructuring efforts in connection with our business transformation plan, we may experience a loss of continuity, loss of accumulated knowledge or loss of efficiency during transitional periods. Reorganization and restructuring can require a significant amount of management and other employees' time and focus, which may divert attention from operating activities and growing our business. If we fail to achieve some or all of the expected benefits of these activities, it could have a material adverse effect on our competitive position, business, financial condition, results of operations and cash flows.

 

The Company experiences significant competitive pressure, which may negatively impact its results.

 

The market for the Company’s products and services is very competitive and subject to rapid technological advances, new market entrants, non-traditional competitors, changes in industry standards and changes in customer needs and consumption models. Not only does the Company compete with global distributors, it also competes for customers with regional distributors and some of the Company’s own suppliers that maintain direct sales efforts. In addition, as the Company expands its offerings and geographies, the Company may encounter increased competition from current or new competitors. The Company’s failure to maintain and enhance its competitive position could adversely affect its business and prospects. Furthermore, the Company’s efforts to compete in the marketplace could cause deterioration of gross profit margins and, thus, overall profitability.

 

The size of the Company’s competitors varies across market sectors, as do the resources the Company has allocated to the sectors and geographic areas in which it does business. Therefore, some competitors may have greater resources or a more extensive customer or supplier base than the Company has in one or more of its market sectors and geographic areas, which may result in the Company not being

 

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able to effectively compete in certain markets which could impact the Company’s profitability and prospects.

 

Our International Operations Expose Us to a Number of Risks

 

Our international activities are significant to our revenues and profits, and we plan to further expand internationally. In certain international market segments, we have relatively little operating experience and may not benefit from any first-to-market advantages or otherwise succeed. It is costly to establish, develop, and maintain international operations and platforms, and promote our brand internationally.

 

Our international sales and operations are subject to a number of risks, including:

local economic and political conditions;
government regulation of e-commerce and other services, electronic devices, and competition, and restrictive governmental actions (such as trade protection measures, including export duties and quotas and custom duties and tariffs), nationalization, and restrictions on foreign ownership;
restrictions on sales or distribution of certain products or services and uncertainty regarding liability for products, services, and content, including uncertainty as a result of less Internet-friendly legal systems, local laws, lack of legal precedent, and varying rules, regulations, and practices regarding the physical and digital distribution of media products and enforcement of intellectual property rights;
limitations on the repatriation and investment of funds and foreign currency exchange restrictions;
limited technology infrastructure;
shorter payable and longer receivable cycles and the resultant negative impact on cash flow;
laws and regulations regarding consumer and data protection, privacy, network security, encryption, payments, and restrictions on pricing or discounts;

geopolitical events, including war and terrorism.

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

 

There were no unregistered sales of equity securities during the fiscal quarter ended September 30, 2017, other than those that were previously reported in our Current Reports on Form 8-K.

 

Item 3. Defaults Upon Senior Securities

 

There were no defaults upon senior securities during the fiscal quarter ended September 30, 2017.

 

Item 4. Mine Safety Disclosures

 

Not applicable.

  

Item 5. Other Information

 

On May 10, 2012, at the request of Seven Stars Cloud Group, Inc. (the “Company’), Mr. Shane McMahon made a loan to the Company in the amount of $3,000,000. In consideration for the loan, the Company issued a convertible note to Mr. McMahon in the principal amount of $3,000,000, as amended on May 18, 2012, October 19, 2012, May 10, 2013, January 31, 2014, December 30, 2014 and December 31, 2016 (as amended, restated, supplemented or otherwise modified from time to time, the “McMahon Note”).

 

Effective on November 9, 2017, the Company and Mr. McMahon entered into Amendment No. 7 to the McMahon Note pursuant to which the McMahon Note will be, at Mr. McMahon’s option, payable on demand or convertible on demand into Common Stock at a conversion price of $1.50, until December 31, 2019.

 

The foregoing description of Amendment No. 7 to the McMahon Note is qualified in its entirety by reference to the actual Amendment No. 7 to the McMahon Note, a copy of which is filed as Exhibit 10.4 hereto and incorporated herein by reference.

  

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Item 6. Exhibits

 

Exhibit     
No.    Description 
     
10.1   Form of Stockholder Proxy and Lock-Up Agreement, by and between Seven Stars Cloud Group, Inc., Bruno Wu and certain stockholders.*
10.2   License Agreement, dated October 17, 2017, by and between Wecast Services Group Limited and Guangxi Dragon Coin Network Technology Co., Ltd*
10.3   Securities Purchase Agreement, dated October 23, 2017, by and between Seven Stars Cloud Group, Inc., and Hong Kong Guo Yuan Capital Holdings Limited.*

10.4  Amendement No. 7 to the Convertible Promissory Note in $3,000,000 principal amount issued to Shane McMahon, dated November 9, 2017.*
31.1   Certifications of Principal Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.*
31.2   Certifications of Principal Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.*
32.1   Certification of Principal Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.**
32.2   Certification of Principal Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.**
101.INS   XBRL Instance Document
101.SCH   Taxonomy Extension Schema Document
101.CAL   Taxonomy Extension Calculation Linkbase Document
101.DEF   Taxonomy Extension Definition Linkbase Document
101.LAB   Taxonomy Extension Label Linkbase Document
101.PRE   Taxonomy Extension Presentation Linkbase Document

 

*Filed herewith
**Furnished herewith

 

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SIGNATURES

 

In accordance with the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized on November 13, 2017.

 

Seven Stars Cloud Group, Inc.

 

By: /s/ Simon Wang  
   
Name: Simon Wang  
Title: Chief Financial Officer  
(Principal Financial Officer and an Authorized Officer)  

 

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Exhibit 10.1

 

STOCKHOLDER PROXY AND LOCKUP AGREEMENT

 

This Stockholder Proxy Agreement (this “Agreement”) is made as of [●], 2017, by and among WeCast Network, Inc., a Nevada corporation (the “Company”), Bruno Wu (the “Proxyholder”). and [●] (the “Stockholder”).

 

RECITALS

 

A.            Wecast Media Group Limited (“WMG”) will distribute [●] (the “Distribution”) [●] shares of Company common stock to the Stockholder;

 

B.            The Stockholder has agreed to enter into this Agreement as an inducement to and in consideration for the willingness of WMG to make the Distribution.

 

C.            The Company, the Proxyholder and the Stockholder desire to enter into this Agreement with respect to the voting and the transfer of the Shares.

 

D.            This Agreement, among other things, requires the Stockholder to vote all of the shares and all equity that the Stockholder owns or hereafter acquires or as to which the Stockholder otherwise exercises voting or dispositive authority, (together, all such shares referred to in this sentence and any securities of the Company issued with respect to, upon conversion of, or in exchange or substitution of such shares, the “Shares”) in the manner set forth herein until the termination of this Agreement in accordance with Section 4 hereof.

 

E.            This Agreement is being entered into for good and valuable consideration, the sufficiency of which is hereby acknowledged and agreed.

 

AGREEMENT

 

The parties agree as follows:

 

1.           Voting Arrangements. The Stockholder hereby agrees that the Proxyholder shall have the right to vote or consent as to all Shares, in the Proxyholder’s sole discretion, on all matters submitted to a vote of stockholders of the Company at a meeting of stockholders or through the solicitation of a written consent of stockholders, the term of the aforesaid proxy shall be the maximum period permitted by law until the Stockholder ceases to be the holder of the Shares.

