10-K 1 form10k.htm YOU ON DEMAND HOLDINGS INC 10-K 12-31-2012 form10k.htm
 UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
x
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended: December 31, 2012

o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ____________ to _____________

Commission File No. 000-19644
 
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YOU ON DEMAND HOLDINGS, 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.)

27 Union Square West, Suite 502
New York, New York  10003
(Address of principal executive offices)

 
(212) 206-1216
 
 
(Registrant’s telephone number, including area code)
 

Securities registered pursuant to Section 12(g) of the Exchange Act: Common Stock, par value $0.001 per share

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yeso Nox

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yeso Nox

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.   Yesx   Noo

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).   Yesx   Noo

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o
 
 
 
 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act
 
Large Accelerated Filer o
Accelerated Filer o
Non-Accelerated Filer o  (Do not check if a smaller reporting company)
Smaller reporting company x
 
Indicate by check mark whether registrant is a shell company (as defined in Rule 12b-2 of the Act).    Yeso Nox
 
As of June 30, 2012 (the last business day of the registrant’s most recently completed second fiscal quarter), the aggregate market value of the shares of the registrant’s common stock held by non-affiliates (based upon the closing price of such shares as reported by Nasdaq) was approximately $ 33,970,755.  Shares of the registrant’s common stock held by each executive officer and director and each by each person who owns 10% or more of the outstanding common stock have been excluded from the calculation in that such persons may be deemed to be affiliates of the registrant. This determination of affiliate status is not necessarily a conclusive determination for other purposes.
 
There were a total of 14,819,691 shares of the registrant’s common stock outstanding as of March 31, 2013.
 
DOCUMENTS INCORPORATED BY REFERENCE
None.
 
 
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YOU ON DEMAND HOLDINGS, INC.

Annual Report on FORM 10-K
For the Fiscal Year Ended December 31, 2012 
 

PART I
 
 
Page
Item 1.
6
Item 1A.   
15
Item 1B.
26
Item 2.
26
Item 3.
26
Item 4.
26
 
 
PART II
 
 
 
Item 5.
26
Item 6.
27
Item 7.
27
Item 7A.
28
Item 8.
37
Item 9.
37
Item 9A.
38
Item 9B.
39
 
 
PART III
 
 
 
Item 10.
39
Item 11.
46
Item 12.
48
Item 13.
51
Item 14.
51
 
 
PART IV
 
 
 
Item 15.
53
 
 
Special Note Regarding Forward Looking Statements

In addition to historical information, this report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. We use words such as “believe,” “expect,” “anticipate,” “project,” “target,” “plan,” “optimistic,” “intend,” “aim,” “will” or similar expressions which are intended to identify forward-looking statements. Such statements include, among others, those concerning market and industry segment growth and demand and acceptance of new and existing products or services; any projections of sales, earnings, revenue, margins or other financial items; any statements of the plans, strategies and objectives of management for future operations; any statements regarding future economic conditions or performance; uncertainties related to conducting business in China, as well as all assumptions, expectations, predictions, intentions or beliefs about future events. You are cautioned that any such forward-looking statements are not guarantees of future performance and involve risks and uncertainties, including, and without limitation those identified in Item 1A, “Risk Factors” included herein, as well as assumptions, which, if they were to ever materialize or prove incorrect, could cause the results of the Company to differ materially from those expressed or implied by such forward-looking statements.

Although we believe the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, level of activity, performance, or achievements.  Moreover, neither we nor any other person assumes responsibility for the accuracy or completeness of any of these forward-looking statements. You should not rely upon forward-looking statements as predictions of future events. We are under no duty to update any of these forward-looking statements after the date of this report to conform our prior statements to actual results or revised expectations.

Use of Terms
 
Except as otherwise indicated by the context, references in this report to “we,” “us,” “our,” “our Company,” or “the Company” are to the combined business of YOU On Demand Holdings, Inc., a Nevada corporation, and its consolidated subsidiaries and variable interest entities.

In addition, unless the context otherwise requires and for the purposes of this report only:
 
 
·
“AdNet” refers to Wanshi Wangjing Media Technologies (Beijing) Co., Ltd. (a/k/a Adnet Media Technologies (Beijing) Co., Ltd.), a PRC company previously controlled by CB Cayman through a contractual arrangement;
 
·
“CB Cayman” refers to our wholly-owned subsidiary China Broadband, Ltd., a Cayman Islands company;
 
·
“Exchange Act” refers to the Securities Exchange Act of 1934, as amended;
 
·
“Hong Kong” refers to the Hong Kong Special Administrative Region of the People’s Republic of China;
 
·
“Hua Cheng” refers to Hua Cheng Hu Dong (Beijing) Film and Television Communication Co., Ltd., a PRC company 39% owned by Sinotop Beijing;
 
·
“Jinan Broadband” refers to Jinan Guangdian Jia He Broadband Co., Ltd., a PRC joint venture owned 51% by WFOE and 49% by Jinan Parent;
 
·
“Jinan Parent” refers to Jinan Guangdian Jia He Digital Television Co., Ltd., a PRC company; “Jinan Zhong Kuan” refers to Jinan Zhong Kuan Dian Guang Information Technology Co., Ltd., a PRC company owned 90% by Weicheng Liu 10% by Liang Yuejing, PRC individuals
 
·
“Modern Movie” refers to Modern Movie & TV Biweekly Press, a PRC company;
 
·
“Networks Center” refers to the shareholder of Jinan Parent, Jinan Radio & Television Network, which had been dissolved and merged into Shandong Broadcast Network;
 
·
“PPV” refers to pay-per-view;
 
 
 
·
“PRC,” “China,” and “Chinese,” refer to the People’s Republic of China;
 
·
“Renminbi” and “RMB” refer to the legal currency of China;
 
·
“SARFT” refers to the State Administration of Radio, Film & Television, an executive branch under the State Council of the People’s Republic of China;
 
·
“SEC” refers to the United States Securities and Exchange Commission;
 
·
“Securities Act” refers to the Securities Act of 1933, as amended;
 
·
“Shandong Broadcast” refers to Shandong Broadcast & TV Weekly Press, a PRC company;
 
·
Shandong Media” refers to Shandong Lushi Media Co., Ltd., a PRC company owned 50% by Jinan Zhong Kuan, 30% by Shandong Broadcast and 20% by Modern Movie;
 
·
“Shandong Newspaper Entities” refers to Shandong Broadcast and Modern Movie;
 
·
“Sinotop” or “Sinotop Beijing” refers to Beijing Sino Top Scope Technology Co., Ltd., a PRC company controlled by Sinotop Hong Kong through contractual arrangements;
 
·
“Sinotop Hong Kong” refers to Sinotop Group Limited, a Hong Kong company wholly-owned by CB Cayman;
 
·
“U.S. dollars,” “dollars,” “USD,” “US$,” and “$” refer to the legal currency of the United States;
 
·
“VIEs” refers to our variable interest entities, including Jinan Broadband, Shandong Media and Sinotop Beijing;
 
·
“VOD” refers to video on demand, which includes near video on demand (“NVOD”), subscription video on demand (“SVOD”), and transactional video on demand (“TVOD”);
 
·
“WFOE” refers to Beijing China Broadband Network Technology Co., Ltd., a PRC company wholly-owned by CB Cayman;
 
·
“YOD WFOE” refers to YOU On Demand (Beijing) Technology Co., Ltd., a PRC company wholly-owned by Sinotop Hong Kong; and
 
·
“Zhong Hai Video” refers to Zhong Hai Shi Xun Information Technology Co., Ltd., a PRC company 80% owned by Sinotop Beijing.
 
In this report we are relying on and we refer to information and statistics regarding the media industry in China that we have obtained from various public sources.  Any such information is publicly available for free and has not been specifically prepared for us for use or incorporation in this report or otherwise.
 
 
PART I

ITEM 1.
 
Overview

YOU On Demand Holdings, Inc. is a corporation formed in the State of Nevada on October 19, 2004.

We operate in the Chinese media segment through our Chinese subsidiaries and variable interest entities (“VIEs”): (1) a business which provides to cable providers both an integrated value-added service solution and platform for the delivery of pay-per-view (“PPV”) and video on demand (“VOD”) as well as enhanced premium content for cable providers and (2) a cable broadband business based in the Jinan region of China.

On July 30, 2010, we acquired Sinotop Group Limited (“Sinotop Hong Kong”) through our subsidiary China Broadband, Ltd. (“CB Cayman”).  Through a series of contractual arrangements, Sinotop Hong Kong controls Beijing Sino Top Scope Technology Co., Ltd. (“Sinotop Beijing”), a corporation established in the People’s Republic of China (“PRC”) which is the 80% owner of our Zhong Hai Shi Xun Information Technology Co., Ltd. (“Zhong Hai Video”) joint venture.  Through Zhong Hai Video, we provide integrated value-added service solutions for the delivery of PPV, VOD, and enhanced premium content for cable providers.

Through our VIE Jinan Guangdian Jia He Broadband Co., Ltd. (“Jinan Broadband”), we provide cable and wireless broadband services, principally internet services, Internet Protocol Point wholesale services, related network equipment rental and sales, and fiber network maintenance.  Jinan Broadband’s revenue consists primarily of sales to our PRC-based internet consumers, cable modem consumers, business customers and other internet and cable services.  This broadband business accounted for  approximately 75% and 62% of our revenues in 2012 and 2011, respectively.

Through our VIE Shandong Lushi Media Co., Ltd. (“Shandong Media”), we operate a print-based media business, which includes a television programming guide publication, the distribution of periodicals, the publication of advertising, the organization of public relations events, the provision of information-related services, copyright transactions, the production of audio and video products, and the provision of audio value-added communication services.  Shandong Media’s revenue consists primarily of sales of publications and advertising revenues.  This print-based media business accounted for approximately 25% and 38% of our revenues in 2012 and 2011, respectively.  On July 1, 2012, we sold 20% of Shandong Media, reducing our ownership interest from 50% to 30%.  Accordingly, as of December 31, 2012, we account for our investment in Shandong Media under the equity method.

Our Video On Demand Business

At year end our VOD product was implemented on a limited basis for testing. Our full product launch occurred in conjunction with the Chinese New Year during our first quarter of 2013.  Full roll out of our video on demand products began in the first quarter of 2013.

Through the acquisition of Sinotop Hong Kong and its VIE Sinotop Beijing, YOU On Demand has an exclusive 20-year joint venture with CCTV-6's China Home Cinema, or CHC, to become the first national Pay-Per-View (PPV) and Video On Demand (VOD) platform in China. We operate under a national government license obtained by CHC to serve as their exclusive agent in the PRC, for operating and marketing PPV, Transactional Video On Demand, or TVOD, Subscription Video On Demand, or SVOD, Near Video On Demand, or NVOD, and related Value-Added Services, or VAS. Our platform and services include content and distribution agreements, governmental partnerships and approvals, infrastructure, encoding and transcoding, metadata management, marketing services and data reporting, collection and remittance. Our core revenues will be generated from both a one-time fee for our TVOD services, as well as a monthly fee for our SVOD services.

We are China's most sophisticated aggregator of VOD content, offering a suite of services modeled after the most successful VOD platforms in the world. Led by extensive industry experience and comprehensive analyses of consumer viewing habits, our TVOD and SVOD services are designed to maximize buys and revenue. We currently provide cable television household subscribers the ability to view the best Hollywood titles, high-grossing domestic content and other popular movies, such as The Avengers. Our platforms provide viewers with access to the top selection of quality content during the earliest possible VOD windows for the best viewing experience with full DVD-like control. We will also offer free content including trailers, behind-the-scenes footage, celebrity interviews and more.
 
 
YOU On Demand currently has distribution agreements with Warner Bros. Entertainment, Disney Media Distribution, Paramount Pictures, NBCUniversal, Miramax, Lionsgate, Magnolia Pictures, Screen Media Ventures, Gravitas Ventures, 3Net,,K2 Communications and Film Buff. As of December 31, 2012, YOU On Demand has distribution agreements with 7 Chinese Cable TV broadcast companies in 7 provinces which can reach approximately 18.2 million households.  In addition, we plan to expand our content offering to include YOU 3D, YOU TV, YOU Kids, YOU Sports, YOU Music, YOU Karaoke and YOU Events. Currently, there is no other provider offering VOD or SVOD services on a national level in China through a secured digital cable TV set-top box.

China is the largest cable TV market in the world with 400 million total TV households and 202 million cable TV households with an untapped potential for premium content.  China expects to be twice the size of the United States in terms of digital households by 2015.  With the increase of middle class income and greater disposable budgets, we anticipate seeing greater demand for entertainment, including movies, concerts and sporting events. This projection has been reflected through box office receipts, up 28% in 2012 from 2011 according to China’s Film Bureau, and the exploding sales of flat screen televisions, as China became the largest overall TV market in 2009 and the largest LCD TV market in 2011, according to NPD Display Research.  Premium content remains scarce in the market and we believe the key opportunity for growth is in China’s next generation broadcasting initiatives, which is expected to power 200 million digital cable customers with high definition television, internet and 2-way interactive service capability by 2020, according to the Chinese State Administration of Radio, Film and Television.

Our Broadband Business

Jinan Guangdian Jia He Digital Television Co., Ltd. (“Jinan Parent”), the entity that sold 51% of its cable broadband business to us, is an emerging cable TV consolidator and operator in China’s cable broadband market.   Jinan Broadband, which is 49% owned by Jinan Parent and 51% owned by our wholly owned subsidiary Beijing China Broadband Network Technology Co., Ltd. (“WFOE”), is operated in accordance with a cooperation agreement and an exclusive service agreement.  Jinan Broadband operates out of its base in Shandong where it has an exclusive cable broadband deployment partnership and exclusive service agreement with Jinan Radio & Television Network (“Networks Center”), the only cable TV operator in Jinan.  Pursuant to the exclusive service agreement, Jinan Broadband, Jinan Parent and Networks Center cooperate and provide each other with technical services related to their respective broadband, cable and internet content-based businesses.

We believe that we compete on the basis of more favorable rates and our ability to provide a variety of interactive media services through a partnership with Networks Center.  Finally, cable enjoys a high household penetration rate in urban areas and our internet service is competitively fast and reliable.  (See www.jinan.gov.cn ).

Our Publishing Business

Shandong Media, our print-based media business, was deconsolidated as of July 1, 2012, when our effective ownership decreased from 50% to 30%.  Prior to deconsolidating the business, Shandong Media was 50% owned by Shandong Broadcast & TV Weekly Press (“Shandong Broadcast”) and Modern Movie & TV Biweekly Press (“Modern Movie”) (together the “Shandong Newpaper Entities”) and 50% owned by Jinan Zhong Kuan Dian Guang Information Technology Co., Ltd. (“Jinan Zhong Kuan”), an entity controlled by us through a series of contractual arrangements.  The business of Shandong Media includes a television programming guide publication, the distribution of periodicals, the publication of advertising, the organization of public relations events, the provision of information related services, copyright transactions, the production of audio and video products, and the provision of audio value added communication services.  Our cooperation agreement with Shandong Broadcast and Modern Movie also provides that these businesses will be operated primarily by employees contracted to Shandong Media through secondment by Shandong Broadcast and Modern Movie.  In addition to being the exclusive provincial television programming guide publishing group in the Shandong province, Shandong Media has a combined subscription basis of approximately 225,000 subscribers.
 
 
Corporate Structure

The following chart depicts our corporate structure as of the date of this report:

Image 2
 
1.
Controlled through a Trust Agreement with controlling shareholder(s).

2.
Equity Pledge of 100% of Jinan Zhong Kuan in favor of WFOE.

3.
Exclusive Service Agreements dated December 2006 and March 2007 between Jinan Broadband, Jinan Parent and Networks Center; Cooperation Agreement dated as of January 2007 between Jinan Broadband and Networks Center; Cooperation Agreement dated as of December 26, 2006 between CB Cayman and Jinan Parent.

4.
Sinotop VIE Agreements, including with Zhang Yan, the sole shareholder of Sinotop Beijing.

5.
Controlled through a Loan Agreement dated January 2008, an Equity Option Agreement dated January 2008, a Trustee Arrangement dated January 2008, and a Power of Attorney dated January 2008.

6.
Sinotop Joint Venture Agreements with Zhong Hai Video.  Hua Cheng Hu Dong (Beijing) Film and Television Communication Co., Ltd. (“Hua Cheng”) owns 20% of Zhong Hai Video.
 
VIE Structure and Arrangements

Jinan Broadband

In December 2006, through our WFOE, we entered into a cooperation agreement with Jinan Parent, pursuant to which we acquired and currently own a 51% controlling interest in Jinan Broadband.  The cooperation agreement provided WFOE the authority to appoint a majority of the board of directors of Jinan Broadband, as well as the general manager and finance manager, and provides that Jinan Broadband’s operations and pre-tax revenues would be assigned to our WFOE for 20 years, effectively providing for an acquisition of the business.  In consideration for this 20 year business and management rights license, we paid approximately $2,572,000, including expenses, in March 2007 and the remaining approximate $3.2 million (based on RMB 23 million) in March 2008.  While this acquisition was completed in late March 2007 with an effective transfer of assets date of April 1, 2007, we commenced certain operational oversight of this entity prior to such time.
 
 
Under the terms of an exclusive services agreement between Jinan Broadband, Jinan Parent and Networks Center, Jinan Broadband is obligated to provide certain technical services needed by Jinan Parent and is entitled to receive 100% of the pre-tax income of Jinan Parent related to the business of Jinan Broadband in exchange.  Accordingly, because all of the pre-tax income of Jinan Broadband is then required to be paid over to our WFOE under the terms of the cooperation agreement, and due to the nature of our ownership/control of Jinan Broadband, Jinan Broadband is considered a VIE and therefore is consolidated in our financial statements.

Sinotop Beijing

On July 30, 2010, we acquired Sinotop Hong Kong through CB Cayman.  Through a series of contractual arrangements, Sinotop Hong Kong controls Sinotop Beijing.  Sinotop Beijing, a corporation established in the PRC is the 80% owner of the Zhong Hai Video joint venture, which was established to provide integrated value-added service solutions for the delivery of VOD, PPV and enhanced premium content for cable providers.

In March 2010, Sinotop Hong Kong entered into a management services agreement with Sinotop Beijing pursuant to which Sinotop Beijing pays consulting and service fees, equal to 100% of all pre-tax revenues of Sinotop Beijing, to Sinotop Hong Kong for various management, technical, consulting and other services in connection with its business.  Payment of the fees under the management services agreement is secured through an equity pledge agreement pursuant to which the sole shareholder of Sinotop Beijing pledged all equity interests in Sinotop Beijing to Sinotop Hong Kong.  In addition, Sinotop Hong Kong entered into a voting rights agreement with Sinotop Beijing and the sole shareholder of Sinotop Beijing, whereby Sinotop Hong Kong was entrusted with all of the voting rights of the sole shareholder of Sinotop Beijing.  Through these contractual arrangements, upon our acquisition of Sinotop Hong Kong, we acquired control over, and rights to 100% of the economic benefit of Sinotop Beijing.  Accordingly, Sinotop Beijing is considered a VIE and, therefore, is consolidated in our financial statements.

Shandong Media

As of July 1, 2012 we deconsolidated Shandong Media due to a decrease in ownership from 50% to 30%.

On March 7, 2008, we entered into the Shandong Cooperation Agreement with the Shandong Newspaper Entities.  The Shandong Cooperation Agreement provides for, among other terms, the creation of a joint venture entity in the PRC, Shandong Media, that would own and operate the television program guide, newspaper and magazine publishing businesses previously owned and operated by the Shandong Newspaper Entities pursuant to exclusive licenses.  In addition, Shandong Media entered into an exclusive advertising agency agreement and an exclusive consulting services agreement with the Shandong Newspaper Entities and another third party, Music Review Press, which requires that the Shandong Newspaper Entities and Music Review Press shall appoint Shandong Media as their exclusive advertising agent and provider of technical and management support for a fee.
 
Under the terms of the Shandong Cooperation Agreement and related pledge and trust documents, the Shandong Newspaper Entities contributed their entire Shandong newspaper business and transferred certain employees to Shandong Media in exchange for a 50% stake in Shandong Media, with the other 50% of Shandong Media to be owned directly by Jinan Zhong Kuan and indirectly by our WFOE in the PRC in the second quarter of 2008, with the joint venture becoming operational in July of 2008.  In exchange, therefore, the Shandong Cooperation Agreement provided for total initial consideration from us of approximately $1.5 million (approximately 10 million RMB).  As part of the transaction, and to facilitate our subsidiary’s ownership and control over Shandong Newspaper under PRC law, through our WFOE in the PRC, this acquisition was completed in accordance with a pledge and loan agreement, pursuant to which all of the shares of Shandong Media which we acquired are held in trust on our behalf by a nominee holder, as security for a loan to Shandong Media’s parent seller.

On January 19, 2012, through Jinan Zhong Kuan, we entered into a Memorandum of Understanding with the Shandong Newspaper Entities pursuant to which we expressed the intention to amend the terms of the Shandong Cooperation Agreement to transfer an aggregate of 20% of our ownership interest in Shandong Media to the Shandong Newspaper Entities. Shandong Media received notice of approval by the PRC State Administration for Industry & Commerce to effect the changes made in the Articles of Association and complete the transaction. The equity transfer ownership was effective as of July 1, 2012, and we have deconsolidated Shandong Media and recorded our 30% ownership under the equity method of accounting.
 
 
We are entitled to 100% of the pre-tax income of Jinan Zhong Kuan, in two ways which are discussed below.  First, there are two individual owners of Jinan Zhong Kuan which hold all of the equity in that company in trust for the benefit of CB Cayman, pursuant to trustee arrangements entered into with them in 2008.  The trustee arrangements relieve the individual shareholders from any responsibilities for the day-to-day operations of the company and any liability arising from their role as equity holders.  All actions taken by them as shareholders will be in accordance with instructions provided by CB Cayman.  The trustee arrangements provide that, in consideration for an up-front fee paid by CB Cayman, and monthly cash payments thereafter, the equity holders of Jinan Zhong Kuan will hold the equity of Jinan Zhong Kuan in trust for, and only for the benefit of, CB Cayman.  We believe CB Cayman’s right to receive 100% of the dividends paid on the equity held in trust for it by the two individuals is appropriate under PRC transfer pricing rules, which are found in Arts. 41-48 of the PRC Enterprise Income Tax Law and Arts. 109-123 of the Implementing Regulations thereunder, and complies with the “arm’s length principle” mandated by Art. 41 of the Enterprise Income Tax Law, because those individuals have no responsibilities and take no risk in connection with their role as trustee shareholders other than to vote when requested and as directed by CB Cayman.
 
As a practical matter, however, there are not likely to be any dividends paid on the equity of Jinan Zhong Kuan, because all of its pre-tax income is required to be paid over to the WFOE under the terms of an exclusive services agreement entered into in January 2008. Under the terms of the exclusive services agreement, the WFOE is obligated to provide all management, technical and support services needed by Jinan Zhong Kuan and is entitled to receive 100% of the pre-tax income of Jinan Zhong Kuan in exchange. Jinan Zhong Kuan has no income other than profit distributions from Shandong Media.  Jinan Zhong Kuan and our WFOE are related parties, and all of the risk and burden of the operations of Jinan Zhong Kuan is shifted to the WFOE under the exclusive services agreement, and therefore all of the economic benefit is shifted to the WFOE, as well.  If the PRC tax authorities were to disagree with our position regarding the pricing under the exclusive services agreement between Jinan Zhong Kuan and the WFOE, there is no potential for past-due tax liability with respect to Jinan Zhong Kuan because, as noted above, Jinan Zhong Kuan has never recognized any profits.
 