 

2.           Irrevocable Proxy and Power of Attorney. To secure the Stockholder’s obligation to vote the Shares in accordance with this Agreement and to comply with the other terms hereof, the Stockholder hereby appoints the Proxyholder, as the Stockholder’s true and lawful proxy and attorney, with the power to act alone and with full power of substitution, to vote or act by written consent with respect to all the Shares in accordance with the provisions set forth in this Agreement and to execute any applicable instruments, agreements and written consents consistent with this Agreement on behalf of the Stockholder. The Proxyholder shall, upon any exercise of the proxy granted hereby, provide the Stockholder with copies of all documents related to or executed in connection with such exercise by the Proxyholder. The proxy and power granted by the Stockholder pursuant to this Section 3 are coupled with an interest and are given to secure the performance of the Stockholder’s duties under this Agreement. The proxy and power will be irrevocable for the term hereof. For the avoidance of doubt, the Stockholder agrees, and agrees not to dispute, that the proxy granted hereunder is coupled with an interest and is enforceable against the Stockholder.

 

 

 

 

3.Additional Representations, Covenants and Agreements.

 

3.1         Lock-Up Agreement. (a) In recognition of the benefit that the Distribution will confer upon the undersigned as a securityholder of the Company, and for other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the undersigned agrees that, during the period beginning on the date hereof and ending on the date that is one (1) year from the date of (1) the execution of this Agreement or (2) the date on which the Stockholder becomes the legal holder of the Shares, whichever is later (the “Lock-Up Period”), the undersigned will not (and will cause any spouse, domestic partner, lineal descendant, parent, stepparent, sibling, stepsibling, uncle, aunt, niece, nephew, first cousin, or any other person with whom the undersigned has a relationship by blood, marriage or adoption not more remote than first cousin (“Immediate Family Member”) not to), without the prior written consent of the Company, which may withhold its consent in its sole discretion, directly or indirectly, (i) sell, offer to sell, contract to sell or lend, effect any short sale or establish or increase a Put Equivalent Position (as defined in Rule 16a-1(h) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) or liquidate or decrease any Call Equivalent Position (as defined in Rule 16a-1(b) under the Exchange Act), pledge, hypothecate or grant any security interest in, or in any other way transfer or dispose of, any Common Stock or any securities convertible into or exchangeable or exercisable for Common Stock, in each case whether now owned or hereafter acquired by the undersigned or with respect to which the undersigned has or hereafter acquires the power of disposition (collectively, the “Lock-Up Securities”), (ii) make any demand for, or exercise any right with respect to the registration of any of the Lock-Up Securities, or the filing of any registration statement, prospectus or prospectus supplement (or an amendment or supplement thereto) in connection therewith, under the Securities Act of 1933, as amended (the “Securities Act”), (iii) enter into any swap, hedge or any other agreement or any transaction that transfers, in whole or in part, the economic consequence of ownership of the Lock-Up Securities, whether any such swap or transaction is to be settled by delivery of Common Stock or other securities, in cash or otherwise, or (iv) publicly announce the intention to do any of the foregoing.

 

(b)          The Stockholder also agrees and consents to the entry of stop transfer instructions with the Company’s transfer agent and registrar against the transfer of the Lock-Up Securities.

 

(c)          The Stockholder confirms that the Stockholder has not, and has no knowledge that any Immediate Family member has, directly or indirectly, taken any action designed to or that might reasonably be expected to cause or result in the stabilization or manipulation of the price of any security of the Company to facilitate the sale of the Shares. During the Lock-Up Period, the Stockholder will not, and will cause any Immediate Family member not to take, directly or indirectly, any such action.

 

(d)          The Stockholder represents and warrants that the undersigned has full power, capacity and authority to enter into this letter agreement. This letter agreement is irrevocable and will be binding on the undersigned and the successors, heirs, personal representatives and assigns of the undersigned.

 

3.2        Transfers by Stockholder. During the Lock-Up Period, no Shares shall be transferred by the Stockholder until the pledgee, transferee or donee of such Shares (the Transferee) furnishes the Company with a written agreement to be bound by the terms of this Agreement (an “Assumption Agreement”), it being understood and agreed that the Company shall be entitled to issue stop

 

 2 

 

 

transfer instructions in respect of such Shares to preclude any transfer of Shares in contravention of the foregoing.

 

 

3.3         Legends. The Company shall cause each certificate representing the Shares to bear the following legend, in addition to any legends that may be required by state or federal securities laws or the terms of the Company’s Bylaws or any voting or other agreements that apply. This legend shall be removed after the Lock-Up Period ends:

 

THE SHARES EVIDENCED HEREBY ARE SUBJECT TO A STOCKHOLDER PROXY AGREEMENT THAT INCLUDES PROVISIONS POTENTIALLY RESTRICTING THE STOCKHOLDER’S RIGHT TO VOTE AN INTEREST IN THE SHARES EVIDENCED HEREBY, AND BY ACCEPTING ANY INTEREST IN SUCH SHARES THE PERSON ACCEPTING SUCH INTEREST SHALL BE DEEMED TO AGREE TO AND SHALL BECOME BOUND BY ALL THE PROVISIONS OF SAID COMPANY PREFERRED STOCKHOLDER PROXY AGREEMENT.

 

3.4          Stock Splits, Dividends, Etc. In the event of any issuance of shares of the Company’s voting securities hereafter to the Stockholder (including in connection with any stock split, stock dividend, recapitalization, reorganization, or the like), such shares shall automatically become subject to this Agreement and shall be endorsed with the legend set forth in Section 4.2.

 

3.5          Specific Enforcement. During the Lock-Up Period, it is agreed and understood that monetary damages would not adequately compensate an injured party for the breach of this Agreement by any party, that this Agreement shall be specifically enforceable, and that any breach or threatened breach of this Agreement shall be the proper subject of a temporary or permanent injunction or restraining order. Further, each party hereto waives any claim or defense that there is an adequate remedy at law for such breach or threatened breach.

 

3.6          Proxy holders Liability. In voting the Shares in accordance with Section 1, the Proxyholder shall not be liable for any error of judgment nor for any act done or omitted, nor for any mistake of fact or law nor for anything which the Proxyholder may do or refrain from doing in good faith, nor shall the Proxyholder have any accountability hereunder, except for his own willful misconduct.

 

4.            Termination. This Agreement shall continue in full force and effect from the date hereof through the date the Stockholder decide to sell Shares after the Lock-Up Period ends by a prior written notice to the Company and the Proxyholder.

 

5.           Miscellaneous.

 

5.1          Additional Shares. In the event that subsequent to the date of this Agreement any shares or other securities are issued on, or in exchange for, any of the Stockholder Shares by reason of any stock dividend, stock split, combination of shares, reclassification or the like, such shares or securities shall be deemed to be Stockholder Shares, as the case may be, for purposes of this Agreement.

 

5.2          Successors and Assigns. The terms and conditions of this Agreement shall inure to the benefit of and be binding upon the respective successors of the Company and the Stockholder. Nothing in this Agreement, express or implied, is intended to confer upon any party other than the parties hereto or the respective successors of the Company and the Stockholder any rights, remedies, obligations, or liabilities under or by reason of this Agreement, except as expressly provided in this Agreement. This

 

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Agreement may not be assigned without the written consent of the Company, the Proxyholder and the Stockholder.

 

5.3         Delays or Omissions. It is agreed that no delay or omission to exercise any right, power or remedy accruing to any party, upon any breach, default or noncompliance by another party under this Agreement shall impair any such right, power or remedy, nor shall it be construed to be a waiver of any such breach, default or noncompliance, or any acquiescence therein, or of or in any similar breach, default or noncompliance thereafter occurring. It is further agreed that any waiver, permit, consent or approval of any kind or character on any parly’s part of any breach, default or noncompliance under this Agreement or any waiver on such party’s part of any provisions or conditions of the Agreement must be in writing and shall be effective only to the extent specifically set forth in such writing. All remedies, either under this Agreement by law, or otherwise afforded to any party, shall be cumulative and not alternative.