The Company, through CB Cayman, is the sole owner of the WFOE, and exercises the overall voting power over the WFOE.  In addition, through the various contractual agreements between CB Cayman, the trustees, the WFOE and Jinan Zhong Kuan, as discussed above, Jinan Zhong Kuan is considered a VIE.  As the Company bears all risks and is entitled to all benefits relating to the investment in Jinan Zhong Kuan, the Company is a primary beneficiary of Jinan Zhong Kuan and is required to consolidate Jinan Zhong Kuan under the variable interest model.  With respect to Shandong Media, it cannot finance its own activities without the cash contribution from Jinan Zhong Kuan.  In addition, apart from its equity interest in Shandong Media, Jinan Zhong Kuan has the obligation to bear expected losses and receive expected returns through the exclusive services agreement, which entitles Jinan Zhong Kuan to all net profits of Shandong Media.

Our Industry

Until 2005, there were over 3,000 independent cable operators in the PRC.  While the State Administration of Radio, Film and Television (“SARFT”), an executive branch under the State Council of the PRC, has advocated for national consolidation of the country’s sprawling cable networks, the consolidation has primarily occurred at the provincial level.  The 30 provinces are highly variable in their consolidation efforts and processes.  To expedite consolidation, SARFT announced in 2010 that it would permit and encourage state-owned cable operators to expand and consolidate through mergers and acquisitions.  We believe that as consolidation proceeds it will smooth the way to two-way digitization through common technical standards.
 
We believe that SARFT and its broadcasters are currently focusing on increasing subscription revenues by converting Chinese television viewers from “analog” service to “digital” (pay TV) service.  The digitalization efforts include providing upgraded digital set-top-boxes free of charge that will provide the bandwidth to deliver pay channels and services beyond the basic tier as part of a digital television service bundling initiative.  Aligned with its intention to spur convergence of cable TV and telecommunications, the Chinese government has mandated completion of the digital conversion of its cable infrastructure by 2015.

Our Competition

Video On Demand Business
 
We currently have no direct competitors in China that offer VOD services nationally over a cable platform through a secured digital cable TV set-top box.  Although we can provide no assurances that other companies will not enter the market of providing such services, we believe that we will have a competitive advantage over any new market entrant because of our partnership with CCTV-6’s pay channel, CHC, and first to market advantage.  We do have some indirect competition from both the pirated DVD market as well as alternative platform providers.  We believe our product offers the highest quality end user experience.
 
 
Broadband Business

We believe that local telecom carriers that offer non-cable internet services, such as DSL, represent our primary broadband internet segment competition in the PRC.  An example is China Netcom, a telecom carrier in the Shandong province of China.  Many of our competitors also have resources and capital resources that exceed our own.

Local telecom carriers are actively marketing broadband services on national, provincial, as well as local levels in China.  Telecom carriers own “last mile access” to urban households in the form of fixed phone lines.  We believe, however, that cable operators have a competitive advantage by owning last mile connections in the form of cable lines that have a larger bandwidth relative to phone lines.  In urban areas that we target, a large number of households have both fixed phone line and cable television access.  Many of these homes currently have telecom based internet access.

Cable operators in China must purchase internet connection bandwidth from the local telecom carriers.  Since the local telecom carriers are not required to pay for internet connection bandwidth, which increases their profit margins relative to cable broadband service providers, this affords them a potential price advantage.  But to-date, their prices remain in line with our prices.
 
Our Growth Strategy

We intend to implement the following strategic plans to take advantage of industry opportunities and expand our business:
 
 
·
Video On Demand Services. Through our acquisition of Sinotop Hong Kong, and its VIE, Sinotop Beijing, which is a party to two joint ventures consisting of partnerships with CHC, we have received the rights to utilize an exclusive national license to deploy VOD services onto cable TV networks throughout China. Currently, we have access to some of the largest movie libraries in China and the U.S., and we will continue to acquire content from entertainment companies and studios in the U.S. and other parts of the world to deliver an integrated solution for enhanced premium content through cable providers in China. There are over 202 million cable television households in China and we will attempt to capitalize on the revenue opportunities as the government continues to mandate the switch from analog to digital cable by 2015.

 
·
Focus on Additional Delivery Platforms. Once we build an extensive entertainment content library and establish our reputation within the cable television industry, we plan to expand the distribution of our content over multiple delivery platforms including internet, mobile, Internet Protocol television (“IPTV”), and satellite to expand our product offerings and diversify our revenue streams.

 
·
Deployment of Value-Added Services. To augment our product offerings and create other revenue sources, we work with strategic partners to deploy value-added services to our cable broadband customers.  Value-added services, including multiple content offerings, will become a focus of revenue generation.
 
Our Customers

As of December 31, 2012, Jinan Broadband had approximately 50,000 cable internet subscribers.   All of our customers are in the PRC.

Intellectual Property

We are not a party to any royalty agreements, labor contracts or franchise agreements, and, in addition to our right to own and operate Jinan Broadband, we own the trademark “YOU On Demand,” which is registered in the PRC.   We intend to apply for other trademarks for the regions in which we operate, such as with respect to Jinan Broadband.

Our Employees

As of December 31, 2012, we had a total of 108 full-time employees. The following table sets forth the number of our employees by function at December 31, 2012.
 

Function
 
Number of Employees
Sales and Marketing
 
29
Technical
 
41
Research and Development
 
10
Operating
 
9
Financial
 
11
Administrative
 
8
TOTAL
 
108
 
Our employees are not represented by a labor organization or covered by a collective bargaining agreement.  We have not experienced any work stoppages.
 
We are required under PRC law to make contributions to employee benefit plans at specified percentages of after-tax profit.  In addition, we are required by the PRC law to cover employees in China with various types of social insurance.  We believe that we are in material compliance with the relevant PRC laws.

Seasonality

Our operating results and operating cash flows historically have not been subject to seasonal variations. This pattern may change, however, as a result of new market opportunities or new product introductions.
 
Regulation

General Regulation of Businesses

Our PRC-based operating subsidiaries and VIEs are regulated by the national and local laws of the PRC. The radio and television broadcasting industries is highly regulated in China.  Local broadcasters including national, provincial and municipal radio and television broadcasters are 100% state-owned assets.  SARFT regulates the radio and television broadcasting industry.  In China, the radio and television broadcasting industries are designed to serve the needs of government programming first, and to make profits next.  The SARFT interest group controls broadcasting assets and broadcasting contents in China.

The Ministry of Industry Information (“MII”) plays a similar role to SARFT in the telecom industry.  China’s telecom industry is much more deregulated than the broadcasting industry.  While China’s telecom industry has substantial financial backing, SARFT, and its regulator, the Propaganda Ministry under China’s Communist Party Central Committee, never relinquished ultimate regulatory control over content and broadcasting control.

The major internet regulatory barrier for cable operators to migrate into multiple-system operators and to be able to offer telecom services is the license barrier.  Few independent cable operators in China acquired full and proper broadband connection licenses from MII.  The licenses, while awarded by MII, are given on very-fragmented regional market levels.  With cable operators holding the last mile to access end users, SARFT cable operators pose a competitive threat to local telecom carriers.  While internet connection licenses are deregulated to even the local private sector, MII still tries to utilize the license as a barrier to entry from cable operators that fall under the SARFT interest group.

We are required to obtain government approval from the Ministry of Commerce of the People’s Republic of China (“MOFCOM”), and other government agencies in China for the transactions such as our acquisition or disposition of business entities in China.  Additionally, foreign ownership of business and assets in China is not permitted without specific government approval.  For this reason, we acquired only 51% of Jinan Broadband, with the remaining 49% owned by Jinan Parent and its affiliates.  Sinotop Beijing was acquired through our acquisition of Sinotop Hong Kong, which controls Sinotop Beijing through a series of contractual agreements.   We use revenue sharing and voting control agreements among the parties so as to obtain equitable and legal ownership of our subsidiaries.
 

Licenses and Permits

Jinan Broadband
 
Through the cooperation agreement with Jinan Parent and Networks Center, we enjoy the benefits of licenses that Jinan Parent holds that allow us to roll out cable broadband services as well as to provide value-added services of radio and TV content in Shandong province, including:

Description
 
License/Permit
Internet Multi-media Content Transmission
 
License No. 1502005
Radio & Television Program Transmission & Operation Business
 
Permit Shandong No. 1552013
Radio & TV Program Production & Operation License
 
Shandong No. 46
PR China Value-added Telecom Service License
 
Shandong No. B2-20050002
PR China Value-added Telecom Service License
 
Shandong B2-20051013
 
Shandong Publishing

Shandong Publishing holds the following licenses:

Description
 
License/Permit
PRC Newspaper Publication License for Shandong Broadcast & TV Weekly
 
National Unified Publication CN 37-0014
PRC Magazine Publication License for View Weekly
 
Ruqichu Nor:1384
PRC Magazine Publication License for Modern Movie & TV Biweekly
 
Ruqichu No:1318
Advertising License for Shandong Broadcast & TV Weekly
 
3700004000093
Advertising License for View Weekly
 
3700004000186
Advertising License for Modern Movie & TV Biweekly
 
3700004000124

Taxation

On March 16, 2007, the National People’s Congress of China passed the EIT Law, and on November 28, 2007, the State Council of China passed its implementing rules which took effect on January 1, 2008. The EIT Law and its implementing rules impose a unified earned income tax, or EIT, rate of 25.0% on all domestic-invested enterprises and foreign invested enterprises, or FIEs, unless they qualify under certain limited exceptions.  As a result, our PRC operating entities and VIEs are subject to an earned income tax of 25.0%.  Before the implementation of the EIT Law, FIEs established in the PRC, unless granted preferential tax treatments by the PRC government, were generally subject to an EIT rate of 33.0%, which included a 30.0% state income tax and a 3.0% local income tax.

In addition to the changes to the current tax structure, under the EIT Law, an enterprise established outside of China with “de facto management bodies” within China is considered a resident enterprise and will normally be subject to an EIT of 25% on its global income. The implementing rules define the term “de facto management bodies” as “an establishment that exercises, in substance, overall management and control over the production, business, personnel, accounting, etc., of a Chinese enterprise.” If the PRC tax authorities subsequently determine that we should be classified as a resident enterprise, then our organization’s global income will be subject to PRC income tax of 25%.  For detailed discussion of PRC tax issues related to resident enterprise status, see “Risk Factors – Risks Related to Doing Business in China – Under the New Enterprise Income Tax Law,” we may be classified as a “resident enterprise” of China. Such classification will likely result in unfavorable tax consequences to us and our non-PRC stockholders.

Foreign Currency Exchange

All of our sales revenue and significant expenses are denominated in RMB.  Under the PRC foreign currency exchange regulations applicable to us, RMB is convertible for current account items, including the distribution of dividends, interest payments, trade and service-related foreign exchange transactions. Currently, our PRC operating entities may purchase foreign currencies for settlement of current account transactions, including payments of dividends to us, without the approval of SAFE, by complying with certain procedural requirements.  Conversion of RMB for capital account items, such as direct investment, loan, security investment and repatriation of investment, however, is still subject to the approval of SAFE.  In particular, if our PRC operating entities borrow foreign currency through loans from us or other foreign lenders, these loans must be registered with SAFE, and if we finance the subsidiaries by means of additional capital contributions, these capital contributions must be approved by certain government authorities, including the MOFCOM, or their respective local branches.  These limitations could affect our PRC operating entities’ ability to obtain foreign exchange through debt or equity financing.
 
 
Dividend Distributions

All of our revenues are earned by our PRC entities.  However, PRC regulations restrict the ability of our PRC entities to make dividends and other payments to their offshore parent company.  PRC legal restrictions permit payments of dividends by our PRC entities only out of their accumulated after-tax profits, if any, determined in accordance with PRC accounting standards and regulations.  Each of our PRC subsidiaries is also required under PRC laws and regulations to allocate at least 10% of our annual after-tax profits determined in accordance with PRC GAAP to a statutory general reserve fund until the amounts in such fund reaches 50% of its registered capital.  These reserves are not distributable as cash dividends. Our PRC subsidiaries have the discretion to allocate a portion of their after-tax profits to staff welfare and bonus funds, which may not be distributed to equity owners except in the event of liquidation.

In addition, under the new EIT law, the Notice of the State Administration of Taxation on Negotiated Reduction of Dividends and Interest Rates , or Notice 112, which was issued on January 29, 2008, and the   Notice of the State Administration of Taxation Regarding Interpretation and Recognition of Beneficial Owners under Tax Treaties  , or Notice 601, which became effective on October 27, 2009, dividends from our PRC operating subsidiaries paid to us through our entities will be subject to a withholding tax at a rate of 10%. Furthermore, the ultimate tax rate will be determined by treaty between the PRC and the tax residence of the holder of the PRC subsidiary.  Dividends declared and paid from before January 1, 2008 on distributable profits are grandfathered under the EIT Law and are not subject to withholding tax.

The Company intends on reinvesting profits, if any, and does not intend on making cash distributions of dividends in the near future.
 
 
ITEM 1A.
 
An investment in any of the company’s securities is highly speculative in nature, involves a high degree of risk and illiquidity and should be purchased only by persons who can afford to lose the entire amount invested in the common stock. Before purchasing any securities of the Company, you should carefully consider the following factors relating to our business and prospects. You should pay particular attention to the fact that we conduct all of our operations in China and are governed by a legal and regulatory environment that in some respects differs significantly from the environment that may prevail in the U.S. and other countries.  If any of the following risks actually occurs, our business, financial condition or operating results will suffer, the trading price of our common stock could decline, and you may lose all or part of your investment.
 
RISKS RELATED TO OUR BUSINESS

Our auditors have expressed in their report on our financial statements substantial doubt about our ability to continue as a going concern.

Our auditors have included an explanatory paragraph in their report dated as of April 5, 2013 on our consolidated financial statements for the year ended December 31, 2012, indicating that there is substantial doubt regarding our ability to continue as a going concern.  As discussed in Note 3 to the consolidated financial statements included in this report, the Company has incurred significant losses during 2012 and 2011 and has relied on debt and equity financings to fund their operations. These conditions raise substantial doubt about the Company’s ability to continue as a going concern. Management’s plans regarding these matters are also described in Note 3. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.   If we are in fact unable to continue as a going concern, our shareholders may lose their entire investment in our Company.

Expansion of our business may put added pressure on our management and operational infrastructure impeding our ability to meet any potential increased demand for our services and possibly hurting our future operating results.

Our business plan is to significantly grow our operations to meet anticipated growth in demand for the services that we offer, and by the introduction of new goods or services.  Growth in our businesses may place a significant strain on our personnel, management, financial systems and other resources.  The evolution of our business also presents numerous risks and challenges, including:

 
●
our ability to successfully and rapidly expand sales to potential new distributors in response to potentially increasing demand;

 
●
the costs associated with such growth, which are difficult to quantify, but could be significant; and

 
●
rapid technological change.

To accommodate any such growth and compete effectively, we may need to obtain additional funding to improve information systems, procedures and controls and expand, train, motivate and manage our employees, and such funding may not be available in sufficient quantities, if at all.  If we are not able to manage these activities and implement these strategies successfully to expand to meet any increased demand, our operating results could suffer.

In order to comply with PRC regulatory requirements, we operate our businesses through companies with which we have contractual relationships but in which we do not have controlling ownership. If the PRC government determines that our agreements with these companies are not in compliance with applicable regulations, our business in the PRC could be materially adversely affected.
 
We do not have direct or indirect equity ownership of our VIEs, which collectively operate all our businesses in China. At the same time, however, we have entered into contractual arrangements with each of our VIEs and their individual owners pursuant to which we received an economic interest in, and exert a controlling influence over each of the VIEs, in a manner substantially similar to a controlling equity interest.
 
 
Although we believe that our current business operations are in compliance with the current laws in China, we cannot be sure that the PRC government would view our operating arrangements to be in compliance with PRC regulations that may be adopted in the future. If we are determined not to be in compliance, the PRC government could levy fines, revoke our business and operating licenses, require us to discontinue or restrict our operations, restrict our right to collect revenues, require us to restructure our business, corporate structure or operations, impose additional conditions or requirements with which we may not be able to comply, impose restrictions on our business operations or on our customers, or take other regulatory or enforcement actions against us that could be harmful to our business. As a result, our business in the PRC could be materially adversely affected.
 
We rely on contractual arrangements with our VIEs for our operations, which may not be as effective in providing control over these entities as direct ownership.

Our operations and financial results are dependent on our VIEs in which we have no equity ownership interest and must rely on contractual arrangements to control and operate the businesses of each of our VIEs. These contractual arrangements are not as effective in providing control over the VIEs as direct ownership. For example, one of the VIEs may be unwilling or unable to perform their contractual obligations under our commercial agreements. Consequently, we would not be able to conduct our operations in the manner currently planned. In addition, any of the VIEs may seek to renew their agreements on terms that are disadvantageous to us. Although we have entered into a series of agreements that provide us with substantial ability to control the VIEs, we may not succeed in enforcing our rights under them insofar as our contractual rights and legal remedies under PRC law are inadequate. In addition, if we are unable to renew these agreements on favorable terms when these agreements expire or to enter into similar agreements with other parties, our business may not be able to operate or expand, and our operating expenses may significantly increase.
 
Our arrangements with our VIEs and their respective shareholders may be subject to a transfer pricing adjustment by the PRC tax authorities which could have an adverse effect on our income and expenses.
 
We could face material and adverse tax consequences if the PRC tax authorities determine that our contracts with our VIEs and their respective shareholders were not entered into based on arm’s length negotiations. Although our contractual arrangements are similar to other companies conducting similar operations in China, if the PRC tax authorities determine that these contracts were not entered into on an arm’s length basis, they may adjust our income and expenses for PRC tax purposes in the form of a transfer pricing adjustment. Such an adjustment may require that we pay additional PRC taxes plus applicable penalties and interest, if any.

The success of our business is dependent on our ability to retain our existing key employees and to add and retain senior officers to our management.

We depend on the services of our existing key employees, in particular, Mr. Shane McMahon, our Chairman and Chief Executive Officer, Mr. Marc Urbach, our President and Chief Financial Officer, and Mr. Weicheng Liu, a China Chief Executive Officer.  Our success will largely depend on our ability to retain these key employees and to attract and retain qualified senior and middle level managers to our management team. We have recruited executives and management in China to assist in our ability to manage the business and to recruit and oversee employees.  While we believe we offer compensation packages that are consistent with market practice, we cannot be certain that we will be able to hire and retain sufficient personnel to support our business.  In addition, severe capital constraints have limited our ability to attract specialized personnel.  Moreover, our budget limitations will restrict our ability to hire qualified personnel.  The loss of any of our key employees would significantly harm our business. We do not maintain key person life insurance on any of our employees.

We may be unable to compete successfully against new entrants and established internet industry competitors.

The Chinese market for internet content and services is intensely competitive and rapidly changing. Barriers to entry are relatively minimal, and current and new competitors can launch new websites at a relatively low cost.  Many companies offer competitive products or services including Chinese language-based Web search, retrieval and navigation services, wireless value-added services, online games and extensive Chinese language content, informational and community features and e-mail.  In addition, as a consequence of China joining the World Trade Organization, the Chinese government has partially lifted restrictions on foreign-invested enterprises so that foreign investors may hold in the aggregate up to approximately 51% of the total equity ownership in any value-added telecommunications business, including an internet business in China.
 
 
Currently, our competition comes from standard “telephone” internet providers. Any of our present or future competitors may offer products and services that provide significant performance, price, creativity or other advantages over those offered by us and, therefore, achieve greater market acceptance than ours.

Because many of our existing competitors, as well as a number of potential competitors, have longer operating histories in the internet market, greater name and brand recognition, better connections with the Chinese government, larger customer bases and databases and significantly greater financial, technical and marketing resources than we have, we cannot assure you that we will be able to compete successfully against our current or future competitors. Any increased competition could reduce page views, make it difficult for us to attract and retain users, reduce or eliminate our market share, lower our profit margins and reduce our revenues.
 
Unexpected network interruption caused by system failures may reduce user base and harm our reputation.

Both the continual and foremost accessibility of internet service websites and the performance and reliability of our technical infrastructure are critical to our reputation and the ability of our internet services to attract and retain users and advertisers. Any system failure or performance inadequacy that causes interruptions or delays in the availability of our services or increases the response time of our services could reduce user satisfaction and traffic, which would reduce the internet service appeal to users of “high speed” internet usage. As the number of users and traffic increase, we cannot assure you that we will be able to scale our systems proportionately. In addition, any system failures and electrical outages could materially and adversely impact our business.
 
Computer viruses may cause delays or interruptions on our systems and may reduce our customer base and harm our reputation.

Computer viruses may cause delays or other service interruptions on our systems. In addition, the inadvertent transmission of computer viruses could expose us to a material risk of loss or litigation and possible liability. We may be required to expend significant capital and other resources to protect our internet service against the threat of such computer viruses and to alleviate any problems. Moreover, if a computer virus affecting our system is highly publicized, our reputation could be materially damaged and customers may cancel our service.
 
If our providers of bandwidth and server custody service fail to provide these services, our business could be adversely affected.

We rely on affiliates of Jinan Parent to provide us with bandwidth and server custody service for internet users.  If Jinan Parent or their affiliates fail to provide such services or raise prices for their services, we may not be able to find a reliable and cost-effective substitute provider on a timely basis or at all. If this happens, our business could be adversely affected.

We may be unable to compete successfully against new entrants and established film and media industry competitors.

The Chinese market for film and media content and services is intensely competitive and rapidly changing. Barriers to entry may be relatively minimal, and current and new competitors may be able to provide film and media content at a lower cost.  Although the Chinese government continues to improve its efforts to enforce intellectual property protection, pirated film and media content continues to be prevalent in China, which may reduce our potential profits.  In addition, other companies offer competitive products or services including Chinese language content.

Because many of our existing competitors, as well as a number of potential competitors, have longer operating histories in the film and media market, greater name and brand recognition, better connections with the Chinese government, larger customer bases and libraries and significantly greater financial, technical and marketing resources than we have, we cannot assure you that we will be able to compete successfully against our current or future competitors. Any increased competition could reduce our subscribers, make it difficult for us to attract and retain subscribers, reduce or eliminate our market share, lower our profit margins and reduce our revenues.

Our VOD business depends on third parties to provide the programming that we offer to subscribers in China, and if we are unable to secure access to this programming, we may be unable to attract subscribers.

Our VOD business depends on third parties to provide us with programming content which we would distribute to our subscribers in China. We continue to negotiate with various U.S. entertainment studios to secure access to additional programming content, however, we may not be able to obtain access to additional programming content on favorable terms or at all.  If we are unable to successfully negotiate agreements for access to more high quality programming content, we may not be able to attract many subscribers for our service and our operating results would be negatively affected.
 
 
If we are unable to attract many subscribers for our VOD services, or are unable to successfully negotiate additional agreements with cable television providers in China to deliver our programming content, our financial performance will be adversely affected.

At present, there is a limited market for VOD services in China, and there is no guarantee that a market will develop or that we will be able to attract subscribers to purchase our services.  In addition, we rely on cable television providers to deliver our programming content to subscribers and we may not be able to negotiate additional agreements to deliver our programming content on favorable terms or at all.  If we are unable to attract many subscribers or successfully negotiate additional delivery agreements with cable television providers, our financial performance will be adversely affected.
 
We may be exposed to potential risks relating to our internal controls over financial reporting.

As directed by Section 404 of the Sarbanes-Oxley Act of 2002 “SOX 404”, the SEC adopted rules requiring public companies to include a report of management on the company’s internal controls over financial reporting in their annual reports, including Form 10-K.  Under current law, we were subject to these requirements beginning with our annual report for the fiscal year ended December 31, 2007.  Our internal control over financial reporting and our disclosure controls and procedures have been ineffective, and failure to improve them could lead to future errors in our financial statements that could require a restatement or untimely filings, which could cause investors to lose confidence in our reported financial information, and a decline in our stock price.

We are constantly striving to establish and improve our business management and internal control over financial reporting to forecast, budget and allocate our funds.  However, as a PRC company that has become a US public company, we face difficulties in hiring and retaining a sufficient number of qualified employees to achieve and maintain an effective system of internal control over financial reporting in a short period of time.

In connection with the preparation and audit of our 2012 financial statements and notes, we were informed by our auditor, UHY LLP, or UHY, of certain accounting and reporting deficiencies in our internal controls that UHY considered to be material weaknesses.  These deficiencies related to our financial reporting procedures.  We have devoted significant resources since 2010 to upgrade our internal controls.  We have placed key accounting personnel at each of our entities, engaged an outside consulting company to perform independent Sarbanes Oxley procedures and testing, and plan to continue to upgrade all internal control-related processes.

Because of the above-referenced deficiencies and weaknesses in our disclosure controls and procedures and internal control over financial reporting, we may be unable to comply with the SOX 404 internal controls requirements.  As a result of any deficiencies and weaknesses, we may experience difficulty in collecting financial data and preparing financial statements, books of account and corporate records, and instituting business practices that meet international standards, failure of which may prevent us from accurately reporting our financial results or detecting and preventing fraud.
 
RISKS RELATED TO DOING BUSINESS IN CHINA

Changes in China's political or economic situation could harm us and our operating results.

Economic reforms adopted by the Chinese government have had a positive effect on the economic development of the country, but the government could change these economic reforms or any of the legal systems at any time. This could either benefit or damage our operations and profitability. Some of the things that could have this effect are:

 
●
Level of government involvement in the economy;

 
●
Control of foreign exchange;

 
●
Methods of allocating resources;

 
●
Balance of payments position;

 
●
International trade restrictions; and
 
 
●
International conflict.

The Chinese economy differs from the economies of most countries belonging to the Organization for Economic Cooperation and Development, or OECD, in many ways. For example, state-owned enterprises still constitute a large portion of the Chinese economy, and weak corporate governance and the lack of a flexible currency exchange policy still prevail in China. As a result of these differences, we may not develop in the same way or at the same rate as might be expected if the Chinese economy was similar to those of the OECD member countries.

Increased government regulation of the telecommunications and internet industries in China may result in the Chinese government requiring us to obtain additional licenses or other governmental approvals to conduct our business which, if unattainable, may restrict our operations.

The telecommunications industry is highly regulated by the Chinese government, the main relevant government authority being the MII. Prior to China’s entry into the World Trade Organization, the Chinese government generally prohibited foreign investors from taking any equity ownership in or operating any telecommunications business.  Internet Content Provider, or ICP, services are classified as telecommunications value-added services and therefore fall within the scope of this prohibition. This prohibition was partially lifted following China’s entry into the World Trade Organization, allowing foreign investors to own interests in Chinese businesses. In addition, foreign and foreign invested enterprises are currently not able to apply for the required licenses for operating cable broadband services in China.
 
We cannot be certain that we will be granted any of the appropriate licenses, permits or clearance that we may need in the future. Moreover, we cannot be certain that any local or national ICP or telecommunications license requirements will not conflict with one another or that any given license will be deemed sufficient by the relevant governmental authorities for the provision of our services.
 
We rely exclusively on contractual arrangements with Jinan Parent and its approvals to operate as an ICP. We believe that our present operations are structured to comply with applicable Chinese law. However, many Chinese regulations are subject to extensive interpretive powers of governmental agencies and commissions. We cannot be certain that the Chinese government will not take action to prohibit or restrict our business activities. We are uncertain as to whether the Chinese government will reclassify our business as a media or retail company, due to our acceptance of fees for internet advertising, online games and wireless value-added and other services as sources of revenues, or as a result of our current corporate structure. Such reclassification could subject us to penalties, fines or significant restrictions on our business. Future changes in Chinese government policies affecting the provision of information services, including the provision of online services, internet access, e-commerce services and online advertising, may impose additional regulatory requirements on us or our service providers or otherwise harm our business.

Uncertainties with respect to the PRC legal system could limit the legal protections available to you and us.

We conduct substantially all of our business through our subsidiaries in the PRC. Our subsidiaries are generally subject to laws and regulations applicable to foreign investments in China and, in particular, laws applicable to foreign-invested enterprises. The PRC legal system is based on written statutes, and prior court decisions may be cited for reference but have limited precedential value. Since 1979, a series of new PRC laws and regulations have significantly enhanced the protections afforded to various forms of foreign investments in China. However, since the PRC legal system continues to evolve rapidly, the interpretations of many laws, regulations, and rules are not always uniform, and enforcement of these laws, regulations, and rules involve uncertainties, which may limit legal protections available to you and us. In addition, any litigation in China may be protracted and result in substantial costs and diversion of resources and management attention. In addition, all of our executive officers and all of our Directors are residents of China and not of the United States, and substantially all the assets of these persons are located outside the United States. As a result, it could be difficult for investors to affect service of process in the United States or to enforce a judgment obtained in the United States against our Chinese operations and subsidiaries.
 
 
You may have difficulty enforcing judgments against us.

Most of our assets are located outside of the United States and most of our current operations are conducted in the PRC. In addition, some of our Directors and officers are nationals and residents of countries other than the United States. A substantial portion of the assets of these persons is located outside the United States. As a result, it may be difficult for you to effect service of process within the United States upon these persons. It may also be difficult for you to enforce in U.S. courts judgments on the civil liability provisions of the U.S. federal securities laws against us and our officers and Directors that are not residents in the United States and the substantial majority of whose assets are located outside of the United States. In addition, there is uncertainty as to whether the courts of the PRC would recognize or enforce judgments of U.S. courts. Our counsel as to PRC law has advised us that the recognition and enforcement of foreign judgments are provided for under the PRC Civil Procedures Law. Courts in China may recognize and enforce foreign judgments in accordance with the requirements of the PRC Civil Procedures Law based on treaties between China and the country where the judgment is made or on reciprocity between jurisdictions. China does not have any treaties or other arrangements that provide for the reciprocal recognition and enforcement of foreign judgments with the United States. In addition, according to the PRC Civil Procedures Law, courts in the PRC will not enforce a foreign judgment against us or our Directors and officers if they decide that the judgment violates basic principles of PRC law or national sovereignty, security, or the public interest. So it is uncertain whether a PRC court would enforce a judgment rendered by a court in the United States.
 
The PRC government exerts substantial influence over the manner in which we must conduct our business activities.

The PRC government has exercised and continues to exercise substantial control over virtually every sector of the Chinese economy through regulation and state ownership. Our ability to operate in China may be harmed by changes in its laws and regulations, including those relating to taxation, import and export tariffs, environmental regulations, land use rights, property, and other matters. We believe that our operations in China are in material compliance with all applicable legal and regulatory requirements. However, the central or local governments of the jurisdictions in which we operate may impose new, stricter regulations or interpretations of existing regulations that would require additional expenditures and efforts on our part to ensure our compliance with such regulations or interpretations.

Accordingly, government actions in the future, including any decision not to continue to support recent economic reforms and to return to a more centrally planned economy or regional or local variations in the implementation of economic policies, could have a significant effect on economic conditions in China or particular regions thereof and could require us to divest ourselves of any interest we then hold in Chinese properties or joint ventures.

Future inflation in China may inhibit our ability to conduct business in China.

In recent years, the Chinese economy has experienced periods of rapid expansion and highly fluctuating rates of inflation. During the past ten years, the rate of inflation in China has been as high as 8.7% and as low as -1.8%. These factors have led to the adoption by the Chinese government, from time to time, of various corrective measures designed to restrict the availability of credit or regulate growth and contain inflation. High inflation may in the future cause the Chinese government to impose controls on credit and/or prices, or to take other action, which could inhibit economic activity in China, and thereby harm the market for our products and our company.

Restrictions on currency exchange may limit our ability to receive and use our sales effectively.

The majority of our revenues will be settled in RMB and U.S. dollars, and any future restrictions on currency exchanges may limit our ability to use revenue generated in RMB to fund any future business activities outside China or to make dividend or other payments in U.S. dollars. Although the Chinese government introduced regulations in 1996 to allow greater convertibility of the RMB for current account transactions, significant restrictions still remain, including primarily the restriction that foreign-invested enterprises may only buy, sell or remit foreign currencies after providing valid commercial documents, at those banks in China authorized to conduct foreign exchange business. In addition, conversion of RMB for capital account items, including direct investment and loans, is subject to governmental approval in China, and companies are required to open and maintain separate foreign exchange accounts for capital account items. We cannot be certain that the Chinese regulatory authorities will not impose more stringent restrictions on the convertibility of the RMB.
 
 
Fluctuations in exchange rates could adversely affect our business and the value of our securities.
 
The value of our common stock will be indirectly affected by the foreign exchange rate between the U.S. dollar and RMB and between those currencies and other currencies in which our revenues may be denominated. Appreciation or depreciation in the value of the RMB relative to the U.S. dollar would affect our financial results reported in U.S. dollar terms without giving effect to any underlying change in our business or results of operations. Fluctuations in the exchange rate will also affect the relative value of any dividend we issue that will be exchanged into U.S. dollars, as well as earnings from, and the value of, any U.S. dollar-denominated investments we make in the future.
 
Since July 2005, the RMB has no longer been pegged to the U.S. dollar. Although the People’s Bank of China regularly intervenes in the foreign exchange market to prevent significant short-term fluctuations in the exchange rate, the RMB may appreciate or depreciate significantly in value against the U.S. dollar in the medium to long term. Moreover, it is possible that in the future PRC authorities may lift restrictions on fluctuations in the RMB exchange rate and lessen intervention in the foreign exchange market.

Very limited hedging transactions are available in China to reduce our exposure to exchange rate fluctuations. To date, we have not entered into any hedging transactions. While we may enter into hedging transactions in the future, the availability and effectiveness of these transactions may be limited, and we may not be able to successfully hedge our exposure at all. In addition, our foreign currency exchange losses may be magnified by PRC exchange control regulations that restrict our ability to convert RMB into foreign currencies.
 
Restrictions under PRC law on our PRC VIEs’ ability to make dividends and other distributions could materially and adversely affect our ability to grow, make investments or acquisitions that could benefit our business, pay dividends to you, and otherwise fund and conduct our business.

Substantially all of our revenues are earned by our PRC VIEs. However, PRC regulations restrict the ability of our PRC VIEs to make dividends and other payments to its offshore parent company. PRC legal restrictions permit payments of dividends by our PRC VIEs only out of their accumulated after-tax profits, if any, determined in accordance with PRC accounting standards and regulations. Our PRC VIEs are also required under PRC laws and regulations to allocate at least 10% of their annual after-tax profits determined in accordance with PRC generally accepted accounting principles to a statutory general reserve fund until the amounts in said fund reaches 50% of our registered capital. Allocations to these statutory reserve funds can only be used for specific purposes and are not transferable to us in the form of loans, advances, or cash dividends. Any limitations on the ability of our PRC VIEs to transfer funds to us could materially and adversely limit our ability to grow, make investments or acquisitions that could be beneficial to our business, pay dividends and otherwise fund and conduct our business.

Because Our Assets Are Located In China, Any Dividends Of Proceeds From Liquidation Is Subject To The Approval Of The Relevant Chinese Government Agencies.

Our assets are located inside China. Under the laws governing foreign invested enterprises in China, dividends of proceeds from liquidation are allowed but subject to special procedures under the relevant laws and rules. Any dividend of proceeds from liquidation is subject to both the relevant government agency’s approval and supervision as well as the foreign exchange control. This may generate additional risk for our investors in case of liquidation.

Failure to comply with PRC regulations relating to the establishment of offshore special purpose companies by PRC residents may subject our PRC resident stockholders to personal liability, limit our ability to acquire PRC companies or to inject capital into PRC subsidiaries, limit our PRC subsidiary's ability to distribute profits to us or otherwise materially adversely affect us.

In October 2005, the PRC State Administration of Foreign Exchange, or SAFE, issued the Notice on Relevant Issues in the Foreign Exchange Control over Financing and Return Investment Through Special Purpose Companies by Residents Inside China, generally referred to as Circular 75, which required PRC residents to register with the competent local SAFE branch before establishing or acquiring control over an offshore special purpose company, or SPV, for the purpose of engaging in an equity financing outside of China on the strength of domestic PRC assets originally held by those residents. Internal implementing guidelines issued by SAFE, which became public in June 2007 (known as Notice 106), expanded the reach of Circular 75 by (1) purporting to cover the establishment or acquisition of control by PRC residents of offshore entities which merely acquire “control” over domestic companies or assets, even in the absence of legal ownership; (2) adding requirements relating to the source of the PRC resident’s funds used to establish or acquire the offshore entity; (3) covering the use of existing offshore entities for offshore financings; (4) purporting to cover situations in which an offshore SPV establishes a new subsidiary in China or acquires an unrelated company or unrelated assets in China; and (5) making the domestic affiliate of the SPV responsible for the accuracy of certain documents which must be filed in connection with any such registration, notably, the business plan which describes the overseas financing and the use of proceeds. Amendments to registrations made under Circular 75 are required in connection with any increase or decrease of capital, transfer of shares, mergers and acquisitions, equity investment or creation of any security interest in any assets located in China to guarantee offshore obligations, and Notice 106 makes the offshore SPV jointly responsible for these filings. In the case of an SPV which was established, and which acquired a related domestic company or assets, before the implementation date of Circular 75, a retroactive SAFE registration was required to have been completed before March 31, 2006. This date was subsequently extended indefinitely by Notice 106, which also required that the registrant establish that all foreign exchange transactions undertaken by the SPV and its affiliates were in compliance with applicable laws and regulations. Failure to comply with the requirements of Circular 75, as applied by SAFE in accordance with Notice 106, may result in fines and other penalties under PRC laws for evasion of applicable foreign exchange restrictions. Any such failure could also result in the SPV’s affiliates being impeded or prevented from distributing their profits and the proceeds from any reduction in capital, share transfer or liquidation to the SPV, or from engaging in other transfers of funds into or out of China.
 

We have asked our stockholders who are PRC residents, as defined in Circular 75, to register with the relevant branch of SAFE as currently required in connection with their equity interests in us and our acquisitions of equity interests in our PRC subsidiary. However, we cannot provide any assurances that they can obtain the above SAFE registrations required by Circular 75 and Notice 106. Moreover, because of uncertainty over how Circular 75 will be interpreted and implemented, and how or whether SAFE will apply it to us, we cannot predict how it will affect our business operations or future strategies. For example, our present and prospective PRC subsidiaries' ability to conduct foreign exchange activities, such as the remittance of dividends and foreign currency-denominated borrowings, may be subject to compliance with Circular 75 and Notice 106 by our PRC resident beneficial holders.
 
In addition, such PRC residents may not always be able to complete the necessary registration procedures required by Circular 75 and Notice 106. We also have little control over either our present or prospective direct or indirect stockholders or the outcome of such registration procedures. A failure by our PRC resident beneficial holders or future PRC resident stockholders to comply with Circular 75 and Notice 106, if SAFE requires it, could subject these PRC resident beneficial holders to fines or legal sanctions, restrict our overseas or cross-border investment activities, limit our subsidiaries' ability to make distributions or pay dividends or affect our ownership structure, which could adversely affect our business and prospects.

The implementation of the new PRC employment contract law and increases in the labor costs in China may hurt our business and profitability.

We are primarily a service provider. A new employment contract law became effective on January 1, 2008 in China. It imposes more stringent requirements on employers in relation to entry into fixed-term employment contracts, recruitment of temporary employees and dismissal of employees. In addition, under the newly promulgated Regulations on Paid Annual Leave for Employees, which also became effective on January 1, 2008, employees who have worked continuously for more than one year are entitled to paid vacation ranging from 5 to 15 days, depending on the length of the employee’s service. Employees who waive such vacation entitlements at the request of the employer will be compensated for three times their normal daily salaries for each vacation day so waived. As a result of the new law and regulations, our labor costs may increase. There is no assurance that disputes, work stoppages or strikes will not arise in the future. Increases in the labor costs or future disputes with our employees could damage our business, financial condition or operating results.

Under the New Enterprise Income Tax Law, we may be classified as a “resident enterprise” of China. Such classification will likely result in unfavorable tax consequences to us and our non-PRC stockholders.

China passed a new Enterprise Income Tax Law, or the EIT Law, and its implementing rules, both of which became effective on January 1, 2008. Under the EIT Law, an enterprise established outside of China with “de facto management bodies” within China is considered a “resident enterprise,” meaning that it can be treated in a manner similar to a Chinese enterprise for enterprise income tax purposes. The implementing rules of the EIT Law define de facto management as “substantial and overall management and control over the production and operations, personnel, accounting, and properties” of the enterprise.

On April 22, 2009, the State Administration of Taxation issued the Notice Concerning Relevant Issues Regarding Cognizance of Chinese Investment Controlled Enterprises Incorporated Offshore as Resident Enterprises pursuant to Criteria of de facto Management Bodies, or the Notice, further interpreting the application of the EIT Law and its implementation against non-Chinese enterprise or group controlled offshore entities. Pursuant to the Notice, an enterprise incorporated in an offshore jurisdiction and controlled by a Chinese enterprise or group will be classified as a “domestically incorporated resident enterprise” if (i) its senior management in charge of daily operations reside or perform their duties mainly in China; (ii) its financial or personnel decisions are made or approved by bodies or persons in China; (iii) its substantial assets and properties, accounting books, corporate chops, Board and shareholder minutes are kept in China; and (iv) at least half of its Directors with voting rights or senior management often resident in China. A resident enterprise would be subject to an enterprise income tax rate of 25% on its worldwide income and its non-PRC stockholders would be subject to a withholding tax at a rate of 10% when dividends are paid to such non-PRC stockholders. However, it remains unclear as to whether the Notice is applicable to an offshore enterprise incorporated by a Chinese natural person. Nor are detailed measures on enforcement of PRC tax against non-domestically incorporated resident enterprises are available. Therefore, it is unclear how tax authorities will determine tax residency based on the facts of each case.
 
 
We may be deemed to be a resident enterprise by Chinese tax authorities. If the PRC tax authorities determine that we are a “resident enterprise” for PRC enterprise income tax purposes, a number of unfavorable PRC tax consequences could follow. First, we may be subject to the enterprise income tax at a rate of 25% on our worldwide taxable income as well as PRC enterprise income tax reporting obligations. In our case, this would mean that income such as interest on financing proceeds and non-China source income would be subject to PRC enterprise income tax at a rate of 25%. Second, although under the EIT Law and its implementing rules dividends paid to us from our PRC subsidiary would qualify as “tax-exempt income,” we cannot guarantee that such dividends will not be subject to a 10% withholding tax, as the PRC foreign exchange control authorities, which enforce the withholding tax, have not yet issued guidance with respect to the processing of outbound remittances to entities that are treated as resident enterprises for PRC enterprise income tax purposes. Finally, it is possible that future guidance issued with respect to the new “resident enterprise” classification could result in a situation in which a 10% withholding tax is imposed on dividends we pay to our non-PRC stockholders and with respect to gains derived by our non-PRC stockholders from transferring our shares. We are actively monitoring the possibility of “resident enterprise” treatment for the 2010 tax year and are evaluating appropriate organizational changes to avoid this treatment, to the extent possible.
 
If we were treated as a “resident enterprise” by PRC tax authorities, we would be subject to taxation in both the U.S. and China, and our PRC tax may not be creditable against our U.S. tax.

We May Be Classified As A Passive Foreign Investment Company, Which Could Result In Adverse U.S. Tax Consequences To U.S. Investors.

We are a U.S. corporation which indirectly owns more than a 50% interest in certain Chinese operating companies, and also owns 50% or less of certain other Chinese operating companies.  The Chinese subsidiaries in which we own more than a 50% interest are classified as Controlled Foreign Corporations (“CFC”) for U.S. tax purposes.  Under the CFC tax rules, if a Chinese subsidiary’s income is considered to be foreign personal holding company or foreign sales or services income, such income could be subject to U.S. taxation whether or not distributed to us under the current U.S. tax rules.
 
On the other hand, the Chinese subsidiaries in which we own 50% or less, might be classified as a Passive Foreign Investment Company (“PFIC”) by the United States Internal Revenue Service.  This characterization could result in adverse U.S. tax consequences to us.  For example, if our Chinese subsidiary is a PFIC, we might become subject to increased U.S. tax liabilities and will also become subject to additional reporting requirements. The determination of whether or not the subsidiary is a PFIC is made on an annual basis, and those determinations depend on the composition of its income and assets.  We intend to operate our business so as to minimize the risk of PFIC treatment.  However, you should be aware that certain factors that could affect classification as PFIC are outside of our control.  In the event our Chinese subsidiaries are determined to be a PFIC, our stock may become less attractive to U.S. investors, which may negatively impact the price of our common stock.

We face uncertainty from China’s Circular on Strengthening the Administration of Enterprise Income Tax on Non-Resident Enterprises' Share Transfer, or Circular 698, that was released in December 2009 with retroactive effect from January 1, 2008.

The Chinese State Administration of Taxation released a circular on December 15, 2009 that addresses the transfer of shares by nonresident companies, generally referred to as Circular 698. Circular 698, which is effective retroactively to January 1, 2008, may have a significant impact on many companies that use offshore holding companies to invest in China. Circular 698, which provides parties with a short period of time to comply with its requirements, indirectly taxes foreign companies on gains derived from the indirect sale of a Chinese company. Where a foreign investor indirectly transfers equity interests in a Chinese resident enterprise by selling the shares in an offshore holding company, and the latter is located in a country or jurisdiction where the effective tax burden is less than 12.5% or where the offshore income of his, her, or its residents is not taxable, the foreign investor is required to provide the tax authority in charge of that Chinese resident enterprise with the relevant information within 30 days of the transfers. Moreover, where a foreign investor indirectly transfers equity interests in a Chinese resident enterprise through an abuse of form of organization and there are no reasonable commercial purposes such that the corporate income tax liability is avoided, the PRC tax authority will have the power to re-assess the nature of the equity transfer in accordance with PRC’s “substance-over-form” principle and deny the existence of the offshore holding company that is used for tax planning purposes. There is uncertainty as to the application of Circular 698. For example, while the term "indirectly transfer" is not defined, it is understood that the relevant PRC tax authorities have jurisdiction regarding requests for information over a wide range of foreign entities having no direct contact with China. It is also unclear, in the event that an offshore holding company is treated as a domestically incorporated resident enterprise, whether Circular 698 would still be applicable to transfer of shares in such offshore holding company. Moreover, the relevant authority has not yet promulgated any formal provisions or formally declared or stated how to calculate the effective tax in the country or jurisdiction and to what extent and the process of the disclosure to the tax authority in charge of that Chinese resident enterprise. In addition, there are not any formal declarations with regard to how to decide “abuse of form of organization” and “reasonable commercial purpose,” which can be utilized by us to balance if our Company complies with the Circular 698. If Circular 698 is determined to be applicable to us based on the facts and circumstances around such share transfers, we may become at risk of being taxed under Circular 698 and we may be required to expend valuable resources to comply with Circular 698 or to establish that we should not be taxed under Circular 698, which could have a material adverse effect on our financial condition and results of operations.
 