 

5.4         Amendments and Waivers. Any term hereof may be amended or waived only with the written consent of the Company, the Proxyholder and the Stockholder.

 

5.5         Notices. Any and all notices required or permitted to be given to a party pursuant to the provisions of this Agreement will be in writing and will be effective and deemed to provide such party sufficient notice under this Agreement on the earliest of the following: (a) at the time of personal delivery, if delivery is in person, (b) at the time of transmission by facsimile, addressed to the other party at its facsimile number specified herein (or hereafter modified by subsequent notice to the parties hereto), with confirmation of receipt made by printed confirmation sheet verifying successful transmission of the facsimile, (c) one business day after deposit with an express overnight courier, with proof of delivery from the courier requested or (d) three business days after deposit in the mail by certified mail (return receipt requested).

 

5.6         Severability. If one or more provisions of this Agreement are held to be unenforceable under applicable law, the parties agree to renegotiate such provision in good faith. In the event that the parties cannot reach a mutually agreeable and enforceable replacement for such provision, then (a) such provision shall be excluded from this Agreement, (b) the balance of the Agreement shall be interpreted as if such provision were so excluded and (c) the balance of the Agreement shall be enforceable in accordance with its terms.

 

5.7         Governing Law; Jurisdiction; Venue. This Agreement and all acts and transactions pursuant hereto and the rights and obligations of the parties hereto shall be governed, construed and interpreted in accordance with the laws of the State of Delaware, without giving effect to conflict of law principles. In addition, each of the parties hereto (i) consents to submit itself to the exclusive jurisdiction of the Court of Chancery or other courts of the State of Delaware in the event any dispute arises out of this Agreement or any of the transactions contemplated by this Agreement, (ii) agrees that it will not attempt to deny or defeat such jurisdiction by motion or other request for leave from such court, (iii) agrees that it will not bring any action relating to this Agreement or any of the transactions contemplated by this Agreement in any court other than the Court of Chancery or other courts of the State of Delaware and (iv) hereby waives, and agrees not to assert, by way of motion, as a defense, or otherwise, in any such suit, action or proceeding, any claim that it is not subject to the jurisdiction of the above-named courts, that its property is exempt or immune from attachment or execution, that the suit, action or proceeding is brought in an inconvenient forum, that the venue of the suit, action or proceeding is improper or that this Agreement or the subject matter hereof may not be enforced in or by such court.

 

5.8         Counterparts. This Agreement may be executed in two or more counterparts, each of which shall be deemed an original and all of which together shall constitute one instrument.

 

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5.9         Titles and Subtitles. The titles and subtitles used in this Agreement are used for convenience only and are not to be considered in construing or interpreting this Agreement.

 

5.10       Entire Agreement. This Agreement constitutes the full and entire understanding and agreement between the parties with regard to the subjects hereof, and no party shall be liable or bound to any other in any manner by any oral or written representations, warranties, covenants and agreements except as specifically set forth herein and therein. Each party expressly represents and warrants that it is not relying on any oral or written representations, warranties, covenants or agreements outside of this Agreement.

 

[Signature Page Follows]

 

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IN WITNESS WHEREOF, the parties hereto have executed this Stockholder Proxy Agreement as of the date first set forth above.

 

COMPANY:  
   
WECAST NETWORK, INC.  
   
   
Name:  
Title:  

 

PROXYHOLDER:  
   
   
Name: Bruno Wu  

 

STOCKHOLDER:  
   
 
   
   
Name:  
Title:  

 

[Signature Page to Stockholder Proxy Agreement]

 

 

 

Exhibit 10.2

Technical License Agreement

 

Party A (Licensee): Guangxi Dragon Coin Network Technology Co., Ltd.

 

Party A’s shareholders

Zhou Qijun

 

Song Fei

 

Party B (Licensor): Wecast Services Group Limited

 

Whereas, Party A will be licensed from Party B the joint interests of project technology and operation earnings of Party B’s associated companies for business development, Party A and Party B have entered into this Agreement via friendly negotiation in accordance with the Contract Law of P.R.C. and related laws and regulations on 17th Oct. 2017.

 

1.Parties to the agreement

 

1.1Party A: Guangxi Dragon Coin Network Technology Co., Ltd. is a limited company incorporated in China;

Zhou Qijun

Song Fei

 

1.2Party B: Wecast Services Group Limited, a company registered in Hong Kong, the registered address: 16 / F, Wing On CTR, 111 Connaught RD, Central, Hong Kong, and its designated affiliates, including but not limited to Seven Stars Cloud Group, Inc. a Nasdaq-listed company registered in Nevada, USA (code: SSC, Chinese name for the seven stars cloud group, referred to as "Seven Stars Cloud"), Registered Address: 318 North Carson Street, Suite 208, Carson City Nevada.

 

2.Licensing:

 

2.1Part B shall authorize Party A to operate the offering of real-asset-based digital assets of red coin chain and securitization of associated assets, and entitle Party A with the non-exclusive permanent right to use the technologies of trading platform and the right of earnings generated from direct operation;

 

2.2Rights and interests of securitizing real assets generated from industry internet transactions between red-coin-chain-related Seven Stars Cloud and other companies.

 

2.3The capability of global top block-chain team to design and offer real-asset-based digital assets and self-own digital assets, i.e., the operation licensing of and long term technical support to red coin chain. Try to optimize the investment returns and realize scalable investment earnings that can be consolidated at the premise of controllable risks

 

2.4Provide rights and interests of cooperation with the US leading and highly regulated trading platform DBOT. When the offering and trading of digital assets is legalized, and meanwhile generate scalable and consolidated earnings from investment and trading via ABS, ETF, BTF (block chain based ETF), index products and financial derivatives。

 

 

 

 

3.Licensed consideration

 

3.1Party A proposes to pay 17.9% of the existing total equity (i.e. 457,376,784 shares)of Courage Investment Group Limited (ticker symbol: 1145) (its parent company listed in Hong Kong) to Party B (i.e. 82,327,491.9 common shares), which is about HKD 151,482,585 based on the closing price of HKD1.84 dated on 16th Oct. 2017. Both Parties agree to adjust the licensed consideration appropriately based on the licensed assets assessment methods of international professional assessment institutions.

 

3.2The executive director of Courage Investment Group Limited shall be designated by Party B.

 

4.Time of payment and joint guarantees

 

4.1Party A shall deliver the Consideration Shares to Party B within 40 working days after the signing of this Agreement.

 

4.2Party A and its shareholders shall undertake the joint and several liability guarantee in respect of the payment obligation.

 

5.Exclusive Clause

 

Within 40 working days from the date of signing this agreement (or such later date as the parties agree in writing), Party B undertakes to give Party A the exclusive right to cooperate on the red coin chain technology platform. During the period in which this exclusive right is valid, Party B, its holding or affiliated companies, and its representatives or intermediaries shall not, directly or indirectly, (a) initiate, respond to or participate in any other buyer's direct or indirect proposal and discussion on the cooperation of the red coin chain technology platform; (b) solicit or encourage any inquiries, discussions or proposals regarding acquisitions, investments, or any other transactions made by any other party to discuss a similar transaction with party A; (c) continue or propose negotiate, or discuss on any other transaction that is similar to the transaction negotiated with Party A.; and (d) to enter into any agreement or memorandum or memorandum of understanding in respect of the acquisition, investment, or any other transaction similar to the transaction discussed with Party A for the red coin chain technology platform.

 

6.Confidentiality

 

For the content of this agreement, both parties shall have the obligation of confidentiality and may not disclose to any third party, except for the mandatory provisions of laws.

 

7.Applicable law and dispute resolution

 

7.1The Agreement shall be governed and explained by relative laws of PRC.

 

7.2 Any dispute arising out of or in connection with this Agreement shall be resolved through friendly negotiation. In case no settlement to disputes can be reached through negotiation, the disputes shall be submitted to people’s court where the contract is signed.

 

 

 

 

8.Miscellaneous

 

8.1 For any matters uncovered or to be changed, the parties shall sign a separate supplemental agreement and the supplemental agreement shall have the same effect as this agreement.

 

8.2 This agreement shall come into effect upon signing and stamping of two parties. 

 

Party A: (seal) Party B: (seal)
   
Authorized signatory:(signature) Authorized signatory:(signature)
   
Party A’s shareholders: (Signature)  
   
Place of Signing Contract: Chaoyang District, Beijing, China
Signing Date: October 17, 2017

 

 

 

 

Exhibit 10.3

 

Confidential   Execution Version

  

 

 

 

 

Stock Purchase Agreement

 

 

 

Between

 

 

 

Seven Stars Cloud Group, Inc.

 

 

 

 

and

 

 

 

Hong Kong Guoyuan Group Capital Holdings Limited

 

 

 

 

 

Dated October 23, 2017

 

 

 

  

 
 

Execution Version

 

Table of Contents

 

Table of Contents

 

Article 1 Certain Definitions 1
Article 2 7
Sales and Purchase 7
2.1. Sales and Purchase of the Purchased Shares. 7
2.2. Closing 7
2.3. Deliveries at Closing 7
Article 3 Representations, Warranties and Covenants of the Company 8
3.1 Organization and Structure. 8
3.2 Due Authorization. 8
3.3 Non-violation. 9
3.4 Consent 9
3.5 Share Capital 10
3.6 Legal Proceedings. 10
3.7 Contract; Non-violation. 11
3.8 Compliance with Legal Requirements and Government Authorizations 11
3.9 Insurance 11
3.10 Rights and Interests of Senior Executives and Directors of the Company. 11
3.11 Compliance with U.S. Foreign Corrupt Practices Act and Other Applicable Anti-corruption Laws. 12
3.12 Internal Control. 12
3.13 Financial Statements. 13
3.14 Solvency of the Company. 13
3.15 Title to Properties and Assets; Lien, etc. 13
3.16 No Undisclosed Liabilities. 13
3.17 No Material Adverse Changes. 14
3.18 Report Status. 14
3.19 No Manipulation of Stock. 14
3.20 Investment Corporation. 14
3.21 Anti-takeover Statute. 14
3.22 Private Placement. 15
3.23 Full Disclosure. 15
3.24 Broker Charge. 15
3.25 Advisors. 15
3.26 Transactions with Affiliates. 15
3.27 No Other Representation. 15

 

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Execution Version

 

Article 4  Representations, Warrantiess and Covenants of the Purchaser 16
4.1. Representations, Warrantiess and Covenants of the Purchaser. 16
4.2. Other Commitments. 17
4.4. Title to Shares. 18
4.5. Broker’s Charge. 18
4.6. Financing. 18
Article 5 Supplementary Agreement 18
5.1 Board Representative. 18
5.2 Maintaining Listing; Report Obligation. 19
5.3 Use of Funds. 19
5.4 Anti-dilution. 19
5.5 Restrictions on the Share Transfer. 19
5.6 Right of First Refusal. 20
5.7 Tag Along Rights. 20
5.8 Liquidation Preference. 20
5.9 Preferential Treatment. 20
5.10 Affiliate Transaction. 20
5.11 Further Assurance. 21
Article 6 Pre-closing covenants 21
6.1 General Provisions 21
6.2 Notification and Consent 21
6.3 Business Conduct 21
6.4 Reserved business. 24
6.5 Visit and Investigation 24
6.6 Notices. 25
6.7 Confidentiality and publicity 25
6.8 No soliciting. 26
6.9 Investment Company law. 27
6.10 Proxy statement (if applicable). 28
6.11 Approval of Company shareholders(if applicable). 28
6.12 Cooperation and submission of data to the supervision authority 30
6.13 Notices and other data to be submitted to CIFUS (if applicable) 30
6.14 Continued Listing on a National Secuurities Exchange. 31
6.15 Voting agreement (if applicable) 31
6.17 Compensation and insurance for directors and executives 31
6.18 Nocontrol 31
Article 7 Conditions precedented for the Purchaser to fulfill the closing obligation 31
7.1 Fulfillment 31
7.2 Representations and Warranties 32
7.3 No orders 32
7.4 Approval of shareholders (if applicable) 32
7.5 CFIUS conclusion (if applicable) 32
7.6 Board of Directors appointment 32
7.7 Company certificate 32

 

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Execution Version

 

7.8 Horizontal competition 32
7.10 No Competing 33
7.11 Transaction Agreement 33
Article 8  Preconditions for the Company to fulfill the closing obligation 33
8.1 Fulfillment 33
8.2 No order 33
8.3 CFIUS conclusion (if applicable) 33
8.4 Governmental approval 33
8.5 Executive’s certificate 33
8.6 Transaction Document 33
8.7 Approval of shareholders 33
8.8 Approval of the Purchaser 34
Article 9 Representations, Warranties and Survival; Indemnities 34
9.1 Representations, Warranties and Survival. 34
9.2 Indemnities. 34
9.3 Matters concerning the third party. 34
9.4 Negative Consequences. 35
9.5 No other indeminity provision 35
9.6 Indeminity limitation; derogation 35
Article 10 Terminaition; Remedy 35
10.1 Terminiation Event. 35
10.2 Effectiveness of termination. 36
10.3 Fees. 37
10.4 Performance of Agreement 37
Article 11 General Provisions 38
11.1 Entire Agreement. 38
11.2 Disclosure Schedule. 38
11.3 Notice. 38
11.4 Caption. 39
11.5 Assignment 39
11.6 Jury Trial Waiver 39
11.7 Severability 39
11.8 Interpretation rule; attorney-client previlege 39
11.9 No third Party beneficiary 39
11.10 Modification; waiver 39
11.11 Applicable laws; consent to jurisdiction 39
11.12 Language and version 40
11.13 Counterparts 40

 

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Execution Version

 

Stock Purchase Agreement

 

This Stock Purchase Agreement (hereinafter referred to as this “Agreement”), dated as of October 23, 2017 (“Effective Date”), is made and entered into by and between Seven Stars Cloud Group, Inc. (hereinafter referred to as the “Company”) and Hong Kong Guoyuan Group Capital Holdings Limited (hereinafter referred to as the “Purchaser”). The parties are hereinafter individually referred to as a “Party”, and collectively as the “Parties”.