 
We may be exposed to liabilities under the Foreign Corrupt Practices Act and Chinese anti-corruption laws, and any determination that we violated these laws could have a material adverse effect on our business.
 
We are subject to the Foreign Corrupt Practice Act, or FCPA, and other laws that prohibit improper payments or offers of payments to foreign governments and their officials and political parties by U.S. persons and issuers as defined by the statute, for the purpose of obtaining or retaining business. We have operations, agreements with third parties, and make most of our sales in China. The PRC also strictly prohibits bribery of government officials. Our activities in China create the risk of unauthorized payments or offers of payments by the employees, consultants, sales agents, or distributors of our Company, even though they may not always be subject to our control. It is our policy to implement safeguards to discourage these practices by our employees. However, our existing safeguards and any future improvements may prove to be less than effective, and the employees, consultants, sales agents, or distributors of our Company may engage in conduct for which we might be held responsible. Violations of the FCPA or Chinese anti-corruption laws may result in severe criminal or civil sanctions, and we may be subject to other liabilities, which could negatively affect our business, operating results and financial condition. In addition, the U.S. government may seek to hold our Company liable for successor liability FCPA violations committed by companies in which we invest or that we acquire.
 
RISKS RELATED TO THE MARKET FOR OUR STOCK

The market price of our common stock is volatile, leading to the possibility of its value being depressed at a time when you may want to sell your holdings.
 
The market price of our common stock is volatile, and this volatility may continue.  Numerous factors, many of which are beyond our control, may cause the market price of our common stock to fluctuate significantly.  In addition to market and industry factors, the price and trading volume for our common stock may be highly volatile for specific business reasons.  Factors such as variations in our revenues, earnings and cash flow, announcements of new investments, cooperation arrangements or acquisitions, and fluctuations in market prices for our products could cause the market price for our shares to change substantially.

Securities class action litigation is often instituted against companies following periods of volatility in their stock price.  This type of litigation could result in substantial costs to us and divert our management’s attention and resources.

Moreover, the trading market for our common stock will be influenced by research or reports that industry or securities analysts publish about us or our business.  If one or more analysts who cover us downgrade our common stock, the market price for our common stock would likely decline.  If one or more of these analysts cease coverage of us or fail to regularly publish reports on us, we could lose visibility in the financial markets, which, in turn, could cause the market price for our common stock or trading volume to decline.

Furthermore, securities markets may from time to time experience significant price and volume fluctuations for reasons unrelated to operating performance of particular companies.  These market fluctuations may adversely affect the price of our common stock and other interests in our company at a time when you want to sell your interest in us.
 
 
Although publicly traded, the trading market in our common stock has been substantially less liquid than the average trading market for a stock quoted on the NASDAQ Global Market and this low trading volume may adversely affect the price of our common stock.
 
Our common stock trades on the NASDAQ Capital Market.  The trading market in our common stock has been substantially less liquid than the average trading market for companies quoted on the NASDAQ Capital Market.    Limited trading volume will subject our shares of common stock to greater price volatility and may make it difficult for you to sell your shares of common stock at a price that is attractive to you.
 
Provisions in our articles of incorporation and bylaws or Nevada law might discourage, delay or prevent a change of control of us or changes in our management and, therefore depress the trading price of the common stock.

Our articles of incorporation authorize our Board of Directors to issue up to 50,000,000 shares of preferred stock. The preferred stock may be issued in one or more series, the terms of which may be determined at the time of issuance by the Board of Directors without further action by the stockholders. These terms may include preferences as to dividends and liquidation, conversion rights, redemption rights and sinking fund provisions. The issuance of any preferred stock could diminish the rights of holders of our common stock, and therefore could reduce the value of such common stock. In addition, specific rights granted to future holders of preferred stock could be used to restrict our ability to merge with, or sell assets to, a third party. The ability of our Board of Directors to issue preferred stock could make it more difficult, delay, discourage, prevent or make it more costly to acquire or effect a change-in-control, which in turn could prevent our stockholders from recognizing a gain in the event that a favorable offer is extended and could materially and negatively affect the market price of our common stock.
 
In addition, Nevada corporate law and our articles of incorporation and bylaws contain certain other provisions that could discourage, delay or prevent a change in control of our Company or changes in its management that our stockholders may deem advantageous.  These provisions:

 
●
deny holders of our common stock cumulative voting rights in the election of Directors, meaning that stockholders owning a majority of our outstanding shares of common stock will be able to elect all of our Directors;

 
●
require any stockholder wishing to properly bring a matter before a meeting of stockholders to comply with specified procedural and advance notice requirements; and

 
●
allow any vacancy on the Board of Directors, however the vacancy occurs, to be filled by the Directors.
 
Certain of our stockholders hold a significant percentage of our outstanding voting securities.

Mr. Shane McMahon, our Chairman and Chief Executive Officer, is the beneficial owner of approximately 49.0% of our outstanding voting securities, and Mr. Weicheng Liu, our China Chief Executive Officer,  is the beneficial owner of approximately 8.8% of our outstanding voting securities (as calculated in accordance with Rule 13d-3(d)(1) of the Exchange Act). As a result, each possesses significant influence and can elect a majority of our Board of Directors and authorize or prevent proposed significant corporate transactions. Their respective ownership and control may also have the effect of delaying or preventing a future change in control, impeding a merger, consolidation, takeover or other business combination or discourage a potential acquirer from making a tender offer.

We do not intend to pay dividends for the foreseeable future.

For the foreseeable future, we intend to retain any earnings to finance the development and expansion of our business, and we do not anticipate paying any cash dividends on our common stock. Accordingly, investors must be prepared to rely on sales of their common stock after price appreciation to earn an investment return, which may never occur. Investors seeking cash dividends should not purchase our common stock. Any determination to pay dividends in the future will be made at the discretion of our Board of Directors and will depend on our results of operations, financial condition, contractual restrictions, restrictions imposed by applicable law and other factors our Board deems relevant.

 
Not Applicable.
 
 
ITEM 2.
 
Our principal executive offices are located at 27 Union Square West, Suite 502, New York, New York 10003.  We do not currently have a lease agreement for the use of this office space and currently pay $10,000 per month for the use of this space.

The principal address of Zhong Hai Video is Suite 2603-2607, Building AB, Office Park, 10 Jintong West Road, Chaoyang District, Beijing 100020 China.  We paid approximately $305,000 for rent in 2012.

The principal address of Jinan Broadband is c/o Jinan Guangdian Jiahe Digital TV Co. Ltd., No. 32, Jing Shi Yi Road, Jinan Shandong 250014, Tel: (86531)-85652255.  We paid approximately $90,000 for rent in 2012.
 
We believe that all our properties have been adequately maintained, are generally in good condition, and are suitable and adequate for our business.


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.  We are currently not aware of any such legal proceedings or claims that we believe will have a material adverse effect on our business, financial condition or operating results.


Not applicable.
 
PART II

 
Market Information

Our common stock is quoted under the symbol “YOD” on the Nasdaq Capital Markets.  Our stock was previously listed as “CBBD” on the OTCBB.  As of May 30, 2012 our stock was listed on the Nasdaq Capital Market under the symbol “YOD”.  Trading of our common stock is sometimes limited and sporadic.  The following table sets forth, for the periods indicated, the high and low closing prices of our common stock.  These prices were adjusted for the 75-for-1 reverse stock split that occurred on February 9, 2012 and reflect inter-dealer prices, without retail mark-up, mark-down or commission, and may not represent actual transactions.
 
 
 
Closing Bid Prices(1)
 
 
 
High
 
 
Low
 
Year Ended December 31, 2012
 
 
 
 
 
 
1st Quarter
 
$
7.05
  
 
$
3.90
 
2nd Quarter
 
 
5.49
 
 
 
4.25
 
3rd Quarter
 
 
4.99
 
 
 
3.07
 
4th Quarter
 
 
3.50
 
 
 
1.46
 
 
 
 
 
 
 
 
 
 
Year Ended December 31, 2011
 
 
 
 
 
 
 
 
1st Quarter
 
$
6.60
 
 
$
3.01
 
2nd Quarter
 
 
9.00
 
 
 
3.53
 
3rd Quarter
 
 
8.70
 
 
 
3.75
 
4th Quarter
 
 
5.16
 
 
 
3.38
 
 
(1) The above table sets forth the range of high and low closing bid prices per share of our common stock as reported by Bloomberg for the periods indicated, and adjusted for the reverse stock split that occurred on February 9, 2012.
 
 
Approximate Number of Holders of Our Common Stock

As of March 30, 2013, there were approximately 350 holders of record of our common stock.  This number excludes the shares of our common stock beneficially owned by stockholders holding stock in securities trading accounts through DTC, or under nominee security position listings.

Dividends

We have never declared or paid a cash dividend.  Any future decisions regarding dividends will be made by our Board of Directors.  We currently intend to retain and use any future earnings for the development and expansion of our business and do not anticipate paying any cash dividends in the foreseeable future.  Our Board of Directors has complete discretion on whether to pay dividends, subject to the approval of our stockholders.  Even if our Board of Directors decides to pay dividends, the form, frequency and amount will depend upon our future operations and earnings, capital requirements and surplus, general financial condition, contractual restrictions and other factors that the Board of Directors may deem relevant. In addition, our ability to declare and pay dividends is dependent on our ability to declare dividends and profits in our PRC subsidiaries.  PRC rules greatly restrict and limit the ability of our subsidiaries to declare dividends to our parent which, in addition to restricting our cash flow, limits our ability to pay dividends.

Securities Authorized for Issuance Under Equity Compensation Plans

See Item 12, “Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters — Securities Authorized for Issuance Under Equity Compensation Plans.”

Recent Sales of Unregistered Securities

We did not sell any equity securities during the fiscal year ended December 31, 2012 that were not previously disclosed in a quarterly report on Form 10-Q or a current report on Form 8-K that was filed during the 2012 fiscal year.

Purchases of Equity Securities

No repurchases of our common stock were made during the fourth quarter of 2012.
 
 
Not Applicable.


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 “Special Note Regarding Forward Looking Statements” above for certain information concerning those forward looking statements.

Overview

We operate in the Chinese media segment, through our Chinese subsidiaries and VIEs, (1) a business which provides integrated value-added service solutions for the delivery of VOD and enhanced premium content for cable providers and (2) a cable broadband business based in the Jinan region of China.

Through our VIE, Sinotop, and it’s 80% owned operating joint venture Zhong Hai Video, we provide integrated value-added service solutions for the delivery of  VOD, and enhanced premium content for cable providers. Zhong Hai Video's revenue will be derived primarily from a VOD model, consisting of a fee to view movies, popular titles and live events.  At year end our VOD product was implemented on a limited basis for testing.  Our full product launch occurred in conjunction with the Chinese New Year during our first quarter of 2013.  Full roll out of our video on demand products began in the first quarter of 2013.
 
 
Through our VIE, Jinan Broadband, we provide cable and wireless broadband services, principally internet services, Internet Protocol Point wholesale services, related network equipment rental and sales, and fiber network construction and maintenance. Jinan Broadband’s revenue consists primarily of sales to our PRC-based internet consumers, cable modem consumers, business customers and other internet and cable services.

Through Shandong Media, we operate our publishing business, which includes the distribution of periodicals, the publication of advertising, the organization of public relations events, the provision of information related services, copyright transactions, the production of audio and video products, and the provision of audio value added communication services. Shandong Media's revenue consists primarily of sales of publications and advertising revenues. The Company has deconsolidated the net assets of Shandong Media as of July 1, 2012 and accounts for the remaining 30% interest in Shandong Media by the equity method.

Principal Factors Affecting Our Financial Performance

Our operating results are primarily affected by the following factors:

 
·
Growth in the Chinese Economy. We operate in China and derive all of our revenues from sales to customers in China. Economic conditions in China, therefore, affect virtually all aspects of our operations, including the demand for our products, the availability and prices of our supplies and our other expenses. China has experienced significant economic growth, achieving an average annual growth rate of approximately 10% in gross domestic product from 1996 through 2011. China is expected to experience continued growth in all areas of investment and consumption, even in the face of a global economic recession. However, China has not been entirely immune to the global economic slowdown and is experiencing a slowing of its growth rate.

 
·
PRC Economic Stimulus Plans. The PRC government has issued a policy entitled “Central Government Policy On Stimulating Domestic Consumption To Counter The Damage Result From Export Business Of The Country,” pursuant to which the PRC Central Government is dedicating approximately $580 billion to stimulate domestic consumption. Companies that are either directly or indirectly related to construction, and to the manufacture and sale of building materials, electrical household appliances and telecommunication equipment, are expected to benefit. We could potentially benefit if the stimulus plan injects funds into cable infrastructure allowing access to our PPV network.

 
·
Deployment of Value-added Services. To augment our product offerings and create other revenue sources, we work with strategic partners to deploy value-added services to our cable customers. Value-added services, including but not limited to the synergies created by the additions of our new assets, will become a focus of revenue generation for our company. No assurance can be made that we will add other value-added services, or if added, that they will succeed.

Taxation

United States

YOU On Demand Holdings, Inc. is subject to United States tax at a tax rate of 34%. No provision for income taxes in the United States has been made as YOU On Demand Holdings, Inc. had no income taxable in the United States.

Cayman Islands

CB Cayman was incorporated in the Cayman Islands. Under the current law of the Cayman Islands, it is not subject to income or capital gains tax. In addition, dividend payments are not subject to withholding tax in the Cayman Islands.

Hong Kong

Our subsidiary, Sinotop Hong Kong, was incorporated in Hong Kong and under the current laws of Hong Kong, is subject to Profits Tax of 16.5%. No provision for Hong Kong Profits Tax has been made as Sinotop Hong Kong has no taxable income.

The People’s Republic of China

Under the EIT Law, our Chinese subsidiaries and VIEs are subject to an earned income tax of 25.0%.
 
 
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 legal developments to determine if there will be any change in the statutory income tax rate.

Consolidated Results of Operations

Comparison of Years Ended December 31, 2012 and 2011

In order to provide a more meaningful comparison of our financial results, our presentation of the Company’s Consolidated Results of Operations utilizes Pro Forma 2012 and 2011 financial information to exclude the impact of Shandong Media which was deconsolidated effective July 1, 2012 (See Note 11 to the audited financial statements included in this report for more information regarding the Deconsolidation of Shandong Media).
 

   
Pro Forma Comparisons
  
   
Year Ended
  
   
As Reported
    
Shandong Media
    
Pro Forma
  
   
December 31,
    
6 months
    
December 31,
  
   
2012
          
2012
  
               
(excluding
Shandong Media)
  
                   
Revenue
   $ 6,873,000     $ 1,696,000     $ 5,177,000  
Cost of revenue
     7,083,000       1,229,000       5,854,000  
Gross profit (loss)
     (210,000 )     467,000       (677,000 )
                         
Operating expense:
                        
Selling, general and administrative expenses
     10,811,000       717,000       10,094,000  
Professional fees
     1,345,000       -       1,345,000  
Depreciation and amortization
     4,083,000       58,000       4,025,000  
Impairments of long-lived assets
     840,000       -       840,000  
Total operating expense
     17,079,000       775,000       16,304,000  
                         
Loss from operations
     (17,289,000 )     (308,000 )     (16,981,000 )
                         
Interest & other income / (expense)
                        
Interest income
     9,000       -       9,000  
Interest expense
     (79,000 )     -       (79,000 )
Right to purchase expense
     (44,000 )     -       (44,000 )
Cost of reset provision
     (659,000 )     -       (659,000 )
Change in fair value of warrant liabilities
     647,000       -       647,000  
Change in fair value of contingent consideration
     1,313,000       -       1,313,000  
Gain on investment in unconsolidated entities
     68,000       -       68,000  
Loss on investment write-off
     (95,000 )     -       (95,000 )
Loss on write-off of uncollectible loans
     (514,000 )     (473,000 )     (41,000 )
Gain on deconsolidation of Shandong Media
     142,000       -       142,000  
Other
     (140,000 )     -       (140,000 )
                         
Loss before income taxes and noncontrolling interests
     (16,641,000 )     (781,000 )     (15,860,000 )
                         
Income tax benefit
     353,000       9,000       344,000  
                         
Net loss
     (16,288,000 )     (772,000 )     (15,516,000 )
                         
Net loss attributable to noncontrolling interests
     2,074,000       386,000       1,688,000  
                         
Net loss attributable to YOU On Demand shareholders
   $ (14,214,000 )   $ (386,000 )   $ (13,828,000 )
                         
Deemed dividends on preferred stock
     (924,000 )     -       (924,000 )
                         
Net loss attributable to YOU on Demand common shareholders
   $ (15,138,000 )   $ (386,000 )   $ (14,752,000 )
 
 
   
Pro Forma Comparisons
  
   
Year Ended
  
   
As Reported
    
Shandong Media
    
Pro Forma
  
   
December 31,
    
12 months
    
December 31,
  
   
2011
          
2011
  
               
(excluding 
Shandong Media)
  
                   
Revenue
   $ 7,868,000     $ 2,993,000     $ 4,875,000  
Cost of revenue
     5,526,000       2,159,000       3,367,000  
Gross profit
     2,342,000       834,000       1,508,000  
                         
Operating expense:
                        
Selling, general and administrative expenses
     8,801,000       1,306,000       7,495,000  
Professional fees
     2,115,000       5,000       2,110,000  
Depreciation and amortization
     4,424,000       110,000       4,314,000  
Impairments of long-lived assets
     244,000       -       244,000  
Total operating expense
     15,584,000       1,421,000       14,163,000  
                         
Loss from operations
     (13,242,000 )     (587,000 )     (12,655,000 )
                         
Interest & other income / (expense)
                        
Interest income
     11,000       -       11,000  
Interest expense
     (2,000 )     -       (2,000 )
Stock purchase right
     (194,000 )     -       (194,000 )
Change in fair value of contingent consideration
     3,000       -       3,000  
Loss on investment in unconsolidated entities
     (14,000 )     -       (14,000 )
Gain on deconsolidation of AdNet
     470,000       -       470,000  
Other
     (44,000 )     (2,000 )     (42,000 )
                         
Loss before income taxes and noncontrolling interests
     (13,012,000 )     (589,000 )     (12,423,000 )
                         
Income tax benefit
     370,000       95,000       275,000  
                         
Net loss
     (12,642,000 )     (494,000 )     (12,148,000 )
                         
Net loss attributable to noncontrolling interests
     1,372,000       247,000       1,125,000  
                         
Net loss attributable to YOU On Demand shareholders
   $ (11,270,000 )   $ (247,000 )   $ (11,023,000 )
 
 
The following table sets forth key components of our results of operations. As noted above, the table shows a Pro Forma 2012 and 2011 which excludes the impact of Shandong Media.

    Year Ended              
   
December 31,
    
December 31,
    
Amount
    
%
  
   
2012
    
2011
    
Change
    
Change
  
   
(Pro Forma)
    
(Pro Forma)
              
                         
Revenue
   $ 5,177,000     $ 4,875,000     $ 302,000       6 %
Cost of revenue
     5,854,000       3,367,000       2,487,000       74 %
Gross (loss) profit
     (677,000 )     1,508,000       (2,185,000 )     -145 %
                                 
Operating expense:
                                
Selling, general and administrative expenses
     10,094,000       7,495,000       2,599,000       35 %
Professional fees
     1,345,000       2,110,000       (765,000 )     -36 %
Depreciation and amortization
     4,025,000       4,314,000       (289,000 )     -7 %
Impairments of long-lived assets
     840,000       244,000       596,000       244 %
Total operating expense
     16,304,000       14,163,000       2,141,000       15 %
                                 
Loss from operations
     (16,981,000 )     (12,655,000 )     (4,326,000 )     34 %
                                 
Interest & other income / (expense)
                                
Interest income
     9,000       11,000       (2,000 )     -18 %
Interest expense
     (79,000 )     (2,000 )     (77,000 )     3,850 %
Stock purchase right
     (44,000 )     (194,000 )     150,000       -77 % 
Cost of reset provision
     (659,000 )     -       (659,000 )     -  
Change in fair value of warrant liabilities
     647,000       -       647,000       -  
Change in fair value of contingent consideration
     1,313,000       3,000       1,310,000       43667 %
Gain on investment in unconsolidated entities
     68,000       (14,000 )     82,000       -586 %
Loss on investment write-off
     (95,000 )     -       (95,000 )     -  
Loss on write-off of uncollectible loans
     (41,000 )     -       (41,000 )     -  
Gain on deconsolidation of Shandong Media
     142,000       -       142,000       -  
Gain on disposal of AdNet
     -       470,000       (470,000 )     -100 %
Other
     (140,000 )     (42,000 )     (98,000 )     233 %
                                 
Loss before income taxes and noncontrolling interests
     (15,860,000 )     (12,423,000 )     (3,437,000 )     28 %
                                 
Income tax benefit
     344,000       275,000       69,000       25 %
                                 
Net  loss
     (15,516,000 )     (12,148,000 )     (3,368,000 )     28 %
                                 
Net loss attributable to noncontrolling interests
     1,688,000       1,125,000       563,000       50 %
                                 
Net loss attributable to YOU On Demand shareholders
   $ (13,828,000 )   $ (11,023,000 )   $ (2,805,000 )     25 %
                                 
Deemed dividends on preferred stock
     (924,000 )     -       (924,000 )     -  
                                 
Net loss attributable to YOU on Demand common shareholders
   $ (14,752,000 )   $ (11,023,000 )   $ (3,729,000 )        
 
 
The information provided below represents pro forma amounts for 2011 to exclude the impact of Shandong Media, which was deconsolidated effective July 1, 2012 (see Note 11 to the audited financial statements included in this report for more information on the Deconsolidation of Shandong Media).

Revenues

Revenues for the year ended December 31, 2012, totaled $5,177,000, as compared to $4,875,000 for 2011. The increase in revenue of approximately $302,000, or 6%, is attributable to increased revenue from Jinan Broadband. Jinan Broadband’s revenue consisted primarily of sales to our PRC based internet consumers, cable modem consumers, business customers and other internet and cable services of $5,172,000, an increase of $320,000, or 7%, as compared to $4,852,000 during 2011. The increase is primarily related to an increase in sales to our business customers.

Gross (loss) Profit

Our gross (loss) profit for the year ended December 31, 2012 was $(677,000), as compared to $1,508,000 during 2011.  The decrease in gross (loss) profit of approximately $2,185,000, or 145%, is mainly due to the amortization of content costs related to our VOD business.