 

RECITALS

 

Whereas, the Company desires to issue and sell to the Purchaser an aggregate of 5,490,000 shares (hereinafter referred to as the “Purchased Shares”) of the authorized but unissued common shares, USD0.001 par value per share, of the Company, at the price of USD1.82 per share (hereinafter referred as the “Purchase Price”), representing an aggregate investment by the Purchaser in the Company of USD10,000,000;

 

Whereas, on the basis of the volume of the stock outstanding as of September 30, 2017, the Purchased Shares will represent 8.10% of the total number of common shares of the Company immediately after the Closing (refer to the definition made herein) contemplated under this Agreement;

 

Whereas, the Parties desire to maintain the Company’s continued compliance with the standards for listing on NASDAQ Stock Market (hereinafter referred as the “NASDAQ”) by making reasonable commercial efforts, and

 

Whereas, the Company intends to issue and sell, and the Purchaser intends to acquire the Purchased Shares, and the Parties intend to carry out the other parts of the strategic relationship between the Parties in accordance with the terms and conditions set forth in this Agreement.

 

NOW THEREFORE, in consideration of the foregoing recitals and the mutual promises set forth herein, the Parties do hereby agree as follows:

  

Article 1
Definitions

 

Affiliate” of any Person refers to other person who directly or indirectly through one or more intermediates, controls, is controlled by this Person or is under common control with this Person. In this definition, “control”(including the correlative “controlling”, “controlled by” and “under common control with”) means the power and ability to direct or cause the direction of the business management and policy of a person directly or indirectly through ownership of voting securities, contracts or otherwise.

 

This Agreement” refer to the recitals hereof.

 

Acquisition Proposal” means any written offer, proposal, inquiry, or representation of intention proposed by other persons in good faith, contemplating or otherwise relating to any Acquisition Transaction (except those offer, proposal, inquiry, representation of intention made by the Purchaser and its Affiliates).

 

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Execution Version

 

 

Acquisition Transaction” means any transaction or series of transactions involving the following items:

 

(a)               Any merger, consolidation, share swap, combination of business, issuance of securities, acquisition of securities, tender offer, offer for share exchange, or other similar transactions, in which (i) the Company or any of its subsidiaries is a party to the transaction; (ii) one person or a group (as defined in the Exchange Act or the regulations made under this Act) composed of two or more persons, directly or indirectly, acquires the beneficial interest or the registered ownership of more than 15% of the outstanding securities of the securities with voting rights of any class of the Company or any of its subsidiaries; or (iii) the Company or any of its subsidiaries issues or sells more than 15% of its outstanding securities of any class of voting securities of the Company or any of its Subsidiaries; or

 

(b)               Any sale (except the sale of inventory in the normal business operation), lease (except the lease in normal business operation), exchange, transfer (except the sale of inventory in stock in the normal business operation), license (except the nonexclusive licensing in normal business operation), acquisition or disposition (except those in relation to liquidation or winding up of the Company or any of its subsidiaries) of any one or more business item or assets that constitute or make up 15% or more of the consolidated net income, net earnings or assets of the Company and its subsidiary.

 

Board” means the board of directors

 

Business day” means any day other than those days on which the banks within New York City in New York State are required or permitted to close.

 

CFIUS” means Committee on Foreign Investment in the United States.

 

Closing” means refer to Article 2.2.

 

Closing Date” means refer to Article 2.2.

 

Code” means the  Internal Revenue Code of 1986 of the USA, as amended.

 

Company”: refer to the recitals of this Agreement.

 

Company’s IP” means any and all intellectual property owned, used or held for use by the Company or any of the Subsidiaries.

 

Company’s SEC Document” means the documents submitted for filing (not furnished) after the date of 14 May 1996 by the Company in accordance with the Securities Act, Exchange Act and the regulations and rules of SEC.

 

Confidentiality Agreement” means the confidentiality agreement entered into by the Company and the Purchaser.

 

Consent” means any approval, consent, ratification, permission, waiver or authorization (including any Governmental Authorization).

 

Proposed Transaction” means any transaction proposed in accordance with and subject to the terms of this Agreement and other transaction agreements.

 

Contract” means any agreement, contract, subcontract, lease, understanding, instrument, note, option, warranty, purchase order, license, sublicense, insurance policy, benefit plan, or undertaking or committee made in written or oral form or other forms.

 

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Execution Version

 

 

Copyright” means all copyrights, copyrightable works, semiconductor topology, mask work right, and the right to apply for registration of the foregoing rights, including all the authorship, use right, right of publication, right of reproduction, right of distribution, right of performance, right of conversion, moral right and ownership to copyrightable works, semiconductor topology work and mask work, all the registration right and the right to update and renew the registration, and any other rights and interests arising under the international copyright, semiconductor topology and mask work conventions.

 

Company Law” means the Company Law of Nevada State.

 

Director” means a member of the Board of Directors of the Company.

 

Disclosure Schedule” means the disclosure schedule has been prepared by the Company and to has been delivered to the Purchaser on the date of this Agreement.

 

EDGAR” the computer system used to receive, accept, review, and disseminate the documents to SEC in electronic form.

 

“Effective Date” refer to the recitals hereof.

 

Encumbrance” means any lien, pledge, hypothecation, guaranty, mortgage, security interest, encumbrance, claim, infringement, intervention, option, right of first refusal, preemptive right, community property interest and the restriction of any nature (including any restriction on voting rights pertaining to any security, any restriction on transfer of any securities or other assets, any restriction on the right to receive any proceeds derived from any assets, any restriction on use of any assets, and any restriction in any other nature on the right to possess, exercise or transfer the title to any assets).

 

Entity” means any corporation (including any non-profit corporations), general partnership, limited partnership, limited liability partnership, joint venture, estate, trust, company (including any joint company limited by shares, Limited Liability Company).

 

ESPP” refer to Article 6.3(b) (1).

 

Exchange Act” means Securities Exchange Act of 1934, as amended.

 

GAAP” means Generally Accepted Accounting Principles.

 

Governmental Authorization” means (a) any permission, license, certificate, franchise, approval, change, release, registration, qualification or authorization issued, granted, made or otherwise provided by and under the authority of Government Agencies or on the basis of the requirements made by any Legal Requirement; or (b) any right granted in accordance with any Contract concluded with Governmental Agencies.

 

Government Agency” means (a) administration of nation, state, unions, province, territory, county, municipality, district or other jurisdiction of any nature; (b) governments of federal, state, local, municipality, foreign country or other government, or (c) any government or quasi-government authorities (including any government branch, department, office, commission, agency, officials, organization, units, organs or Entities and courts or other tribunals).

 

IP” means any and all intellectual property rights and other similar proprietary rights owned, used or held for use under license in any jurisdiction throughout the world, whether registered or not, including the rights in the following respects: (a) Trademark and the goodwill in connection with it; (b) Patent, invention, disclosure of invention, discovery, improvement, whether it may be patented or not; (c) Trade Secret and confidential information and the right to prevent any person from using and disclosing such trade secret and confidential information; (d) all works (whether copyright may be obtained therefor or not), Copyright and database (or other information, data works or other combination of information); (e) software, including date file, source code, object code, firmware, mask works, application programming interface, computerized database and other specification and information related to software; (f) design and industrial design; (g) Internet domain name; (h) right of publication and other right to use individual’s name and other information; (i) moral rights; and (j) petition, cause of action and defense related to current, previous and future enforcement of all the above-mentioned rights; the rights set forth in all the items from (a) through (i) include the registration, application for registration and update and renewed registration of such rights with any Government Agency within any jurisdiction.

 

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Execution Version

 

 

Issued Patent” means all issued patents, re-issued or reviewed patents, revivals of patents, patent for utility models, certificate of invention, patent registration and extensions of patent issued by United States Patent and Trademark Office or other Government Agency, regardless of the nationality or official name of such patents.

 

Knowledge” means, for the Company, Knowledge refers to what the CEO, CFO or general legal counsel of the Company or its subsidiaries actually knows; for the Purchaser, it refers to what the CEO, CFO and the president of the Purchaser actually knows.

 

Litigation” means any action, suit, lawsuit, arbitration, proceeding (including any civil, criminal, administrative, investigation or appeal proceeding), hearing of witness, inquiry, auditing, inspection or investigation initiated, filed, carried out or heard by or otherwise involving any courts or other Government Agency or arbitrator or arbitration court.

 

Legal Requirements” refer to laws, statute law, constitution, rules of common law, resolution, ordinance, code, edict, decree, provisions, rules, decision or requirements of federal, state, local, municipality and foreign country issued, enacted, adopted, promulgated, implemented or otherwise put into effect under the authority or authorization of Government Agencies (or by NASDAQ).

 

License Agreement” means any written or oral Contract licensing any right or interest in or any right to use or utilize any IP, and any alteration of such contracts (including license agreement, sub-license agreement, consultation agreement, research agreement, development agreement, distribution agreement, agreement on permission of use, customer or client contract, agreement for co-existence, waiver of claim and reconciliation, exclusive of sale of product in normal business operation).

 

Lien” means any pledge, lien, guaranty, mortgage, and encumbrance or security interest of any nature.

 

Material Adverse Effect” means any event, condition, circumstance, development, change, effect or matters that, individually or collectively, is or would reasonably be expected to have material adverse effect upon the following items: (i) overall business, conditions (in finance or other respects), assets or operating fruits of the Company or its Subsidiaries taken as a whole; or (ii) the Company’s capacity to complete the Proposed Transaction or perform any of its obligations hereunder; but the above (i) or (ii) is exclusive of any event, condition, circumstance, development, change, effect or matters arising owing to the following reasons: (A) changes in general conditions of economy, regulation or politics, or in general condition in securities, credit loan or financial markets; (B)general change or development of the business in which the Company or its Subsidiaries operate, including any change of Legal Requirements having impact upon such business; (C) Negotiation, execution, announcement, existence or performance of this Agreement or the Proposed Transactions, including (x) any expenses or expenditures incurred in connection therewith, and (y) the impact of the above-mentioned conditions upon clients, suppliers, employees and regulating authorities; (D) The identity of the Purchaser or its Affiliates as the acquirer of the Purchased Shares; (E) The Company’s compliance with this Agreement, or any action taken by the Company under this Agreement or as required or agreed expressly by the Purchaser after the signing date of this Agreement; (F) any terrorist acts, war, natural disaster or events related to weather; (A) change in GAAP or interpretation of GAAP; (H) change in share price or trading volume of common shares (but this (H) item may not be interpreted as “any change, event, circumstance, development, matter or condition that leads to such change in price or trading volume does not constitute or lead to material adverse effect upon the Company” ); (I) failure to realize any internal or publicized forecast, expectation or estimation of revenue or profit for any period or any downward revision forecast thereof (but this (I) item may not be interpreted as “any change, event, circumstance, development, matter or condition that leads to such failure does not constitute or lead to material adverse effect upon the Company”), or (J) any action, litigation, investigation or proceeding initiated or threatened by any holder of the equity of the Company in person or on behalf of the Company on the basis of the principle of derivations in connection with or arising out of any transaction proposed in this article (including the Proposed Transactions contemplated herein), exclusive of any action, litigation, investigation and proceeding initiated or threatened by any senior management officer or director of the Company; in the above items numbered with (A), (B) and (F), however, if the change or development mentioned therein may be reasonably expected to have seriously disproportionate adverse effect upon the whole of the Company and its subsidiaries (compared with other enterprises in the equal size in the same trade), such change or development may not be taken as exceptions.

 

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Execution Version

 

 

Material Contract” shall have the meaning set forth in Section 3.7.

 

NASDAQ” shall have the meaning set forth in Recitals.

 

“Off-Balance Sheet Arrangement” means off-balance sheet arrangements as defined in Item 303(a)(4) of Regulation S-K of the SEC.

 

Order” means any order, injunction, judgment, decree, ruling, stipulation, assessment, or arbitration award of any Governmental Body or arbitrator.

 

Party” or “Parties” shall have the meaning set forth in Recitals.

 

Patent” means the Issued Patents and the Patent Applications.

 

Patent Application” means all published or unpublished no provisional and provisional patent applications, reexamination proceedings, invention disclosures, and records of invention.

 

“Person” means any individual, entity or Government Agency.

 

“Board” shall have the meaning set forth in Article 5.1 (a).

 

“Proprietary Right” means (a) (i) Issued patents; (ii) Patent application; (iii) Trademark, virtual enterprise name and domain name registration; (iv) Copyright; (v) Trade secret; and (vi) all other ideas, invention, design, manufacturing and operating specifications, technical data and other intangible assets, IP and rights (whether such intangible assets, property or rights are protected by taking proper measures according to relevant Legal Requirements); or (b) The right to use or utilize the above-mentioned items .

 

“Proxy Statement” refers to Proxy statement issued to the shareholders of the Company in connection with the shareholders’ meeting of the Company.

 

“Purchase Price” refer to Article 2.1. .

 

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“Purchased Shares” refer to the recitals hereof.

 

“Purchaser” refer to the recitals hereof.

 

“Purchaser’s Disclosure Schedule” means the disclosure schedule compiled by the Purchaser to be presented to the Company on the signing date of this Agreement.

 

“Registered Copyright” means all copyright for which the registration has been made with the U.S. Copyright Office or other Government Agency or the application for registration has been submitted.

 

“Registered Trademark” means all trademarks for which the registration has been made with the United States Patent and Trademark Office or other Government Agency or the application for registration has been submitted.

 

“Regulation S-K” refers to Regulation S-K of SEC.

 

“Representative” refers to senior management officer, director, employee, manager, agent, lawyer, accountant, consultant or representative of a Party or its Affiliate.

 

“SEC” refers to the U.S. Securities and Exchange Commission.

 

“Securities Act” refers to the Securities Act of 1933, as amended.

 

“Subsidiary” refers to Entity owned directly or indirectly by other Persons actually or through registration and such Persons own (a) securities or other interest of this entity with voting rights in a volume enough to qualify this Person to appoint are least a majority of the members to the board of directors or other management authority, or (b) at least 50% of the outstanding equity or economic interest of this entity.

 

“Tax” refers to any tax collected, imposed or levied on the strength of the power of or authorization by any taxation authorities that have the power to collect, impose or levy taxes and charges (including any income tax, franchise tax, capital gains tax, gross receipts tax, value-added tax, surtax, excise tax, ad valorem duty, transfer tax, stamp tax, sales tax, use tax, property tax, business tax, withholding tax, payroll tax), collection, levy, duties (including any customs duties) or expenses, and any and all relevant charges or sum (including penalty, fine and interest).

 

“Tax Return” refers to any return (including any information reporting return), report, statements, declaration, schedule, notification, announcement, form, selection, certificate or other document or information submitted or to be submitted as required to any taxation authorities or to any taxation authorities for registration in connection with the determination, levy, collection or payment of any tax, or administration, implementation, enforcement or observation of any Legal Requirements concerning any tax (including estimation of tax).

 

“Tax Authority” refers to any Government Agency responsible for administering or collecting any Tax.

 

“Trade Secret” refers to all product specifications, data, know-how, formula, ingredient, processes, designs, sketches, photos, figures, drawings, samples, inventions and ideas, research and development, manufacturing or sales approach and processing, clients name list, current and potential client’s requirements, price list, market research, business plan, computer software and program (including object code), computer software and database technology, system, structure and composition (and the relevant course, formula, ingredient, improvement, know-how, invention, discovery, concept, idea, design, method and information) and any other information in any form of record that are in compliance with the definition of trade secret made in the relevant laws on protection of trade secret.