Gross (loss) profit as a percentage of revenue was (13)% for the year ended December 31, 2012, as compared to 30% during 2011. The decrease is mainly due to content acquisition costs related to our VOD business.

Selling, General and Administrative Expenses

Our selling, general and administrative expenses for the year ended December 31, 2012, increased approximately $2,599,000 to $10,094,000, as compared to $7,495,000 for the year ended December 31, 2011.  The increase is mainly due to increased costs related to the development of our VOD business.

Salaries and personnel costs are the primary components of selling, general and administrative expenses. For the year ended December 31, 2012, salaries and personnel costs accounted for 56% of our selling, general and administrative expenses. For the year ended December 31, 2012, salaries and personnel costs totaled $5,566,000, an increase of $1,502,000, or 37%, as compared to $4,064,000 for the same period of 2011. The increase in our salaries and personnel costs increased because of the growth and development of our VOD business.

The other major components of our selling, general and administrative expenses include marketing and promotions, technology, rent and travel. For the year ended December 31, 2012, these costs totaled $2,447,000, an increase of $694,000, or 40% as compared to $1,753,000 in 2011.  The increase is mainly due to the growth and development of our VOD business.

Professional Fees

Professional fees are generally related to public company reporting and governance expenses as well as legal fees related to our VOD business. Our costs for professional fees decreased $765,000, or 36%, to $1,345,000 for the year ended December 31, 2012, from $2,110,000 during 2011.  Such decrease in professional fees was primarily due to increased legal fees in 2011during the early stages of development of our VOD business.

Depreciation and Amortization

Our depreciation expense decreased $438,000, or 18%, to $2,033,000 in the year ended December 31, 2012, from $2,471,000 during 2011, The decrease is due to certain equipment at Jinan Broadband being taken out of service due to changes in customer needs. As such, the Company ceased depreciating such equipment.

Our amortization expense increased $149,000, or 8%, to $1,992,000 in the year ended December 31, 2012, from $1,843,000 during 2011.  The increase is due to software, licenses and website development costs being recognized in 2012.

Impairment of Long-lived Assets

In 2012, we recorded an impairment charge of $840,000 related to our equipment assets at our Jinan Broadband subsidiary as discussed in Note 7 of our audited consolidated financial statements included in this report.
 
 
Right to Purchase Expense
 
FIL Investment Management (Hong Kong) Limited (“Fidelity”), a professional fiduciary for various accounts, had the right to purchase up to 5,625,000 shares of our common stock pursuant to the June 7, 2011 private placement. We recorded a charge of $44,000 for the year ended December 31, 2012, as compared to $194,000 for the same period of 2011, related to the valuation of this right to purchase.

Cost of Reset Provision

As a result of the negative clawback provisions included in our warrant agreements associated with our August 2012 private financings, we have reset the exercise price from $4.25 per share to $1.50 per share.  Accordingly, we valued the cost of this reset provision and recorded a charge to operations of $659,000 for the year ended December 31, 2012.

Change in Fair value of Warrant Liabilities

Our warrants are characterized as derivative liabilities to be re-measured at the end of every reporting period with the change in value reported in the statement of operations and, accordingly, we reported a gain of $647,000 for the year ended December 31, 2012.  The gain is primarily due to the decrease in our closing stock price.

Change in Fair Value of Contingent Consideration

Our contingent consideration related to our acquisition of Sinotop Hong Kong is classified as a liability because the earn-out securities do not meet the fixed-for-fixed criteria under ASC 815-40-15. Further, ASC 815-40-15 requires us to re-measure at the end of every reporting period with the change in value reported in the statement of operations and, accordingly, we reported a gain of approximately $1,313,000 and $3,000 for the years ended December 31, 2012 and 2011, respectively. The gain is primarily due to decreases in our closing stock price.

Loss on Investment Write-off

In 2011, we entered into a purchase agreement with “Shandong Fu Ren” whereby we were obligated to pay approximately $157,000 to acquire 51% ownership of Shanghai Tianduo.  We advanced approximately $47,000 in 2011.  Since we entered into the agreement in 2011, the direction of our company has changed and thus the value of the investment has diminished.  As such, as of December 31, 2012, we wrote-off the initial investment of $47,000 and accrued a liability of$47,000 as an expected settlement payment to terminate the agreement for a total of $95,000.  In addition, in connection with the investment we advanced funds in the form of a loan for $40,000 which we wrote-off and recorded as loss on uncollectible loan.
 
Gain on Deconsolidation of Shandong Media

Effective July 1, 2012, we deconsolidated our ownership in Shandong Media and recorded a gain of $141,814 as discussed in Note 11 of our audited consolidated financial statements included in this report.

Net Loss Attributable to Non-controlling Interest

49% of the operating loss of our Jinan Broadband subsidiary is allocated to Jinan Parent, the 49% co-owner of this business. During the year ended December 31, 2012, $1,278,000 of our operating losses from Jinan Broadband was allocated to Jinan Parent, as compared to $705,000 during the same period of 2011.

20% of the operating loss of our Zhong Hai Video joint venture is allocated to Hua Cheng, our 20% joint venture partner. During the year ended December 31, 2012, $399,000 of our operating loss from Zhong Hai Video was allocated to Hua Cheng, as compared to $420,000 during the same period of 2011.

Deemed Dividends on Preferred Stock

We recorded a beneficial conversion feature associated with the Series C Preferred Stock, which was limited to the proceeds allocated to them. Because the preferred stock is immediately convertible at the option of the holder, we recorded deemed dividends of $924,000 from the beneficial conversion feature associated with the issuance of the Series C Preferred Stock.
 
 
Liquidity and Capital Resources

As of December 31, 2012, we had cash and cash equivalents of approximately $4,381,000. Approximately $1,450,000 is held in our Chinese subsidiaries. The company has no plans to repatriate these funds. We had a working capital deficit at December 31, 2012, of approximately $5,983,000.

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

   
Year Ended
  
   
December 31,
    
December 31,
  
   
2012
    
2011
  
Net cash used in operating activities
   $ (10,601,000 )   $ (5,735,000 )
Net cash used in investing activities
     (1,240,000 )     (3,295,000 )
Net cash provided by financing activities
     8,660,000       10,247,000  
Effect of exchange rate changes on cash
     43,000       (282,000 )
Net (decrease) increase in cash and cash equivalents
     (3,138,000 )     935,000  
Cash and cash equivalents at beginning of period
     7,519,000       6,584,000  
Cash and cash equivalents at end of period
     4,381,000       7,519,000  
 
Operating Activities

The increase in cash used in operating activities relates to corporate and operational costs incurred primarily in the development of our VOD business.

Investing Activities

Cash used in investing activities was used primarily for (i) additions to property and equipment of $954,000 and $2,547,000 in 2012 and 2011, respectively, and (ii) investments in intangibles of $273,000 and $443,000 in 2011 and 2012, respectively.

Financing activities

In 2012, the Company received a $3,000,000 loan from our Chairman and Chief Executive Officer, Mr. Shane McMahon.  Also in 2012, we received net proceeds of $5,660,000 from the sale of our equity securities as discussed in Notes 15 and 16 to the audited consolidated financial statements included in this report. For 2011, the amount consisted primarily of proceeds received from the sale of our equity securities from our June 2011 financings.

We anticipate that we will need to raise additional funds to fully implement our business model and related strategies. We believe we have the ability to raise funds by various methods including utilization of our $50 million shelf registration as well as other means of financing. The fact that we have incurred significant continuing losses and continue to rely on debt and equity financings to fund our operations to date, could raise substantial doubt about our ability to continue as a going concern. The audited 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 adjustments that might result from the outcome of this uncertainty.  As of December 31, 2012 the Company has an accumulated operating loss of approximately $59 million.

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 the price change 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.

Contractual Obligations
 
We have the following purchase obligations:
 
   
Payments due by period
  
         
Less than
                
More than 5
  
Contractual Obligations
  
Total
    
1 year
    
1-3 years
    
3-5 Years
    
years
  
Product costs
   $ 7,344,000     $ 1,860,000     $ 5,484,000     $ -     $ -  
Property leases
     334,000       317,000       17,000       -       -  
Equipment leases
     198,000       198,000       -       -       -  
Other
     90,000       90,000       -       -       -  
Total
   $ 7,966,000     $ 2,465,000     $ 5,501,000     $ -     $ -  

Seasonality

Our operating results and operating cash flows historically have not been subject to seasonal variations. 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 VIEs in accordance with FASB Topic 810, Consolidation. VIEs are required to be consolidated by the primary beneficiary. The primary beneficiary is the entity that holds the majority of the beneficial interests in the variable interest entity. A VIE is an entity for which the primary beneficiary’s interest in the entity can change with changes in factors other than the amount of investment in the entity.

 
·
Revenue Recognition. Revenue is recorded as services are provided to customers. We generally recognize all revenue in the period in which the service is rendered, provided that persuasive evidence of an arrangement exists, delivery has occurred, the sales price is fixed or determinable, and collection is reasonably assured. We record deferred revenue for payments received from customers for the performance of future services and recognizes the associated revenue in the period that the services are performed.
 
 
·
Licensed Content.  The Company obtains content through content license agreements and revenue sharing agreements with studios and distributors. The license agreement may or may not be recognized in licensed content.  When the license fee is not known or reasonably determinable for a specific title, the title does not meet the criteria for recognition in licensed content in accordance with Financial Accounting Standards Boards (FASB) Accounting Standards Codification (ASC) Topic 920, Entertainment – Broadcasters. In the event, the license fee is not known or reasonably determinable for a specific title in content license agreements that do not specify the license fee per title, we expense as costs of revenues the greater of revenue sharing costs incurred through the end of the reporting period or the proportionate value of total minimum license fees expensed on a straight-line basis over the term of each license agreement. As the Company expenses license fees on a straight-line basis, it may result in deferred or prepaid license fees. Prepaid license fees are classified as an asset on the consolidated balance sheets as licensed content and deferred license fees are classified as a liability on the consolidated balance sheets as deferred license fees.
 
 
 
·
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.
 
 
·
Foreign Currency Translation. The businesses of our operating subsidiaries are currently conducted in and from China in Renminbi. The Company makes no representation that any Renminbi or U.S. dollar amounts could have been, or could be, converted into U.S. dollars or Renminbi, as the case may be, at any particular rate, the rates stated below, or at all. The Chinese government imposes control over its foreign currency reserves in part through direct regulation of the conversion of Renminbi into foreign exchange and through restrictions on foreign trade. The Company uses the U.S. dollar as its reporting and functional currency. Translation adjustments are reported as other comprehensive income or expenses and accumulated as other comprehensive income in the equity section of the balance sheet. Financial information is translated into U.S. dollars at prevailing or current rates respectively, except for revenues and expenses which are translated at average current rates during the reporting period. Exchange gains and losses resulting from retained profits are reported as a separate component of stockholders’ equity.

 
·
Business Combinations. We account for acquisitions according to ASC 805, Business Combinations. ASC 805 requires that upon initially obtaining control, an acquirer should recognize 100% of the fair values of acquired assets, including goodwill and assumed liabilities, with only limited exceptions, even if the acquirer has not acquired 100% of its target. Additionally, contingent consideration arrangements will be fair valued at the acquisition date and included on that basis in the purchase price consideration and transaction costs will be expensed as incurred. This statement also modifies the recognition for pre-acquisition contingencies, such as environmental or legal issues, restructuring plans and acquired research and development value in purchase accounting. This statement amends ASC 740-10, Income Taxes, to require the acquirer to recognize changes in the amount of its deferred tax benefits that are recognizable because of a business combination either in income from continuing operations in the period of the combination or directly in contributed capital, depending on the circumstances.
 
Recent Accounting Pronouncements
Management does not believe that any recently issued, but not yet effective, accounting standards, if currently adopted, would have a material effect on the accompanying financial statements.
 

Not Applicable.

 
The full text of our audited consolidated financial statements as of December 31, 2012 and 2011 begins on page F-1 of this annual report.

 
None.
 
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 December 31, 2012.  Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that as of December 31, 2012, 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.
 
Management’s Annual Report on Internal Control Over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. The Exchange Act defines internal control over financial reporting as a process designed by, or under the supervision of, our principal executive and principal financial officers and effected by our Board of Directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America and includes those policies and procedures that:

 
·
Pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the Company;

 
·
Provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with accounting principles generally accepted in the United States of America, and that our receipts and expenditures are being made only in accordance with authorizations of our management and Directors; and
 
 
·
Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on our financial statements.

All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
 
Management assessed the effectiveness of our internal controls over financial reporting as of December 31, 2012. In making this assessment, management used the framework set forth in the report entitled Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission, or COSO. The COSO framework summarizes each of the components of a company’s internal control system, including (i) the control environment, (ii) risk assessment, (iii) control activities, (iv) information and communication, and (v) monitoring.

A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of our annual or interim financial statements will not be prevented or detected on a timely basis.  A significant deficiency is a deficiency, or a combination of deficiencies, in internal control over financial reporting that is less severe than a material weakness, yet important enough to merit attention by those responsible for oversight of our financial reporting.
 
Our internal control over financial reporting was not effective as a result of the following identified material weakness:
 
 
·
As of December 31, 2012, the Company did not maintain sufficient internal personnel with an adequate level of accounting knowledge, experience and training.  The Company has utilized external consultants to assist in the selection and application of US GAAP and related SEC disclosure requirements.  During both 2011 and 2012, the Company has been developing staff including one US GAAP and SEC qualified internal personnel based in our US office to oversee its financial reporting operations.  We plan to hire additional qualified staff to be based in our Beijing office at which time we will be able to fully remediate this material weakness.
 
 
This annual report does not include an attestation report of our registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by our registered public accounting firm pursuant to temporary rules of the SEC that permit the Company to provide only management’s report in this annual report.
 
Changes in Internal Control Over Financial Reporting
 
There have been no changes in internal control.  The Company continues to invest resources in order to upgrade internal controls.
 
ITEM 9B.
 
None.
 
PART III

 
Directors and Executive Officers

The following table sets forth the name and position of each of our current executive officers and Directors.
 
NAME
 
AGE
 
POSITION
Shane McMahon
 
43
 
Chairman and Chief Executive Officer
Marc Urbach
 
40
 
President, Chief Financial Officer
Weicheng Liu
 
55
 
China Chief Executive Officer and Director
Michael Birkin
  
54
  
Director
James Cassano
 
66
 
Director
Michael Jackson
  
55
  
Director
 
Shane McMahon.  Mr. McMahon has served as our Chairman and Chief Executive Officer since July 30, 2010.  Prior to joining us, from 2000 to December 31, 2009, Mr. McMahon served in various executive level positions with World Wrestling Entertainment, Inc. (NYSE: WWE).  Mr. McMahon has significant marketing and promotion experience and has been instrumental in exploiting pay-per-view and video on demand programming on a global basis.  Mr. McMahon also sits on the Boards of Directors of International Sports Management (USA) Inc., a Delaware corporation, and Global Power of Literacy, a New York not-for-profit corporation.

Marc Urbach. Mr. Urbach has over fifteen years of accounting, finance, and operations experience in both large and small companies.  He was the Executive Vice President and Chief Financial Officer of Profile Home Inc., a privately held importer and distributor of home furnishings from September 2004 until February 2008.  He additionally served on the Board and was part owner of Tri-state Trading LLC, a related import company during that same time period.  Mr. Urbach was a Director of Finance at Mercer Inc., a Marsh & McLennan Company from 2002 to 2004.  He was a Finance Manager at Small World Media from 2000 until 2002 and held a similar position at The Walt Disney Company from 1998 to 2000.  He started his career at Arthur Andersen LLP as a senior auditor from 1995 to 1998.  Mr. Urbach received his Bachelor of Science in Accounting from Babson College in 1995.

Weicheng Liu. Mr. Liu was appointed as a China Chief Executive Officer and as a member of our Board of Directors on July 30, 2010.  Prior to joining us, Mr. Liu founded Sinotop Beijing and served as its sole officer and director until his resignation on July 30, 2010.  Mr. Liu is currently a non-executive director of Codent Networks (Shanghai ) Co. Ltd., a mobile software company in China founded by Mr. Liu, and has served in that position since 2011, prior to which he served as the Chairman and CEO since 2003.  Overall, Mr. Liu has almost twenty years of experience in the telecommunications and network technology industries.  Mr. Liu received a degree in engineering physics from Tsinghua University and a Ph.D. from the University of Waterloo.  Mr. Liu’s extensive industry experience, as noted above, along with his management experience of Sinotop Beijing, led us to the conclusion that he should serve as a director of our Company, in light of our business and structure.
 
 
Michael Birkin. Mr. Birkin was appointed as director of the Company effective as of May 29, 2012.  Michael Birkin is a graduate of University College, London, where he studied law. He began his career at Price Waterhouse, moving to Allied Dunbar and then to Interbrand, the Branding and Identity Consultancy, as Chief Executive.  After the acquisition of Interbrand by Omnicom Group Inc. he moved to their Diversified Agency Services (“DAS”) division, as President, Europe.  In 1997 Mr. Birkin became International President of DAS responsible for all DAS companies in Europe and Asia Pacific.  In 1998 he became President of DAS Worldwide based in New York.  In March 2005, Mr. Birkin was appointed Vice Chairman of Omnicom Group Inc. and President and CEO of Omnicom Asia Pacific. In January 2006, he became Chairman and CEO of Omnicom Asia Pacific.  In July 2009, Mr. Birkin left Omnicom to acquire RPMC, an events, hospitality and promotions agency. Having subsequently been awarded Intelʼs global branding and design work, he established The Red Peak Group which owns both Red Peak Branding and RPMC with offices in New York, Los Angeles and London.
 
James S. Cassano. Mr. Cassano was appointed as director of the Company effective as of January 11, 2008.  Mr. Cassano is currently a Partner & Chief Financial Officer of CoActive Health Solutions, LLC, a worldwide contract research organization, supporting the pharmaceutical and biotechnology industries.  Mr. Cassano has served as executive vice president, chief financial officer, secretary and director of Jaguar Acquisition Corporation a Delaware corporation (OTCBB: JGAC), a blank check company, since its formation in June 2005.  Mr. Cassano has served as a managing director of Katalyst LLC, a company which provides certain administrative services to Jaguar Acquisition Corporation, since January 2005.  In June 1998, Mr. Cassano founded New Forum Publishers, an electronic publisher of educational material for secondary schools, and served as its chairman of the Board and chief executive officer until it was sold to Apex Learning, Inc., a company controlled by Warburg Pincus, in August 2003. He remained with Apex until November 2003 in transition as vice president business development and served as a consultant to the company through February 2004.  In June 1995, Mr. Cassano co-founded Advantix, Inc., a high volume electronic ticketing software and transaction services company which handled event related client and customer payments, that was re-named Tickets.com and went public through an IPO in 1999. From March 1987 to June 1995, Mr. Cassano served as senior vice president and chief financial officer of the Hill Group, Inc., a privately-held engineering and consulting organization, and from February 1986 to March 1987, Mr. Cassano served as vice president of investments and acquisitions for Safeguard Scientifics, Inc., a public venture development company. From May 1973 to February 1986, Mr. Cassano served as partner and director of strategic management services (Europe) for the strategic management group of Hay Associates. Mr. Cassano received a B.S. in Aeronautics and Astronautics from Purdue University and an M.B.A. from Wharton Graduate School at the University of Pennsylvania.  Mr. Cassano’s extensive executive experience, as noted above, along with his educational background, led us to the conclusion that he should serve as a director of our Company, in light of our business and structure.

Michael Jackson. Mr. Jackson was appointed as director of the Company effective as of May 29, 2012.  Michael Jackson was one of the first UK independent producers, making factual series for Channel Four between 1981 and 1987. He joined the BBC as a producer in 1988 and was successively Head of Music and Arts, Controller of BBC2, and Director of Television and Controller BBC1. In 1997 he joined Channel Four as CEO and was responsible for launching the Film Four and E4 digital channels and for programming such as Da Ali G Show and Queer As Folk. In 2001 Channel Four was named the UK Media Brand of the Year. In 2001 he left for the US becoming President of USA Entertainment, which encompassed cable networks such as USA and SciFi and USA Films amongst other assets. In 2002 he was named Chairman of Universal Television. During his tenure USA reclaimed its position as the number one general entertainment cable channel. In 2006 he became President of Programming for IAC and was responsible amongst other things for the purchase of Collegehumor.com and Vimeo.com. Since 2010 he has been a director, investor and advisor for a range of media companies. He is a senior adviser for UK merchant bank Lepe, has consulted for The Guardian newspaper, co-founded the UK and US based independent producer Nutopia and is an independent director of STV plc amongst other ventures.

There are no agreements or understandings for any of our executive officers or director to resign at the request of another person and no officer or director is acting on behalf of nor will any of them act at the direction of any other person.

Directors are elected until their successors are duly elected and qualified.
 
 
Family Relationships

There is no family relationship among any of our officers or Directors.

Involvement in Certain Legal Proceedings

To the best of our knowledge, none of our Directors or executive officers has, during the past ten years:
 
 
·
been convicted in a criminal proceeding or been subject to a pending criminal proceeding (excluding traffic violations and other minor offences);

 
·
had any bankruptcy petition filed by or against the business or property of the person, or of any partnership, corporation or business association of which he was a general partner or executive officer, either at the time of the bankruptcy filing or within two years prior to that time;

 
·
been subject to any order, judgment, or decree, not subsequently reversed, suspended or vacated, of any court of competent jurisdiction or federal or state authority, permanently or temporarily enjoining, barring, suspending or otherwise limiting, his involvement in any type of business, securities, futures, commodities, investment, banking, savings and loan, or insurance activities, or to be associated with persons engaged in any such activity;

 
·
been found by a court of competent jurisdiction in a civil action or by the Securities and Exchange Commission or the Commodity Futures Trading Commission to have violated a federal or state securities or commodities law, and the judgment has not been reversed, suspended, or vacated;

 
·
been the subject of, or a party to, any federal or state judicial or administrative order, judgment, decree, or finding, not subsequently reversed, suspended or vacated (not including any settlement of a civil proceeding among private litigants), relating to an alleged violation of any federal or state securities or commodities law or regulation, any law or regulation respecting financial institutions or insurance companies including, but not limited to, a temporary or permanent injunction, order of disgorgement or restitution, civil money penalty or temporary or permanent cease-and-desist order, or removal or prohibition order, or any law or regulation prohibiting mail or wire fraud or fraud in connection with any business entity; or

 
·
been the subject of, or a party to, any sanction or order, not subsequently reversed, suspended or vacated, of any self-regulatory organization (as defined in Section 3(a)(26) of the Exchange Act (15 U.S.C. 78c(a)(26))), any registered entity (as defined in Section 1(a)(29) of the Commodity Exchange Act (7 U.S.C. 1(a)(29))), or any equivalent exchange, association, entity or organization that has disciplinary authority over its members or persons associated with a member.

Except as set forth in our discussion below in “Transactions with Related Persons, Promoters and Certain Control Persons; and Director Independence – Transactions with Related Persons,” none of our Directors, director nominees or executive officers has been involved in any transactions with us or any of our Directors, executive officers, affiliates or associates which are required to be disclosed pursuant to the rules and regulations of the SEC.
 