 

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“Trademark” refers to (a) all trademarks, service marks, marks, logo, insignias, design, name or other symbol; (b) application for registration of trademarks, service marks, marks, logo, insignias, design, name or other symbol, and (c) trademarks, service logo, logo, sign, design, name or other symbol that have been registered.

 

“Transaction Agreement” refers to the shareholder agreement as attached to this Agreement.

  

Article 2
Sales and Purchase

 

 

2.1.      Sales and Purchase of the Purchased Shares.

 

Subject to the terms and conditions of this Agreement and in reliance upon the respective representations and warranties made by the Parties hereunder, the Company hereby agrees to issue, sell and deliver, and the Purchaser hereby desires to purchase, the Purchased Shares, at the Closing, at the price of USD 1.82 per share ("Purchase Price") with the aggregate Purchase Price of USD 10,000,000.

 

2.2.      Closing

 

Subject to the terms and conditions contained herein, the closing of the Purchased Shares (hereinafter referred to as "Closing") shall take place on November 3, 2017 (which is deemed as "Closing Date").

 

2.3.      Deliveries at Closing

 

(a)               Company Deliveries. The Company shall, upon Closing:

 

(i)                 Submit application for stock certificate of the Purchased Shares (or appropriate evidence of book-entry registration of the Purchased Shares in the name of the Purchaser that are in book-entry form);

 

(ii)              Other documents related to the Transaction acceptable to the Parties.

 

(b)               Purchaser Deliveries. The Purchaser shall, upon Closing, deliver to the Company:

 

(i)                 The aggregate Purchase Price in US Dollars before October 24, 2017 with immediately available funds, to the designated account of the Company via wire transfer in accordance with the written instructions of the Company; and

 

(ii)              other agreements, certificates, instructions, documents and items referred to in Article 6 and Article 7 in a form and substance reasonably acceptable to the Company; and

 

(iii)            other documents related to the Transaction acceptable to the Parties.

 

2.4. Registration of Share

 

The Company shall use its best efforts to register the Purchased Shares within twelve (12) months after having received Purchase Price in full from the Purchaser in accordance with the Securities Act and the applicable laws of the competent state.

 

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Article 3
Representations, Warranties and Covenants of the Company

 

Disclosure information of the Company shall include: (i) any information disclosed in the Company's SEC Document prior to the date of this Agreement, excluding any factual disclosure related to risk factors, risk disclosure in Disclaimer and any risk disclosure in the predictable or forward-looking disclaimer or others statements in essence included in the Company's SEC Document; (ii) corresponding contents in the Disclosure Schedule. In addition to paragraphs (i) and (ii), the Company hereby represents warranties and covenants to the Purchaser, as follows:

 

3.1          Organization and Structure.

 

(a)               Company. The Company is an enterprise duly incorporated, validly existing and in good standing under the laws of Nevada, its jurisdiction of incorporation. In any jurisdiction where the character of the Company’s property that is owned, leased and operated by it, or the nature of its business makes such qualification necessary, the Company is a foreign firm with good standing and of qualification or ability required, except that such failure to be so qualified or in good standing would not have a Material Adverse Effect on the Company. The Company has obtained requisite corporate power and authorization that are necessary to own, use and lease various properties thereof, and operate any business it is now being conducted as described in the Company's SEC Documents.

 

(b)               Subsidiary (ies). All Subsidiaries of the Company have been listed in Article 3.1(b) of Disclosure Schedule (hereinafter referred to as "Subsidiary/Subsidiaries"), including the name of the Subsidiary, its jurisdiction where such Subsidiaries were incorporated or established, registered capital (including the percentage ownership held directly or indirectly by the Company and other equity holder of subsidiary). All Subsidiaries listed in Article 3.1(b) of Disclosure Schedule are duly incorporated, validly existing and in good standing under the laws of the jurisdiction of incorporation. In any jurisdiction where the character of the Subsidiary’s property that is owned, leased and operated by it, or the nature of business makes such qualification necessary, the Subsidiary is a foreign firm with good standing and of qualification or ability required, except that such failure to be so qualified or in good standing would not have a Material Adverse effect on the Company. All Subsidiaries have obtained requisite corporate power and authorization that are necessary to own, use and lease various properties thereof, and operate any business as it is now being conducted. Unless otherwise stated in Article 3.1(b) of Disclosure Schedule, each subsidiary is a wholly owned subsidiary of the Company.

 

3.2          Due Authorization.

 

The Company has any and all requisite corporate powers and authorizations that are necessary to enter into and deliver this Agreement and each of the Transaction Agreements, to perform any obligations referred in preceding agreement to reach any proposed transactions, subject to receipt of Shareholders’ approval (if applicable). Other than receipt of the Shareholders’ approval, the execution, delivery and performance of this Agreement, Proposed Transactions have been duly and properly authorized through the Company’s actions on the part of the Company that are necessary. The Company has duly and validly entered into and delivered this Agreement and each of the Transaction Agreement and assuming that the other parties hereto have been duly authorized, formally entered into and delivered this Agreement and each of the Transaction Documents as well, the terms of aforesaid agreements shall constitute the valid and binding obligations of the Company, against which the Company can be enforced in accordance with its terms, provided, however, that such enforceability may be limited by applicable bankruptcy, insolvency, reorganization, moratorium and other similar laws which are generally are affecting the rights of both creditors and the Parties, and such enforcement may be subject to the basic principles of equity (regardless of whether in common law or in equitable legal proceedings) (hereinafter referred to as "Enforcement Exceptions").

 

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3.3          Non-violation.

 

Subject to approval of the Shareholders (if applicable), the execution, delivery and performance of any Proposed Transaction and all Transaction Documents shall:

 

(a)               not conflict with certification of incorporation, rules and regulations of the Company;

 

(b)               not require any consent, waiver, approval, order, authorization or permit of ,or registration, filing with or notification to, except for those that have been obtained, except that (i) the filing is required by SEC; (ii) any consent, approval, orders, authorizations, regulation, declarations and filling required by state securities regulations or Blue Sky Laws; (iii) approval of the Shareholders on Proposed Transaction; (iv) a conclusion by CFIUS that there is no national security that request further examination this Agreement, Proposed Transaction, and related Transaction Documents; and (v) such approvals, waiver, authorizations, permit or registration, if not obtained or made, would not have a Material Adverse Effect;

 

(c)               neither breach or violate any terms, conditions or articles of any material contracts as the filing of annexes of the Company's SEC Document, nor constitute any faults under such terms, conditions or articles (with or without notice or lapse of time or both), and even not create any right of termination, forfeiture, cancellation or acceleration, transfer fees, guaranteed payment or a loss of material interest, except for such conflicts, violations, breaches, terminations, cancellation or accelerations, transfer fee, guaranteed payment or loss of material interest not, individually or in the aggregate, would not have a Material Adverse Effect are excepted;

 

(d)               upon reasonable inquiry and to the knowledge of the Company, not conflict with or violate the provisions of order, wit, injunction, judgments, decree, statute, rules or regulations applicable to the Company or any Subsidiary or any assets or properties thereof, except for such conflicts or violations which would not result in a Material Adverse Effect; or

 

(e)               not create any Lien, Encumbrance, clam, security interest or restrictions on any material assets or properties or shares or capital stock of the Company or any Subsidiary under any Material Contract, except which would not result in Material Adverse Effect.