Section 16(A) Beneficial Ownership Reporting Compliance

Under U.S. securities laws, Directors, certain executive officers and persons holding more than 10% of our common stock must report their initial ownership of the common stock, and any changes in that ownership, to the SEC. The SEC has designated specific due dates for these reports. Based solely on our review of copies of such reports filed with the SEC by and written representations of our Directors and executive offers, except as follows we believe that our Directors and executive offers filed the required reports on time during 2012.  Mr. McMahon was late in filing a Form 4 following the purchase of shares of our common stock on December 19, 2012.
 
Corporate Governance
 
Our current corporate governance practices and policies are designed to promote stockholder value and we are committed to the highest standards of corporate ethics and diligent compliance with financial accounting and reporting rules. Our Board provides independent leadership in the exercise of its responsibilities. Our management oversees a system of internal controls and compliance with corporate policies and applicable laws and regulations, and our employees operate in a climate of responsibility, candor and integrity.
 
 
Corporate Governance Guidelines
 
We and our Board are committed to high standards of corporate governance as an important component in building and maintaining stockholder value. To this end, we regularly review our corporate governance policies and practices to ensure that they are consistent with the high standards of other companies. We also closely monitor guidance issued or proposed by the SEC and the provisions of the Sarbanes-Oxley Act, as well as the emerging best practices of other companies. The current corporate governance guidelines are available on the Company’s website yod.com. Printed copies of our corporate governance guidelines may be obtained, without charge, by contacting our Corporate Secretary at 27 Union Square West, Suite 502, New York, New York 10003.
 
The Board and Committees of the Board
 
The Company is governed by the Board that currently consists of five members: Shane McMahon, Weicheng Liu, Michael Birkin, James Cassano and Michael Jackson. The Board has established three Committees: the Audit Committee, the Compensation Committee and the Nominating and Governance Committee. Each of the Audit Committee, Compensation Committee and Nominating and Governance Committee are comprised entirely of independent Directors. From time to time, the Board may establish other committees. The Board has adopted a written charter for each of the Committees which are available on the Company’s website yod.com . Printed copies of these charters may be obtained, without charge, by contacting our Corporate Secretary at 27 Union Square West, Suite 502, New York, New York 10003.
 
Governance Structure
 
Currently, our Chief Executive Officer is also our Chairman. The Board of Directors believes that, at this time, having a combined Chief Executive Officer and Chairman is the appropriate leadership structure for the Company. In making this determination, the Board of Directors determined that his experience, knowledge, and personality allowed him to serve ably as both Chairman and Chief Executive Officer. Among the benefits of a combined Chief Executive Officer/Chairman considered by the Board of Directors is that such structure promotes clearer leadership and direction for our Company and allows for a single, focused chain of command to execute our strategic initiatives and business plans.
 
We encourage our shareholders to learn more about our Company’s governance practices at our website, yod.com .
 
The Board’s Role in Risk Oversight
 
The Board oversees that the assets of the Company are properly safeguarded, that the appropriate financial and other controls are maintained, and that the Company’s business is conducted wisely and in compliance with applicable laws and regulations and proper governance. Included in these responsibilities is the Board of Directors’ oversight of the various risks facing the Company. In this regard, the Board seeks to understand and oversee critical business risks. The Board does not view risk in isolation. Risks are considered in virtually every business decision and as part of the Company’s business strategy. The Board recognizes that it is neither possible nor prudent to eliminate all risk. Indeed, purposeful and appropriate risk-taking is essential for the Company to be competitive on a global basis and to achieve its objectives.
 
While the Board oversees risk management, Company management is charged with managing risk. The Company has robust internal processes and a strong internal control environment to identify and manage risks and to communicate with the Board. The Board and the Audit Committee monitor and evaluate the effectiveness of the internal controls and the risk management program at least annually. Management communicates routinely with the Board, Board Committees and individual Directors on the significant risks identified and how they are being managed. Directors are free to, and indeed often do, communicate directly with senior management.
 
The Board implements its risk oversight function both as a whole and through Committees. Much of the work is delegated to various Committees, which meet regularly and report back to the full Board. All Committees play significant roles in carrying out the risk oversight function. In particular:

 
·
The Audit Committee oversees risks related to the Company’s financial statements, the financial reporting process, accounting and legal matters. The Audit Committee oversees the internal audit function and the Company’s ethics programs, including the Codes of Business Conduct. The Audit Committee members meet separately with representatives of the independent auditing firm.
 
 
 
·
The Compensation Committee evaluates the risks and rewards associated with the Company’s compensation philosophy and programs. The Compensation Committee reviews and approves compensation programs with features that mitigate risk without diminishing the incentive nature of the compensation. Management discusses with the Compensation Committee the procedures that have been put in place to identify and mitigate potential risks in compensation.
 
Independent Directors
 
In considering and making decisions as to the independence of each of the Directors of the Company, the Board considered transactions and relationships between the Company (and its subsidiaries) and each director (and each member of such director’s immediate family and any entity with which the director or family member has an affiliation such that the director or family member may have a material indirect interest in a transaction or relationship with such entity). The Board has determined that Michael Birkin, James Cassano and Michael Jackson are independent as defined in applicable SEC and NASDAQ rules and regulations, and that each constitutes an “Independent Director” as defined in NASDAQ Marketplace Rule 5605.
 
Audit Committee
 
Our Audit Committee consists of Michael Birkin, James Cassano and Michael Jackson.  The Audit Committee oversees our accounting and financial reporting processes and the audits of the financial statements of our company. Mr. Cassano serves as our Audit Committee financial expert as that term is defined by the applicable SEC rules. The Audit Committee is responsible for, among other things:
 
The Audit Committee met by telephone or in person 4 times during the year ended December 31, 2012.
 
Compensation Committee

Our Compensation Committee consists of Michael Birkin, James Cassano and Michael Jackson.  Our Compensation Committee assists the Board in reviewing and approving the compensation structure of our Directors and executive officers, including all forms of compensation to be provided to our Directors and executive officers. Our chief executive officer may not be present at any committee meeting during which his compensation is deliberated. The Compensation Committee is responsible for, among other things:
 
 
·
selecting our independent auditors and pre-approving all auditing and non-auditing services permitted to be performed by our independent auditors;

 
·
reviewing with our independent auditors any audit problems or difficulties and management’s response;

 
·
reviewing and approving all proposed related-party transactions, as defined in Item 404 of Regulation S-K under the Securities Act of 1933, as amended;

 
·
discussing the annual audited financial statements with management and our independent auditors;

 
·
reviewing major issues as to the adequacy of our internal controls and any special audit steps adopted in light of significant internal control deficiencies;

 
·
annually reviewing and reassessing the adequacy of our Audit Committee charter;

 
·
meeting separately and periodically with management and our internal and independent auditors;

 
·
reporting regularly to the full Board of Directors;

 
·
such other matters that are specifically delegated to our Audit Committee by our Board of Directors from time to time.
 
 
 
·
approving and overseeing the compensation package for our executive officers;
 
 
·
reviewing and making recommendations to the Board with respect to the compensation of our Directors;
 
 
·
reviewing and approving corporate goals and objectives relevant to the compensation of our chief executive officer, evaluating the performance of our chief executive officer in light of those goals and objectives, and setting the compensation level of our chief executive officer based on this evaluation; and
 
 
·
reviewing periodically and making recommendations to the Board regarding any long-term incentive compensation or equity plans, programs or similar arrangements, annual bonuses, employee pension and welfare benefit plans.

The Compensation Committee has sole authority to retain and terminate outside counsel, compensation consultants retained to assist the Compensation Committee in determining the compensation of the Chief Executive Officer or senior executive officers, or other experts or consultants, as it deems appropriate, including sole authority to approve the firms' fees and other retention terms. The Compensation Committee may also form and delegate authority to subcommittees and may delegate authority to one or more designated members of the Compensation Committee. The Compensation Committee may from time to time seek recommendations from the executive officers of the Company regarding matters under the purview of the Compensation Committee, though the authority to act on such recommendations rests solely with the Compensation Committee.
 
Our Compensation Committee met by telephone or in person 1 time during the year ended December 31, 2012.
 
Compensation Committee Interlocks and Insider Participation
 
All current members of the Compensation Committee are independent Directors, and all past members were independent Directors at all times during their service on such Committee. None of the past or present members of our Compensation Committee are present or past employees or officers of ours or any of our subsidiaries. No member of the Compensation Committee has had any relationship with us requiring disclosure under Item 404 of Regulation S-K under the Securities Exchange Act of 1934, as amended. None of our executive officers serves on the Board of Directors or compensation committee of a company that has an executive officer that serves on our Board or Compensation Committee.
 
Governance and Nominating Committee
 
Our Governance and Nominating Committee consists of Michael Birkin, James Cassano and Michael Jackson. The Governance and Nominating Committee assists the Board of Directors in identifying individuals qualified to become our Directors and in determining the composition of the Board and its committees. The Governance and Nominating Committee is responsible for, among other things:

 
·
identifying and recommending to the Board nominees for election or re-election to the Board, or for appointment to fill any vacancy;

 
·
reviewing annually with the Board the current composition of the Board in light of the characteristics of independence, age, skills, experience and availability of service to us;

 
·
identifying and recommending to the Board the Directors to serve as members of the Board’s committees; and

 
·
monitoring compliance with our code of business conduct and ethics.
 
Our Governance and Nominating Committee met by telephone or in person 1 time during the year ended December 31, 2012.

Director Qualifications

Directors are responsible for overseeing the Company’s business consistent with their fiduciary duty to shareowners. This significant responsibility requires highly-skilled individuals with various qualities, attributes and professional experience. The Board believes that there are general requirements for service on the Company’s Board of Directors that are applicable to all Directors and that there are other skills and experience that should be represented on the Board as a whole but not necessarily by each director. The Board and the Governance and Nominating Committee of the Board consider the qualifications of Directors and director candidates individually and in the broader context of the Board’s overall composition and the Company’s current and future needs.
 
Qualifications for All Directors
 
In its assessment of each potential candidate, including those recommended by shareowners, the Governance and Nominating Committee considers the nominee’s judgment, integrity, experience, independence, understanding of the Company’s business or other related industries and such other factors the Governance and Nominating Committee determines are pertinent in light of the current needs of the Board. The Governance and Nominating Committee also takes into account the ability of a director to devote the time and effort necessary to fulfill his or her responsibilities to the Company.

The Board and the Governance and Nominating Committee require that each director be a recognized person of high integrity with a proven record of success in his or her field. Each director must demonstrate innovative thinking, familiarity with and respect for corporate governance requirements and practices, an appreciation of multiple cultures and a commitment to sustainability and to dealing responsibly with social issues. In addition to the qualifications required of all Directors, the Board assesses intangible qualities including the individual’s ability to ask difficult questions and, simultaneously, to work collegially.
 
The Board does not have a specific diversity policy, but considers diversity of race, ethnicity, gender, age, cultural background and professional experiences in evaluating candidates for Board membership. Diversity is important because a variety of points of view contribute to a more effective decision-making process.

Qualifications, Attributes, Skills and Experience to be Represented on the Board as a Whole

The Board has identified particular qualifications, attributes, skills and experience that are important to be represented on the Board as a whole, in light of the Company’s current needs and business priorities. The Company’s services are performed in areas of future growth located outside of the United States. Accordingly, the Board believes that international experience or specific knowledge of key geographic growth areas and diversity of professional experiences should be represented on the Board. In addition, the Company’s business is multifaceted and involves complex financial transactions. Therefore, the Board believes that the Board should include some Directors with a high level of financial literacy and some Directors who possess relevant business experience as a Chief Executive Officer or President. Our business involves complex technologies in a highly specialized industry. Therefore, the Board believes that extensive knowledge of the Company’s business and industry should be represented on the Board.
 
Summary of Qualifications of Current Directors
 
Set forth below is a narrative disclosure that summarizes some of the specific qualifications, attributes, skills and experiences of our Directors. For more detailed information, please refer to the biographical information for each director set forth above.
 
Shane McMahon. Mr. McMahon has significant marketing and promotion experience and has been instrumental in exploiting pay-per-view programming on a global basis.  In light of our business and structure, Mr. McMahon’s extensive executive and industry experience led us to the conclusion that he should serve as a director of our Company.
 
Weicheng Liu. Mr. Liu has almost twenty years of experience in the telecommunications and network technology industries, and has significant experience serving in senior executive positions, including chief executive officer.  In light of our business and structure, Mr. Liu’s extensive industry and management experience led us to the conclusion that he should serve as a director of our Company.
 
Michael Birkin. Mr. Birkin has significant senior executive experience including roles as Chief Executive and President as well as a business owner. In light of our business and structure, Mr. Birkin’s extensive executive experience and his educational background led us to the conclusion that he should serve as a director as a director of our Company.
 
James Cassano. Mr. Cassano has significant senior management experience, including service as chief executive officer, executive vice president, chief financial officer, secretary and director.  In light of our business and structure, Mr. Cassano’s extensive executive experience and his educational background led us to the conclusion that he should serve as a director of our Company.
 
 
Michael Jackson. Mr. Jackson has significant senior executive experience including roles as Chairman, Chief Executive Officer and President as well as vast involvement with media companies both as an executive and an investor. In light of our business and structure, Mr. Jackson’s extensive executive experience and background led us to the conclusion that he should serve as a director as a director of our Company.

Code of Ethics

To date, we have not adopted a Code of Ethics as described in Item 406 of Regulation S-K. However, we intend to adopt a code of ethics as soon as practicable.


Summary Compensation Table – 2012 and 2011

The following table sets forth information concerning all cash and non-cash compensation awarded to, earned by or paid to the named persons for services rendered in all capacities during the noted periods.

Name and Principal Position
Year
 
Salary
($)
 
 
Bonus
($)
 
 
Stock
Awards
($)
 
 
Option
Awards
($)
 
 
Total
($)
 
Shane McMahon
2012
 
 
255,000 (1)
 
 
-
 
 
-
 
 
141,536
 
 
 
396,536 (2)
 
Chief Executive Officer
2011
    
251,875
      
-
      
-
      
-
      
251,875
 
Weicheng Liu
2012
    
270,039
                      
141,536
      
411,575
 
China Chief Executive Officer
2011
 
 
266,411
 
 
 
-
 
 
 
-
 
 
 
-
 
 
 
266,411
 
Marc Urbach
2012
    
229,075
                      
94,359
      
323,434
 
President and Chief Financial Officer
2011
 
 
216,875
 
 
 
35,000
 
 
 
-
 
 
 
-
 
 
 
251,875
 
 
(1)
As of October 1, 2012, in an effort to conserve the Company’s working capital, Mr. McMahon elected to cease collecting salary until such time as the Company has sufficient revenues from operations.  During 2012, the Company actually paid to Mr. McMahon $191,250, with the remaining $63,750 due to Mr. McMahon pursuant to his employment agreement deferred until an undetermined future date.
 
Employment Agreements

On July 30, 2010, we entered into an employment agreement with our Chairman and CEO, Shane McMahon.  The agreement is for a term of one year, which will automatically be extended for additional one year terms unless terminated earlier.   Mr. McMahon is also eligible to receive a bonus at the sole discretion of our Board of Directors, and is entitled to participate in all of the benefit plans of the Company. In the event that Mr. McMahon is terminated without cause, he would be entitled to six months of severance pay.  The agreement also contains customary restrictive covenants regarding non-competition relating to the pay-per-view business in the PRC, non-solicitation of employees and customers and confidentiality.  Mr. McMahon does not receive any compensation for service as Chairman of the Company’s Board of Directors.

On July 30, 2010, we entered into an employment agreement with our President and CFO, Marc Urbach.  The agreement is for a term of one year, which will automatically be extended for additional one year terms unless terminated earlier.   Mr. Urbach is also eligible to receive a bonus at the sole discretion of our Board of Directors, and is entitled to participate in all of the benefit plans of the Company. In the event that Mr. Urbach is terminated without cause, he would be entitled to six months of severance pay.  The agreement also contains customary restrictive covenants regarding non-competition relating to the pay-per-view business in the PRC, non-solicitation of employees and customers and confidentiality.  Mr. Urbach does not receive any compensation for service as member of the Company’s Board of Directors.
 
 
On July 30, 2010, we entered into an employment agreement with our  China Chief Executive Officer, Weicheng Liu.  The agreement is for a term of one year, which will automatically be extended for additional one year terms unless terminated earlier by either party.  Mr. Liu is also eligible to receive a bonus at the sole discretion of the Board of Directors of the Company, and is entitled to participate in all of the benefit plans of the Company.  In the event Mr. Liu is terminated without cause, he would be entitled to six months of severance pay.  The Liu Agreement also contains customary restrictive covenants regarding non-competition relating to the pay-per-view business in the PRC, non-solicitation of employees and customers and confidentiality
 
We have not provided retirement benefits (other than a state pension scheme in which all of our employees in China participate) or severance or change of control benefits to our named executive officers.
 
Outstanding Equity Awards at Year End

The following table sets forth the equity awards outstanding at December 31, 2012.
 
   
Option Awards
    
Stock Awards
Name
  
Number of
securities
 underlying
unexercised
options (#)
exercisable
    
Number of
securities
underlying
unexercised
options (#)
unexercisable
    
Equity
incentive
plan awards:
Number of
securities
underlying
unexercised
unearned
options
(#)
    
Option
exercise
 price
($)
    
Number of
shares or
units of
stock that
have not
vested
(#)
    
Market
value of
shares of
units of
stock that
have not
 vested
($)
    
Equity incentive
plan awards:
Number of
unearned
shares, units or
other rights
that have not
vested
(#)
  
Equity incentive
 plan awards:
Market or
payout value of
unearned
shares, units or
other rights that
have not vested
($)
Shane McMahon
     311,111       222,222               3.00                            
      10,000       30,000               4.50                            
Weicheng Liu
     266,667       -               3.75                            
      10,000       30,000               4.50                            
Marc Urbach
     266,667       -               3.00                            
      6,667       20,000               4.50                            
      133,333       -               75.00                            
James Cassano
     667       -               33.75                            
      7,778       5,555               3.00                            

Compensation of Directors

The following table sets forth certain information concerning the compensation paid to our directors for services rendered to us during the fiscal year ended December 31, 2012. Neither Mr. McMahon nor Mr. Liu were compensated for their service as directors in 2012.
 
   
Fees Earned or
                    
   
Paid in Cash
    
Stock Awards
    
Option Awards
    
Total
  
Name
  
($)
    
($)
    
($)
    
($)
  
Michael Birkin
   $       $ 26,250             $ 26,250  
James Cassano
   $       $ 26,250             $ 26,250  
Michael Jackson
   $       $ 26,250             $ 26,250  
 
 

Security Ownership of Certain Beneficial Owners and Management
 
The following table sets forth information regarding beneficial ownership of our common stock as of March 29, 2013 (i) by each person who is known by us to beneficially own more than 5% of our common stock; (ii) by each of our officers and directors; and (iii) by all of our officers and directors as a group.

Unless otherwise specified, the address of each of the persons set forth below is in care of YOU On Demand Holdings, Inc., 27 Union Square West, Suite 502, New York, New York, 10003.
 
 
 
  
Shares Beneficially Owned(1)
  
 
 
  
Common Stock(2)
    
Series A Preferred
Stock(3)
    
Series C Preferred
Stock(4)
    
% Total
 Voting
 Power(5)
  
 
 
  
 
    
 
    
 
    
 
  
Name and Addressof
Beneficial Owner
Office, If
 Any
  
Shares
    
% of
Class
    
Shares
    
% of
Class
    
Shares
    
% of
Class
    
 
  
Directors and Officers
  
Shane McMahon
Chairman and CEO
     2,680,834 (6)     17.6 %     7,000,000 (6)     100 %     0       *       49.0% %
Marc Urbach
President and CFO
     277,445 (7)     1.8 %     0       *       0       *       * %
Weicheng Liu
China CEO and Director
     2,141,466 (8)     14.2 %     0       *       0       *       8.8 %
James Cassano
Director
     15,667 (9)     * %     0       *       0       *       * %
Michael Birkin
Director
     5,000       * %     0       *       0       *       * %
Michael Jackson
Director
     5,000       * %     0       *       0       *       * %
All officers and directors as a group (6 persons named above)
 
     5,125,412       32.5 %     7,000,000       100 %     0       *       57.6 %
5% Security Holders
  
Shane McMahon
Chairman and CEO
     2,680,834 (6)     17.6 %     7,000,000 (6)     100 %     0       *       49.0% %
Weicheng Liu
China CEO and Director
     2,141,466 (8)     14.2 %     0       *       0       *       8.8 %
Steven Oliveira
18 Fieldstone Ct.
New City, NY  10956
 
     250,000 (10)     1.7 %     0       *       250,000 (10)     100 %     * %
FMR LLC
82 Devonshire St.
Boston, MA 02109
 
     1,334,402 (11)     8.90 %     0       *       0       *       5.5 %
* Less than 1%
 
 
(1)
Beneficial Ownership is determined in accordance with the rules of the SEC and generally includes voting or investment power with respect to securities. Each of the beneficial owners listed above has direct ownership of and sole voting power and investment power with respect to our ordinary shares. For each beneficial owner above, any options exercisable within 60 days have been included in the denominator.
 
(2)
Based on 14,819,691 shares of Common Stock issued and outstanding as of March 31, 2013.
 
(3)
Based on 7,000,000 shares of Series A Preferred Stock issued and outstanding as of March 31, 2013.  Each share of Series A Preferred Stock is convertible, at any time at the option of the holder, into shares of Common Stock on a ten-to-one basis (and thereafter adjusted to reflect the Company’s February 9, 2012 1-for-75 reverse stock split).  Holders of Series A Preferred Stock vote with the holders of Common Stock on all matters and are entitled to ten (10) votes for each one (1) share of Common Stock that is issuable upon conversion of a share of Series A Preferred Stock (meaning that holders of Series A Preferred Stock are currently entitled to 100 votes per share).
 
(4)
Based on 250,000 shares of Series C Preferred Stock issued and outstanding as of March 31, 2013.  Each share of Series B Preferred Stock is convertible, at the holder’s option, into one share of Common Stock; provided, however, that the holder of Series B Preferred Stock may not convert the Series B Preferred Stock into Common Stock to the extent that such holder would beneficially own in excess of 9.99% of the number of shares of Common Stock of the Company outstanding immediately after giving effect to such conversion.  The holder of Series B Preferred Stock may waive the restriction on the conversion of the Series B Shares into Common Stock upon 61 days’ notice to the Company.  In addition, the holders of Series B Preferred Stock are not entitled to vote on matters submitted to a vote of the shareholders of the Company.
 
 
(5)
Represents total voting power with respect to all shares of our Common Stock and Series A Preferred Stock.
 
(6)
Includes 366,667 shares underlying options exercisable within 60 days at $3.00 per share, and 14,167 shares underlying options exercisable within 60 days at $4.50 per share
 
(7)
Includes 1,333 shares underlying options exercisable within 60 days at $75.00 per share, 266,667 shares underlying options exercisable within 60 days at $3.00 per share, and 6,667 shares underlying options exercisable within 60 days at $4.50 per share.
 
(8)
Includes 266,667 shares underlying options exercisable within 60 days at $3.75 per share and 14,167 shares underlying options exercisable within 60 days at $4.50 per share.
 
(9)
Includes 667 shares underlying options exercisable within 60 days at $33.75 per share, and 10,000 shares underlying options exercisable within 60 days at $3.00 per share.
 