 

3.4          Consent

 

The Company has, or will have, prior to the Closing Date, given any notice to or obtained and Consent from any third party required in connection with the execution and delivery of this Agreement or the consummation or performance, execution, delivery and performance of the Proposed Transaction under the Transaction Agreements, except where the failure to provide such notices or obtain such Consent would not result in a Material Adverse Effect.

 

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3.5          Share Capital

 

As of September 30, 2017:

 

(a)               The authorized shares of the Company consists of 1,500,000,000 common shares, 16,500,000 Series E Preferred Shares and 7,000,000 Series A Preferred Shares (hereinafter referred to as "Preferred Share(s)"):

 

(b)                

 

(i)               62,264,495 shares of common shares are issued and outstanding, all of which have been duly authorized and validly issued, and are fully paid, non-taxable and issued pursuant to applicable federal and state securities act; the issuance thereof doesn’t in violation of any preemptive right or similar rights to subscribe for or purchase shares.

 

(ii)              0 common share is held by the Company as treasury shares.

 

(iii)            3,118,181 common shares are reserved for the Company's Stock Option or other Company's Benefits Plans.

 

(c)               7,000,000 Series A Preferred Shares have (has) been issued.

 

(d)               Any bonds, debentures, notes or other indebtedness or, (other than common shares) other securities of the Company shall neither be entitled to vote on any matters on which the Shareholders may vote, nor be converted into or exchange for any securities having such voting right.

 

(e)               Except as set forth in Article 3.5 (b), there are no outstanding subscription right, option, right, warranties, convertible securities, stock appreciation rights, phantom equity or other similar agreements or commitment that obligates the Company to for issue, transfer, sell, redeem, buy-back or otherwise obtaining any shares of its share capital of any class.

 

(f)                No preemptive right, co-sale right, registration right, right of first refusal or other similar rights exists in relation to the issuance and sales of Purchased Shares, and there is no any shareholder agreement, voting power agreement or other similar agreement in relation to the common shares to which the Company is a party.

 

(g)               The Purchased Shares to be sold under this Agreement have been granted with requisite authorization, upon issued and paid for in accordance with the terms of this Agreement, will be duly and validly issued and paid in full, and be the non-taxable shares issued and fully paid in accordance with applicable federal and state securities act, and the issuance thereof doesn’t in violation of any preemptive right or similar rights for subscribed or purchase security.

 

3.6          Legal Proceedings.

 

(a)               To the knowledge of the Company, there is no pending legal procedure (i) that has been commenced by or against the Company or any of its Subsidiaries that could individually or in aggregate, reasonably be expected to have a Material Adverse Effect; or (ii) that challenges, or that would reasonably be expected have the effect of preventing, delaying, illegalization or otherwise interfering with any of the Proposed Transactions.

 

(b)               To the knowledge of the Company, no legal procedures that should be disclosed are discovered under the pending contents above has been threatened.

 

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(c)               There are no order, injunction, judgment, decrees, rulings, stipulation, assessment or arbitration award that is made by Government Agency or arbitrator(s) outstanding against the Company or any Subsidiary thereof, which may constitute Material Adverse Effect, individually or in aggregate, upon reasonable expectations.

 

3.7          Contract; Non-violation.

 

All of the Material Contracts have been filed as the Company's SEC Document prior to the date of this Agreement and publicly available on EDGAR.

 

3.8          Compliance with Legal Requirements and Government Authorizations

 

(a)               Both the Company and any Subsidiaries thereof have been compliance with any existing or previous Legal Requirements that are/were applicable to the Company and any Subsidiaries, their conducts, business operation or ownership of assets or use, save the nonconformance circumstances that not (or will not) severally or jointly constitute Material Adverse Effect are expressly excluded.

 

(b)               Neither the Company nor any Subsidiary thereof has received any written notices or, to the knowledge of the Company, any other communication, issued by any Government Agency, all of which are related to (i) any actual, alleged, possible and potential violation or failure of Legal Requirements (which are not corrected thereafter) without residual responsibilities, or (ii) any actual, alleged, possible and potential obligations requesting the Company or any Subsidiary thereof to take any remedial actions of any kind or bear the cost of such remedial actions.

 

3.9          Insurance

 

Except for the situations that do not have any Material Adverse Effect, (a) any and all policies of the Company and any Subsidiaries thereof are valid and fully paid any due and payable premiums; (b) neither the Company nor any of its Subsidiaries thereof have never breached or been in default any policies, neither the Company nor any of its Subsidiaries has taken any action, or failed to take come certain actions which may, with notice or after a certain period, constitute a violation, lack of, permit of termination or modification of any such policies; and (c) such policies are sufficient for compliance with (i) any Legal Requirements applicable to the Company's commercial operations stated in the Company's SEC Document, and (ii) the express requirements of all Contracts to which the Company and any Subsidiaries thereof as a party or by which the Company and any Subsidiaries thereof are restricted in other ways. The Company has provided the Purchaser with a true, accurate and complete copies of all material insurance policies held by or on behalf of the Company, except those which have not been modified and contain all attachments and exhibits submitted prior to the signing of this Agreement as the Company's SEC Document, which has been announced by EDGAR system (if applicable). Neither the Company nor any Subsidiaries thereof has received any written notice from or on behalf of any insurance carrier issuing policies or binder relating to or covering the Company or any Subsidiaries which will cancel the existing insurance or cause nonrenewal of the existing policy (including both formal and provisional insurance policies), or will need to change the equipment or any improvements to real estate occupied or leased to or by the Company or any Subsidiaries, purchase additional equipment or materially change the method of production and management.

 

3.10      Rights and Interests of Senior Executives and Directors of the Company.

 

Except for circumstances which would not lead to a Material Adverse Effect, to the knowledge of the Company, except for any facts all of which have been disclosed in the Company's SEC Document prior to conclusion of this Agreement, and except for normal rights and benefits of the Shareholders, and rights under the Company's Benefits Plan and Stock Option of the Company, no senior executives or directors of the Company or any Subsidiaries or their respective Affiliates (except for the Company and any Subsidiaries thereof) shall have any rights and benefits in any assets used by the business of the Company and any Subsidiaries thereof, in any suppliers, distributors or customers of the Company and any Subsidiaries thereof, or in any other relationship, contract or understanding established and created with the Company and any Subsidiaries thereof (beneficiary rights or personal rights and interests, whether tangible or intangible).

 

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3.11      Compliance with U.S. Foreign Corrupt Practices Act and Other Applicable Anti-corruption Laws.

 

To the knowledge of the Company, the Company or any Subsidiaries or the directors, senior executives, agents or employees of the Company or any Subsidiaries (i) has (have) not used any funds for unlawful contribution, presents, gifts and entertainment or other unlawful expenses relating to political activities; (ii) has (have) neither provided any unlawful payment to any foreign or domestic governmental officials, staff, political parties and campaign, nor gone against with Foreign Corrupt Practices Act, 1977, as amended, and federal, foreign, state and other anti-corruption and anti-bribery laws or any similar Legal Requirements applicable to the Company or any Subsidiaries thereof. The Company and any Subsidiaries thereof has established corresponding guidelines, policies, procedures and control measures to ensure to observe various anti-corruption and anti-bribery laws or any similar Legal Requirements promulgated by U.S. federation, domestic and foreign

 

3.12      Internal Control.

 

(a)               The Company and its Subsidiaries thereof have, in accordance with requirements of Exchange Act, implemented and maintained a complete set of internal control systems over financial reporting (as defined in Rule 13a-15(f) and 15d-15(f) of Exchange Act) which are capable of ensuring the reliability of financial reporting and that the financial statements are prepared as per GAAP for any external purposes.

 

(b)               Upon the da