(10)
Includes 250,000 shares of Common Stock underlying warrants which are exercisable within 60 days.  Mr. Steven Oliveira is the sole member of Oliveira Capital, LLC and has voting and dispositive over securities owned by Oliveira Capital, LLC. See Note 4 above with respect to Shares of Series C Preferred Stock and the restrictions on conversion thereof.
 
(11)
Includes 175,000 shares of Common Stock underlying warrants which are exercisable within 60 days.  FMR LLC carries out the voting of the shares under written guidelines established by the Boards of Trustees of the funds over which FMR LLC is deemed to have beneficial ownership.
 
 
Securities Authorized for Issuance Under Equity Compensation Plans

The following table includes the information as of December 31, 2012 for each category of our equity compensation plan:
 
Plan category
 
Number of securities to
be issued upon exercise
of outstanding options,
restricted stock,
warrants and rights (a)
 
 
Weighted-average
exercise price of
outstanding options,
restricted stock,
warrants and rights (b)
 
 
Number of securities remaining
available for future issuance
 under equity compensation
plans (excluding securities
reflected in column (a)) (c)
 
Equity compensation plans approved by security holders
 
 
-
 
 
 
-
 
 
 
-
 
Equity compensation plans not approved by security holders   (1)
 
 
4,000,000
 
 
$
3.54
 
 
 
2,414,599
 
Total
 
 
4,000,000
 
 
$
3.54
 
 
 
2,414,599
 
 
(1)
Effective as of the December 3, 2010, our Board of Directors approved the YOU On Demand Holdings, Inc. 2010 Equity Incentive Plan, or the 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 December 31, 2012, there are 1,585,401options outstanding under the plan for certain employees.
 

Transactions with Related Persons

The following includes a summary of transactions since the beginning of the 2012 fiscal year, or any currently proposed transaction, in which we were or are to be a participant and the amount involved exceeded or exceeds the lesser of $120,000 or one percent of the average of our total assets at year-end for the last two completed years, and in which any related person had or will have a direct or indirect material interest (other than compensation described under Item 11, “Executive Compensation”). We believe the terms obtained or consideration that we paid or received, as applicable, in connection with the transactions described below were comparable to terms available or the amounts that would be paid or received, as applicable, in arm’s-length transactions.

On May 10, 2012, at the Company’s request, our Chairman and Chief Executive Officer, 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.  On May 21, 2012, at the Company’s request, the Company and Mr. McMahon amended the note to include a provision whereby the price per share at which the note, or any securities into which the note is convertible, shall not be less than $4.75.

Except as set forth in our discussion above, none of our Directors, director nominees or executive officers has been involved in any transactions with us or any of our Directors, executive officers, affiliates or associates which are required to be disclosed pursuant to the rules and regulations of the SEC.
 
Promoters and Certain Control Persons

We did not have any promoters at any time during the past five fiscal years.


Independent Auditor’s Fees
 
The following is a summary of the fees billed to the Company by its principal accountants, UHY LLP, for professional services rendered for the years ended December 31, 2012 and 2011:
 
 
 
Year Ended December 31,
 
 
 
2012
 
 
2011
 
Audit Fees
 
$
252,639
  
 
$
265,199
 
Audit-Related Fees
 
 
  53,553
 
 
 
-
 
Tax Fees
 
 
  -
 
 
 
-
 
All Other Fees
 
 
-
 
 
 
-
 
TOTAL
 
$
306,192
 
 
$
265,199
 
 

“Audit Fees” consisted of the aggregate fees billed for professional services rendered for the audit of our annual financial statements and the reviews of the financial statements included in our Forms 10-Q and for any other services that were normally provided in connection with our statutory and regulatory filings or engagements.
 
“Audit Related Fees” consisted of the aggregate fees billed for professional services rendered for assurance and related services that were reasonably related to the performance of the audit or review of our financial statements and were not otherwise included in Audit Fees.

“Tax Fees” consisted of the aggregate fees billed for professional services rendered for tax compliance, tax advice and tax planning. Included in such Tax Fees were fees for preparation of our tax returns and consultancy and advice on other tax planning matters.

“All Other Fees” consisted of the aggregate fees billed for products and services provided and not otherwise included in Audit Fees, Audit Related Fees or Tax Fees.

Pre-Approval Policies and Procedures

Under the Sarbanes-Oxley Act of 2002, all audit and non-audit services performed by our auditors must be approved in advance by our Board of Directors to assure that such services do not impair the auditors’ independence from us.  In accordance with its policies and procedures, our Board of Directors pre-approved the audit and non-audit service performed by UHY LLP for our consolidated financial statements as of and for the year ended December 31, 2012.
 
 
PART IV

 
Financial Statements and Schedules

The financial statements are set forth under Item 8 of this annual report on Form 10-K. Financial statement schedules have been omitted since they are either not required, not applicable, or the information is otherwise included.
 
Exhibit List

The following exhibits are filed as part of this report or incorporated by reference:

Exhibit
No.
  
Description
1.1
  
Underwriting Agreement, dated December 14, 2012, by and among YOU On Demand Holdings, Inc. and Chardan Capital Markets LLC [incorporated by reference to exhibit 1.1 to the Company’s Current Report on Form 8-K filed on December 14, 2012].
3.1
  
Articles of Incorporation of the Company, as amended to date [incorporated by reference to Exhibit 3.1 to the Company’s Annual Report on Form 10-K filed on March 30, 2012].
3.2
  
Amended and Restated Bylaws of the Company. [incorporated by reference to Exhibit 3.1 to the Company’s Quarterly Report on Form 10-Q filed August 23, 2010]
3.3
  
Certificate of Designation of Series A Preferred Stock [incorporated by reference to Exhibit 3.2 to the Company’s Quarterly Report on Form 10-Q filed August 23, 2010]
3.4
  
Certificate of Designation of Series B Preferred Stock [incorporated by reference to Exhibit 3.3 to the Company’s Quarterly Report on Form 10-Q filed August 23, 2010]
4.1
  
Form of Warrant issued pursuant to the Securities Purchase Agreement dated May 20, 2010 [incorporated by reference to Exhibit 4.1 to the Company’s Quarterly Report on Form 10-Q filed August 23, 2010]
4.2
  
Form of Warrant issued on July 30, 2010 to Shane McMahon. [incorporated by reference to Exhibit 4.2 to the Company’s Quarterly Report on Form 10-Q filed August 23, 2010]
4.3
  
Form of Warrant issued on July 30, 2010 to Steven Oliveira. [incorporated by reference to Exhibit 4.3 to the Company’s Quarterly Report on Form 10-Q filed August 23, 2010]
4.4
  
Form of Warrant issued pursuant to the Securities Purchase Agreement dated August 30, 2012 [incorporated by reference to exhibit 4.1 to the Company’s Current Report on Form 8-K filed on August 31, 2012].
10.1
  
Cooperation Agreement dated as of December 26, 2006 between China Broadband, Ltd. and Jianan Guangdian Jiahe Digital Television Co., Ltd. [incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed March 20, 2007]
10.2
  
Exclusive Service Agreement, dated December, 2006, by and among Beijing China Broadband Network Technology Co., Ltd., Jinan Guangdian Jiahe Digital Television Co., Ltd. and Jinan Broadcast &Televison Information Network Center. [incorporated by reference to Exhibit 10.11 to the Company’s Current Report on Form 8-K filed June 11, 2007]
10.3
  
Cooperation Agreement, dated March 7, 2008, by and among Ji’Nan Zhongkuan Dian Guang Information Technology Co., Shandong Broadcast & TV Weekly Press and Modern Movie & TV Biweekly Press.  [incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed March 13, 2008]
10.4
  
Share Issuance Agreement, dated April 7, 2009 between the Company, China Broadband, Ltd., Waanshi Wangjing Media Technologies (Beijing) Co., Ltd. and its shareholders. [incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed April 14, 2009]
10.5
  
Loan Agreement, dated as of April 7, 2009, between China Broadband, Ltd. and Wangjing Media Technologies (Beijing) Co., Ltd. [incorporated by reference to Exhibit 10.13 to the Company’s Annual Report on Form 10-K filed April 15, 2010]
10.6
  
Equity Option Agreement, dated as of April 7, 2009, between China Broadband, Ltd. and Wangjing Media Technologies (Beijing) Co., Ltd. [incorporated by reference to Exhibit 10.14 to the Company’s Annual Report on Form 10-K filed April 15, 2010]
10.7
  
Pledge Agreement, dated as of April 7, 2009, between China Broadband, Ltd. and Wangjing Media Technologies (Beijing) Co., Ltd. [incorporated by reference to Exhibit 10.15 to the Company’s Annual Report on Form 10-K filed April 15, 2010]
10.8
  
Trustee Appointment Letter, dated as of April 7, 2009, by China Broadband, Ltd., appointing Mr. Wang Yingqi as trustee on its behalf [incorporated by reference to Exhibit 10.16 to the Company’s Annual Report on Form 10-K filed April 15, 2010]
10.9
  
Employment Agreement, dated July 30, 2010 between the Company and Shane McMahon. [incorporated by reference to Exhibit 10.9 to the Company’s Quarterly Report on Form 10-Q filed August 23, 2010]
10.10
  
Employment Agreement, dated July 30, 2010 between the Company and Marc Urbach. [incorporated by reference to Exhibit 10.11 to the Company’s Quarterly Report on Form 10-Q filed August 23, 2010]
10.11
  
Employment Agreement, dated July 30, 2010 between the Company and Weicheng Liu. [incorporated by reference to Exhibit 10.10 to the Company’s Quarterly Report on Form 10-Q filed August 23, 2010]
10.12
  
Consulting Agreement, dated January 24, 2007, between the Company and Maxim Financial Corporation. [incorporated by reference to Exhibit 10.9 to the Company’s Amended Current Report on Form 8-K/A filed June 4, 2007]
10.13
  
Form of Securities Purchase Agreement, dated August 30, 2012, by and among the Company, the Investors and Chardan Capital Management [incorporated by reference to exhibit 10.1 to the Company’s Current Report on Form 8-K filed on August 31, 2012].
10.14
  
Form of Registration Rights Agreement, dated August 30, 2012, by and between the Company and the Investors [incorporated by reference to exhibit 10.2 to the Company’s Current Report on Form 8-K filed on August 31, 2012].
10.15
  
Convertible Promissory Note in $3,000,000 principal amount issued to Shane McMahon [incorporated by reference to Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q filed on May 15, 2012].
10.16
  
Amendment No. 1 to Convertible Promissory Note in $3,000,000 principal amount issued to Shane McMahon [incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on May 21, 2012].
10.17
  
Amendment No. 2 to Convertible Promissory Note in $3,000,000 principal amount issued to Shane McMahon [incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on October 23, 2012].
 
Certifications of Principal Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.*
 
Certifications of Principal Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.*
 
Certification of Principal Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.*
 
Certification of Principal Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.*
101.INS
  
XBRL Instance Document
101.SCH
  
XBRL Taxonomy Extension Schema Document
101.CAL
  
XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF
  
XBRL Taxonomy Extension Definition Linkbase Document
101.LAB
  
XBRL Taxonomy Extension Label Linkbase Document
101.PRE
  
XBRL Taxonomy Extension Presentation Linkbase Document
 
*Filed herewith
 
 
SIGNATURES

In accordance with section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant caused this Report on Form 10-K to be signed on its behalf by the undersigned, thereto duly authorized individual.
 
Date: April 5, 2013

 
YOU ON DEMAND HOLDINGS, INC.
 
 
 
 
By:
/s/ Shane McMahon
 
 
Shane McMahon
 
 
Chief Executive Officer
 
 
 
 
By:
/s/ Marc Urbach
 
 
Marc Urbach
 
 
President and Chief Financial Officer

In accordance with the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.

Each person whose signature appears below hereby authorizes Shane McMahon and Marc Urbach, and each or any of them, as attorneys-in-fact to sign on his or her behalf, individually, and in each capacity stated below, and to file all amendments and/or supplements to this annual report on Form 10-K.

Signature
 
Title
 
Date
 
 
 
 
 
/s/ Shane McMahon
 
Chairman and Chief Executive Officer
 
April 5, 2013
Shane McMahon
 
(Principal Executive Officer)
 
 
 
 
 
 
 
/s/ Marc Urbach
 
President, Chief Financial Officer and Director
 
April 5, 2013
Marc Urbach
 
(Principal Financial and Accounting Officer)
 
 
 
 
 
 
 
/s/ Weicheng Liu
 
China Chief Executive Officer and Director
 
April 5, 2013
Weicheing Liu
 
 
 
 
 
 
 
 
 
/s/ James Cassano
 
Director
 
April 5, 2013
James Cassano
 
 
 
 
 
 
8.
Financial Statements and Supplementary Data

YOU ON DEMAND HOLDINGS, INC. AND SUBSIDIARIES

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

 
Page
Report of Independent Registered Public Accounting Firm
F-1
Consolidated Financial Statements:
  
Balance Sheets as of December 31, 2012 and 2011
F-2
Statements of Operations for the years ended December 31, 2012 and 2011
F-3
Statements of Comprehensive Loss for the years ended December 31, 2012 and 2011
F-4
Statements of Equity for the years ended December 31, 2012 and 2011
F-5
Statements of Cash Flows for the years ended December 31, 2012 and 2011
F-6
Notes to Consolidated Financial Statements
F-7

 
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Shareholders
YOU On Demand Holdings, Inc. and Subsidiaries
 
We have audited the accompanying consolidated balance sheets of YOU On Demand Holdings, Inc. and its Subsidiaries (the “Company”) as of December 31, 2012 and 2011, and the related consolidated statements of operations, comprehensive loss, stockholders’ equity, and cash flows for each of the years in the two-year period ended December 31, 2012.  The Company’s management is responsible for these consolidated financial statements. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
 
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
 
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of YOU On Demand Holdings, Inc. and its Subsidiaries as of December 31, 2012 and 2011, and the results of their operations and their cash flows for each of the years in the two-year period ended December 31, 2012 in conformity with accounting principles generally accepted in the United States of America.
 
The accompanying consolidated financial statements have been prepared assuming the Company will continue as a going concern. As discussed in Note 3 to the consolidated financial statements, the Company has incurred significant losses during 2012 and 2011 and has relied on debt and equity financings to fund their operations. These conditions raise substantial doubt about the Company’s ability to continue as a going concern. Management’s plans regarding these matters are also described in Note 3. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.

April 5, 2013
New York, New York
 
 
YOU On Demand Holdings, Inc. and Subsidiaries
CONSOLIDATED BALANCE SHEETS
December 31, 2012 and 2011
 
   
2012
    
2011
  
ASSETS
            
Current assets:
            
Cash and cash equivalents
   $ 4,381,043     $ 7,519,574  
Marketable equity securities, available for sale
     2,229       2,229  
Accounts receivable, net
     382       399,791  
Inventories, net
     384,088       413,562  
Licensed content, current
     681,457       150,325  
Prepaid expenses
     423,779       438,712  
Loan receivable from related party
     -       316,660  
Amounts due from shareholders
     -       414,743  
Amount due from non-controlling interest
     -       1,572,699  
Other current assets
     135,606       340,175  
Total current assets
     6,008,584       11,568,470  
                 
Property and equipment, net
     4,098,594       5,099,050  
Licensed content, noncurrent
     530,367       450,975  
Intangible assets, net
     5,059,188       7,149,748  
Goodwill
     6,105,478       6,105,478  
Investment in unconsolidated entities
     655,834       582,652  
Other assets
     -       101,031  
Total assets
   $ 22,458,045     $ 31,057,404  
                 
LIABILITIES AND EQUITY
                
Current liabilities:
                
Accounts payable
   $ 2,130,507     $ 3,298,041  
Accrued expenses and liabilities
     2,456,542       862,473  
Deferred revenue
     2,091,788       1,856,674  
Payable to Jinan Parent
     144,592       143,286  
Other current liabilities
     920,888       543,163  
Contingent purchase price consideration liability, current
     368,628       1,091,571  
Convertible promissory note
     3,000,000       -  
Warrant liabilities
     878,380       -  
Total current liabilities
     11,991,325       7,795,208  
                 
Other long-term payable
     -       76,670  
Deferred license fees, noncurrent
     460,547       -  
Contingent purchase price consideration liability
     368,628       2,267,518  
Deferred tax and uncertain tax position liabilities
     305,849       810,616  
Total liabilities
     13,126,349       10,950,012  
Commitments and Contingencies
                
                 
Convertible reedeemable preferred stock, $.001 par value; 50,000,000 shares authorized
                
Series A - 7,000,000 shares issued and outstanding, liquidation preference of $3,500,000 at December 31, 2012 and 2011, respectively
     1,261,995       1,261,995  
Series B - 7,866,800 and 10,266,825 shares issued and outstanding, liquidation preference of $3,933,400 and $5,133,400 at December 31, 2012 and 2011, respectively
     3,223,575       3,950,358  
Series C - 250,000 and 0 shares issued and outstanding, liquidation preference of $1,000,000 and $0 at December 31, 2012 and 2011, respectively
     627,868       -  
                 
Equity:
                
                 
Common stock, $.001 par value; 1,500,000,000 shares authorized, 13,742,394 and 10,467,400 issued at December 31, 2012 and 2011, respectively
     13,742       10,467  
Additional paid-in capital
     62,388,502       54,505,825  
Accumulated deficit
     (58,841,664 )     (43,704,225 )
Accumulated other comprehensive income
     604,632       468,471  
Total YOU On Demand equity
     4,165,212       11,280,538  
Noncontrolling interests
     53,046       3,614,501  
                 
Total equity
     4,218,258       14,895,039  
                 
Total liabilities and equity
   $ 22,458,045     $ 31,057,404  
 
See notes to consolidated financial statements.
 
 
YOU On Demand Holdings, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF OPERATIONS
Years Ended December 31, 2012 and 2011
 
   
2012
    
2011
  
             
Revenue
   $ 6,873,230     $ 7,868,175  
Cost of revenue
     7,083,517       5,525,625  
Gross (loss) profit
     (210,287 )     2,342,550  
                 
Operating expense:
                
Selling, general and administrative expenses
     10,811,548       8,801,085  
Professional fees
     1,344,653       2,114,942  
Depreciation and amortization
     4,082,936       4,423,760  
Impairment of long-lived assets
     840,000       244,861  
Total operating expense
     17,079,137       15,584,648  
                 
Loss from operations
     (17,289,424 )     (13,242,098 )
                 
Interest & other income / (expense)
                
Interest income
     8,636       10,574  
Interest expense
     (78,953 )     (1,764 )
Stock purchase right
     (43,748 )     (194,321 )
Cost of reset provision
     (658,719 )     -  
Change in fair value of warrant liabilities and modification to certain warrants
     647,302       -  
Change in fair value of contingent consideration
     1,313,443       3,016  
Gain (loss) on investment in unconsolidated entities
     67,675       (14,371 )
Loss on investment write-off
     (95,350 )     -  
Loss on write-off of uncollectible loans
     (513,427 )     -  
Gain on deconsolidation of Shandong Media
     141,814       -  
Gain on disposal of AdNet
     -       470,041  
Other
     (139,739 )     (42,849 )
                 
Net loss before income taxes and noncontrolling interest
     (16,640,490 )     (13,011,772 )
                 
Income tax benefit
     353,085       369,707  
                 
Net loss
     (16,287,405 )     (12,642,065 )
                 
Plus:  Net loss attributable to noncontrolling interests
     2,074,098       1,372,164  
                 
Net loss attributable to YOU On Demand shareholders
   $ (14,213,307 )   $ (11,269,901 )
Deemed dividends on preferred stock
     (924,132 )     -  
                 
Net loss attributable to YOU on Demand common shareholders
   $ (15,137,439 )   $ (11,269,901 )
                 
Net loss per share
                
Basic
   $ (1.36 )   $ (1.15 )
Diluted
   $ (1.36 )   $ (1.15 )
                 
Weighted average shares outstanding
                
Basic
     11,099,746       9,759,430  
Diluted
     11,099,746       9,759,430  
 
See notes to consolidated financial statements.
 
 
YOU On Demand Holdings, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
 
   
2012
    
2011
  
Net loss
   $ (16,287,405 )   $ (12,642,065 )
Other comprehensive (loss) income:
                
Foreign currency translation adjustments
     136,161       379,472  
Unrealized losses on available for sale securities
     -       (7,204 )
Less:  Comprehensive loss attributable to non-controlling interest
     1,969,294       1,221,384  
Comprehensive loss attributable to YOU On Demand shareholders
   $ (14,181,950 )   $ (11,048,413 )
 
See notes to consolidated financial statements.
 
 
YOU On Demand Holdings, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF EQUITY
For the Years Ended December 31, 2012 and 2011
 
                           
Accumulated
    
YOU On
              
               
Additional
          
Other
    
Demand
              
   
Common
    
Par
    
Paid-in
    
Accumulated
    
Comprehensive
    
Shareholders'
    
Noncontrolling
    
Total
  
   
Shares
    
Value
    
Capital
    
Deficit
    
Income
    
Equity
    
Interest
    
Equity
  
                                                 
Balance January 1, 2011
     8,810,250     $ 8,810     $ 42,907,048     $ (32,434,324 )   $ 246,983     $ 10,728,517     $ 4,684,126     $ 15,412,643  
                                                                 
Common shares issued for services
     2,667       3       9,997       -       -       10,000       -       10,000  
                                                                 
Warrants issued for service
     -       -       24,816       -       -       24,816       -       24,816  
                                                                 
Stock option compensation expense
     -       -       599,196       -       -       599,196       -       599,196  
                                                                 
Stock purchase right
     -       -       194,321       -       -       194,321       -       194,321  
                                                                 
Stock warrants issued pursuant to licensed content
     -       -       676,462       -       -       676,462       -       676,462  
                                                                 
Common shares issued for cash
     1,654,213       1,654       10,916,152       -       -       10,917,806       -       10,917,806  
                                                                 
Issuance costs related to the issuance of common shares
     -       -       (822,167 )     -       -       (822,167 )     -       (822,167 )
                                                                 
Contribution from noncontrolling interest
     -       -       -       -       -       -       151,759       151,759  
                                                                 
Share adjustment for round lot holders in connection with 75-for-1 reverse split
     270       -       -       -       -       -       -       -  
                                                                 
Net loss attributable to YOU On Demand shareholders
     -       -       -       (11,269,901 )     -       (11,269,901 )     (1,372,164 )     (12,642,065 )
                                                                 
Foreign currency translation adjustments
     -       -       -       -       228,692       228,692       150,780       379,472  
                                                                 
Unrealized losses on marketable securities
     -       -       -       -       (7,204 )     (7,204 )     -       (7,204 )
                                                                 
Balance December 31, 2011
     10,467,400     $ 10,467     $ 54,505,825     $ (43,704,225 )   $ 468,471     $ 11,280,538     $ 3,614,501     $ 14,895,039  
                                                                 
Warrants issued for services
     -       -       38,604       -       -       38,604       -       38,604  
                                                                 
Common shares issued for services
     181,617       182       571,682       -       -       571,864       -       571,864  
                                                                 
Stock option compensation expense
     -       -       766,149       -       -       766,149       -       766,149  
                                                                 
Stock purchase right
     -       -       43,748       -       -       43,748       -       43,748  
                                                                 
Conversion of Series B preferred shares into common
     320,000       320       726,463       -       -       726,783       -       726,783  
                                                                 
Common shares and options issued for Sinotop acquisition earnout
     245,274       245       1,308,145       -       -       1,308,390       -       1,308,390  
                                                                 
Common shares and warrants issued for cash in connection with August 2012 private placement
     646,250       646       2,287,895       -       -       2,288,541       -       2,288,541  
                                                                 
Issuance costs in connection with August 2012 private placement
     80,813       81       (633,746 )     -       -       (633,665 )     -       (633,665 )
                                                                 
Common shares issued for cash in connection with December 2012 retail financing
     1,800,000       1,800       2,698,200       -       -       2,700,000       -       2,700,000  
                                                                 
Issuance costs in connection with December 2012 retail financing
     -       -       (506,262 )     -       -       (506,262 )     -       (506,262 )
                                                                 
Beneficial conversion feature due to modification of Series C preferred stock
      -       -        581,800        -        -         581,800        -         581,800  
                                                                 
Deconsolidation of Shandong Media
     -       -       -       -       -       -       (497,383 )     (497,383 )
                                                                 
Reduction of registered capital for Zhong Hai Video
     -       -       -       -       -       -       (1,094,778 )     (1,094,778 )
                                                                 
Issuance of shares in connection with exercise of options
     324       -       -       -       -       -       -       -  
                                                                 
Share adjustment for round lot holders in connection with 75-for-1 reverse split
     716       1       (1 )     -       -       -       -       -  
                                                                 
Net loss
     -       -       -     $ (15,137,439 )     -       (15,137,439 )     (2,074,098 )     (17,211,537 )
                                                                 
Foreign currency translation adjustments
     -       -       -       -       136,161       136,161       104,804       240,965  
                                                                 
Balance, December 31, 2012
     13,742,394     $ 13,742     $ 62,388,502     $ (58,841,664 )   $ 604,632     $ 4,165,212     $ 53,046     $ 4,218,258  
 
See notes to consolidated financial statements.
 
 
YOU On Demand Holdings, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31, 2012 and 2011
 
   
2012
    
2011
  
Cash flows from operating activities:
            
Net loss
   $ (16,287,405 )   $ (12,642,065 )
Adjustments to reconcile net loss to net cash used in operating activities
                
Stock compensation expense
     1,376,617       634,012  
Depreciation and amortization
     4,082,936       4,423,760  
Amortization of licensed content
     150,324       75,162  
Deferred income tax
     (353,085 )     (369,707 )
(Gain) loss on investment in unconsolidated entities
     (67,675 )     14,371  
Loss on investment write-off
     47,675       -  
Provision for bad debt expense
     163,076       52,429  
Change in fair value of warrant liabilities
     (647,302 )     -  
Change in fair value of contingent purchase price consideration liability
     (1,313,443 )     (3,016 )
Value of right to purchase shares
     43,748       194,321  
Cost of reset provision
     658,719       -  
Gain on deconsolidation of Shandong Media, net of cash
     (334,589 )     -  
Impairment charge for Jinan Broadband equipment
     840,000       -  
Impairment charge for Sinotop equipment
     -       32,681  
Impairment charge to AdNet assets, net of cash
     -       209,497  
Gain on deconsolidation of AdNet
     -       (470,041 )
Loss on uncollectible shareholder loan and related party loan
     473,698       -  
Loss on uncollectible loan to Shanghai Tianduo
     39,729       -  
Other
     7,996       -  
Change in assets and liabilities,
                
Accounts receivable
     (182,094 )     (207,358 )
Inventory
     34,093       33,990  
Licensed content
     (797,987 )     -  
Prepaid expenses and other assets
     (164,046 )     628,805  
Accounts payable
     (29,787 )     1,556,689  
Accrued expenses and liabilities
     693,360       41,206  
Deferred revenue
     317,414       212,220  
Deferred license fee
     462,966       76,670  
Other current liabilities
     26,550       (221,462 )
Other
     157,687       (7,203 )
Net cash used in operating activities
     (10,600,825 )     (5,735,039 )
                 
Cash flows from investing activities:
                
Acquisition of property and equipment
     (953,636 )     (2,547,120 )
Investments in intangibles
     (272,643 )     (442,702 )
Leasehold improvements
     (10,754 )     -  
Advances to Shandong Media shareholders
     (32,771 )     (219,755 )
Repayments from Shandong Media shareholders
     29,663       -  
Investment in unconsolidated entity
     -       (46,411 )
Loan to Shanghai Tianduo
     -       (38,677 )
Net cash used in investing activities
     (1,240,141 )     (3,294,665 )
                 
Cash flows from financing activities
                
Proceeds from sale of equity securities
     6,285,000       10,917,806  
Proceeds from issuance of convertible note
     3,000,000       -  
Costs associated with August 2012 financing and share issuances
     (118,906 )     (822,167 )
Costs associated with December 2012  financing and share issuances
     (506,262 )     -  
Capital contribution from Jinan Parent
     -       151,759  
Net cash provided by financing activities
     8,659,832       10,247,398  
                 
Effect of exchange rate changes on cash
     42,603       (282,516 )
                 
Net (decrease) increase in cash and cash equivalents
     (3,138,531 )     935,178  
Cash and cash equivalents at beginning of period
     7,519,574       6,584,396  
                 
Cash and cash equivalents at end of period
   $ 4,381,043     $ 7,519,574  
                 
Supplemental Cash Flow Information:
                
                 
Cash paid for taxes
   $ -     $ -  
Cash paid for interest
   $ 78,953     $ 1,764  
Software contributed in lieu of issued capital included in intangibles
   $ 398,183     $ -  
Value of shares and warrants issued in connection with August 2012 private financing
   $ 2,639,640     $ -  
Value of shares and options issued for Sinotop contingent consideration earnout
   $ 1,308,391     $ -  
Value of common stock issued from conversion of Preferred Series B shares
   $ 726,783     $ -  
Value of warrants issued for licensed content
   $ -     $ 676,462  
Property and equipment included in accrued expenses
   $ -     $ 192,791  
Intangible assets inlcuded in accounts payable
   $ -     $ 210,000  
 
See notes to consolidated financial statements.
 
 
YOU ON DEMAND HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO AUDITED CONSOLIDATED FINANCIAL STATEMENTS

1.
Basis of Presentation

YOU On Demand Holdings, Inc., a Nevada corporation (“YOU On Demand”, “we”, “us”, or “the Company”) (formerly China Broadband, Inc.), operates in the Chinese media segment through our Chinese subsidiaries and variable interest entities (“VIEs”) (1) an integrated value-added service solutions business for the delivery of video on demand (“VOD”) and enhanced premium content for cable providers, Beijing Sino Top Scope Technology Co., Ltd. (“Sinotop Beijing” or “Sinotop”) , (2) a cable broadband business, Jinan Guangdian Jia He Broadband Co. Ltd. ( “Jinan Broadband”), based in the Jinan region of China through which we provide cable and wireless broadband services, principally internet services, Internet Protocol Point wholesale services, related network equipment rental and sales, and fiber network construction and maintenance and (3) a print based media and television programming guide publication, Shandong Lushi Media Co., Ltd. (“Shandong Media”). Effective July 1, 2012, the Company deconsolidated Shandong Media as discussed below in Note 11.

The Company’s Board of Directors authorized a 75:1 reverse stock split on February 9, 2012, which took effect on February 9, 2012. All share and related option information presented in these consolidated financial statements and related notes has been retroactively adjusted to reflect the reduced number of shares resulting from this reverse stock split.

2.
Summary of Significant Accounting Policies

Principles of Consolidation
The audited consolidated financial statements include the accounts of YOU On Demand and (a) its wholly-owned subsidiary China Broadband, Ltd., ("CB Cayman"), (b) two wholly-owned subsidiaries of CB Cayman: Beijing China Broadband Network Technology Co., Ltd. (“WFOE”) and Sinotop Group Limited (“Sinotop Hong Kong”) and (c) six entities located in the PRC: Jinan Zhong Kuan, Jinan Broadband, Shandong Media, Sinotop, Zhong Hai Shi Xun Information Technology Co., Ltd. (“Zhong Hai Video”), and YOU On Demand (Beijing) Technology Co., Ltd. (“YOD WFOE”), which are controlled by the Company through contractual arrangements, as if they are majority owned subsidiaries of the Company. As of July 1, 2012, the Company deconsolidated Shandong Media as discussed below in Note 11. During the third quarter 2011, AdNet was also deconsolidated as a result of the Company’s termination of control as discussed below in Note 10. All material intercompany transactions and balances are eliminated in consolidation.

Investment in Unconsolidated Entities
The Company has two investments in the PRC entities.  The consolidated financial statements include our original investment in this entity plus our share of undistributed earnings or losses, in the account “Investment in unconsolidated entities.”

Basis of Presentation
The Company's policy is to use the accrual method of accounting to prepare and present financial statements, which conform to the U.S. generally accepted accounting principles (U.S. GAAP).
 
Estimates
The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

The most significant estimates relate to goodwill and intangible asset valuations and useful lives, contingent purchase consideration, warrant liabilities, inventory obsolescence, depreciation and allowance for uncollectible accounts receivable. These estimates may be adjusted as more current information becomes available, and any adjustment could be significant.

Cash and cash equivalents
Cash and cash equivalents consist of cash on hand and marketable securities with original maturities of three months or less.

 
Accounts Receivable
Accounts receivable are recognized and carried at original invoiced amount less an allowance for any uncollectible accounts.
 
Inventories
Inventories, consisting of cables, fiber, connecting material, power supplies and spare parts are stated at the lower of cost or market value, including provisions for obsolescence commensurate with known or estimated exposures. Inventories net of a valuation reserve are approximately $384,000 at December 31, 2012, and $414,000 at December 31, 2011.  Cost is determined using the weighted average method.  
 
Property and Equipment
Property and equipment are stated at cost less accumulated depreciation. Expenditures for major renewals and betterments, which extend the original estimated economic useful lives or applicable assets, are capitalized. Expenditures for normal repairs and maintenance are charged to expense as incurred. The costs and related accumulated depreciation of assets sold or retired are removed from the accounts and any gain or loss thereon is reflected in operations. Depreciation is provided for on a straight-line basis over the estimated useful lives of the respective assets.

Licensed Content
The Company obtains content through content license agreements and revenue sharing agreements with studios and distributors. The license agreement may or may not be recognized in licensed content.

When the license fee is not known or reasonably determinable for a specific title, the title does not meet the criteria for recognition in licensed content in accordance with Financial Accounting Standards Boards (FASB) Accounting Standards Codification (ASC) Topic 920, Entertainment – Broadcasters. In the event, the license fee is not known or reasonably determinable for a specific title in content license agreements that do not specify the license fee per title, we expense as costs of revenues the greater of revenue sharing costs incurred through the end of the reporting period or the proportionate value of total minimum license fees expensed on a straight-line basis over the term of each license agreement. As the Company expenses license fees on a straight-line basis, it may result in deferred or prepaid license fees. Prepaid license fees are classified as an asset on the consolidated balance sheets as licensed content and deferred license fees are classified as a liability on the consolidated balance sheets as deferred license fees. Commitments for license agreements that do not meet the criteria for recognition in licensed content are included in Note 21 to the consolidated financial statements.

Intangible Assets
Intangible assets are stated at acquisition fair value or cost less accumulated amortization. The Company amortizes its intangible assets with definite lives over their estimated useful lives and reviews these assets for impairment. The Company is currently amortizing its intangible assets with definite lives over periods generally ranging between 2.5 to 20 years. The service agreement, publication rights, operating permits and charter/cooperation agreements are amortized over 20 years. Customer relationships, non-compete agreement, and software technology are amortized over 10 years, 2.5 years and 3 years, respectively. Software and licenses are amortized over 3 years and 5 years.

Website development costs
Website development costs are stated at acquisition fair value or cost less accumulated amortization. The Company capitalizes website development costs associated with graphics design and development of the website application and infrastructure. Costs related to planning, content input, and website operations are expensed as incurred. The Company amortizes website development costs over three years and reviews these costs for impairment.

Goodwill
In accordance with U.S. GAAP, the Company tests goodwill for impairment annually as of December 31 and whenever events or circumstances make it more likely than not that impairment may have occurred. The Company reviews goodwill for impairment based on its identified reporting units, which are defined as reportable segments or groupings of businesses one level below the reportable segment level. In September 2011, the FASB issued guidance on testing goodwill for impairment. The guidance provides entities with an option to perform a qualitative assessment to determine whether further quantitative impairment testing is necessary.
 

In accordance with the guidance, the Company reviews goodwill for impairment by first assessing qualitative factors to determine whether the existence of events or circumstances made it more likely than not that the fair value of a reporting unit is less than its carrying amount. If the Company determines 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. Significant assumptions inherent in the valuation methodologies for goodwill are employed and include, but are not limited to, such estimates as projected business results, growth rates, the Company’s weighted-average cost of capital, royalty and discount rates.

Impairment of Long-Lived Assets
Long-lived assets, including property, equipment, intangible assets, website development costs and goodwill, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. 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. If the carrying amount of an asset exceeds its estimated future cash flows, an impairment charge is recognized for the amount by which the carrying amount of the asset exceeds the fair value of the asset.

Assets to be disposed of are separately presented in the balance sheet and reported at the lower of the carrying amount or fair value less costs to sell, and are no longer depreciated. The assets and liabilities of a disposed group classified as held for sale are presented separately in the appropriate asset and liability sections of the balance sheet.

Warrant Liabilities
We account for derivative instruments and embedded derivative instruments in accordance with the accounting standard for Accounting for Derivative Instruments and Hedging Activities, as amended. The amended standard requires an entity to recognize all derivatives as either assets or liabilities in the statement of financial position and measure these instruments at fair value. Fair value is estimated using the Monte Carlo simulation method.  We also follow accounting standards for the Accounting for Derivative Financial Instruments Indexed to and Potentially Settled in, a Company’s Own Stock, which requires freestanding contracts that are settled in a company’s own stock, including common stock warrants, to be designated as an equity instrument, asset or a liability. Under these provisions a contract designated as an asset or a liability must be carried at fair value, with any changes in fair value recorded in the results of operations. A contract designated as an equity instrument can be included in equity, with no fair value adjustments required. The asset/liability derivatives are valued on a quarterly basis using the Black-Scholes Pricing model. Significant assumptions used in the valuation included exercise dates, fair value for our common stock, volatility of our common stock and a proxy-free interest rate. Gains (losses) on warrants are included in “Changes in fair value of warrant liabilities in our consolidated statement of operations”.

Advertising & Marketing Expense
The Company expenses advertising and marketing costs as incurred, which are included in selling expense. Advertising and marketing costs were approximately $1,024,000 and $752,000 for the years ended December 31, 2012 and 2011, respectively.
 
Income Taxes
The Company accounts for income taxes in accordance with the asset and liability method. Deferred taxes are recognized for the future tax consequences attributable to temporary differences between the carrying amounts of assets and liabilities for financial statement purposes and income tax purposes using enacted rates expected to be in effect when such amounts are realized or settled. The effect on deferred taxes of a change in tax rates is recognized in income in the period that includes the enactment date. A tax valuation allowance is established, as needed to reduce net deferred tax assets to the amount expected to be realized. The Company also follows applicable guidance for accounting for uncertainty in income taxes.
 
The evaluation of a tax position is a two-step process. The first step is to determine whether it is more-likely-than-not that a tax position will be sustained upon examination, including the resolution of any related appeals or litigation based on the technical merits of that position. The second step is to measure a tax position that meets the more-likely-than-not threshold to determine the amount of benefit to be recognized in the financial statements. A tax position is measured at the largest amount of benefit that is greater than 50% likely of being realized upon ultimate settlement.
 

Tax positions that previously failed to meet the more-likely-than-not recognition threshold should be recognized in the first subsequent period in which the threshold is met. Previously recognized tax positions that no longer meet the more-likely-than-not criteria should be de-recognized in the first subsequent financial reporting period in which the threshold is no longer met.

The Company recognizes accrued interest and penalties related to unrecognized tax benefits and audits in the provision for income taxes in our consolidated statements of operation.

Revenue Recognition
Revenue is recorded as services are provided or publications are shipped to customers. The Company generally recognizes all revenues in the period in which the service is rendered or shipment is made, provided that persuasive evidence of an arrangement exists, delivery has occurred, the sales price is fixed or determinable, and collection is reasonably assured. The Company records deferred revenue for payments received from customers for the performance of future services and recognizes the associated revenue in the period that the services are performed.

Net Loss Per Share Attributable to YOU On Demand Shareholders
Basic and Diluted net loss per share attributable to YOU On Demand shareholders have been computed by dividing the net loss by the weighted average number of common shares outstanding. The assumed exercise of dilutive warrants, less the number of treasury shares assumed to be purchased from the proceeds of such exercises using the average market price of the Company’s common stock during each respective period, have been excluded from the calculation of diluted net loss per share as their effect would be antidilutive.

Foreign Currency Translation
The Company’s subsidiaries and VIEs located in China use its local currency (RMB) as its functional currency. Translation adjustments are reported as gains or losses in other comprehensive income or loss on the statement of comprehensive loss and accumulated as other comprehensive loss in the equity section of the balance sheet. The exchange rates used to translate amounts in functional currencies into USD for the purpose of preparing the consolidated financial statements were as follows:

   
2012
    
2011
  
Period end RMB:USD exchange rate
     6.3011       6.3588  
Average RMB:USD exchange rate
     6.3116       6.4688  

The RMB is not freely convertible into other foreign currencies, and all foreign exchange transactions must take place through authorized institutions. There is no assurance that the RMB amounts could have been, or could be, converted into USD at the rates used in translation.
 
Economic and Political Risks
The Company’s current operations are conducted in the PRC. Accordingly, the Company’s consolidated financial condition and results of operations may be influenced by the political, economic and legal environment in the PRC and by the general state of the PRC economy.
 
The Company’s operations in the PRC are subject to special considerations and significant risks not typically associated with companies in North America and Western Europe. These include risks associated with, among others, the political, economic and legal environment and foreign currency exchange. The Company’s consolidated results may be adversely affected by changes in the political and social conditions in the PRC and by changes in governmental policies with respect to laws and regulations, anti-inflationary measures, currency conversion, remittances abroad and rates and methods of taxation, among other things.

Concentrations of Credit Risk
Financial instruments that potentially subject the Company to concentrations of credit risk consist principally of accounts receivable. The Company generally requires advance payments for internet services. Other concentrations of credit risk are limited due to the large customer base in Jinan, a sub-provincial city of Shandong province in the People’s Republic of China.
 

Fair value of Financial Instruments
The fair values of accounts receivable, prepaid expenses and accounts payable and accrued expenses are estimated to approximate the carrying values at December 31, 2012 and 2011 due to the short maturities of such instruments.

Stock-Based Compensation
The Company awards stock options and other equity-based instruments to its employees, Directors and consultants (collectively “share-based payments”). Compensation cost related to such awards is measured based on the fair value of the instrument on the grant date and is recognized on a straight-line basis over the requisite service period, which generally equals the vesting period. All of the Company’s stock-based compensation is based on grants of equity instruments and no liability awards have been granted.

Reportable Segment
The Company operates under one reportable business segment, media, for which segment disclosure is consistent with the management decision-making process that determines the allocation of resources and the measuring of performance.

Recent Accounting Pronouncements
Management does not believe that any recently issued, but not yet effective accounting pronouncements, if adopted, would have a material effect on the accompanying financial statements.

3.
Going Concern and Management’s Plans

For the year ended December 31, 2012, we had a net loss of approximately $14,213,000 and we used cash for operations of approximately $10,601,000. We had a working capital deficit of approximately $5,983,000 and accumulated deficit of approximately $59 million, at December 31, 2012. The Company will continue to rely on debt and equity to pay for ongoing operating expenses in order to execute its business plan. We have the ability to raise funds by various methods including utilization of our $50 million shelf registration of which $47.3 million is remaining as well as other means of financing such as debt or private investment.   However, financing may not be available to the Company on terms acceptable to us or at all or that such resources will be received in a timely manner.   Further we may need approval to seek additional financing from the shareholders from the August 2012 private financing in the event we do a public financing.

These conditions raise substantial doubt about the Company’s ability to continue as a going concern. We anticipate that we will need to raise additional funds to fully implement our business model and related strategies.

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.
 
4. 
VIE Structure and Arrangements
 
Management Services Agreement
 
Pursuant to a Management Services Agreement, dated as of March 9, 2010, between Sinotop Beijing and Sinotop Hong Kong (the “Management Services Agreement”), Sinotop 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 Sinotop Hong Kong.  As compensation for providing the services, Sinotop Hong Kong is entitled to receive a fee from Sinotop Beijing, upon demand, equal to 100% of the annual Net Profits of Sinotop Beijing during the term of the Management Services Agreement (Sinotop Hong Kong may request ad hoc quarterly payments of the aggregate fee, which payments will be credited against Sinotop Hong Kong’s future payment obligations).
 
The Management Services Agreement also provides Sinotop 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 Sinotop Hong Kong, Sinotop Beijing may be obligated to transfer to Sinotop 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 Sinotop Hong Kong, including:
 
 
(a) business opportunities presented to, or available to Sinotop Beijing may be pursued and contracted for in the name of Sinotop Hong Kong rather than Sinotop Beijing, and at its discretion Sinotop 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 Sinotop 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 Sinotop Hong Kong by acquisition, lease, license or otherwise, and made available to Sinotop Beijing on terms to be determined by agreement between Sinotop Hong Kong and Sinotop Beijing;
 
(d) contracts entered into in the name of Sinotop Beijing may be transferred to Sinotop Hong Kong, or the work under such contracts may be subcontracted, in whole or in part, to Sinotop Hong Kong, on terms to be determined by agreement between Sinotop Hong Kong and Sinotop Beijing; 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 Sinotop Hong Kong, and in the name of and at the expense of, Sinotop 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 Sinotop 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, Sinotop Hong Kong.
 
Equity Pledge Agreement
 
Pursuant to an Equity Pledge Agreement among Sinotop Hong Kong, Sinotop Beijing and the sole shareholder of Sinotop Beijing (the “Shareholder”), dated March 9, 2010, the Shareholder pledged all of its equity interests in Sinotop Beijing (the “Collateral”) to Sinotop Hong Kong as security for the performance of the obligations of Sinotop Beijing to make all of the required management fee payments pursuant to the Management Services Agreement.  The term of the Equity Pledge Agreement expires two years from Sinotop Beijing’s satisfaction of all obligations under the Management Services Agreement.
 
Option Agreement
 
Pursuant to an Option Agreement among Sinotop Hong Kong, Sinotop Beijing and the sole shareholder of Sinotop Beijing (the “Shareholder”), dated March 9, 2010, and entered into in connection with the Management Services Agreement, the Shareholder granted an exclusive option to Sinotop Hong Kong 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 Shareholder’s equity in Sinotop Beijing.  The aggregate purchase price of the option is equal to the paid-in registered capital of the Shareholder.  The term of the agreement is until all of the equity interest in Sinotop Beijing held by the Shareholder is transferred to Sinotop Hong Kong or its designee, or until the maximum period allowed by law has run, and may not be terminated by any party to the agreement without the consent of the other parties.
 
Voting Rights Proxy Agreement
 
Pursuant to a Voting Rights Proxy Agreement among Sinotop Hong Kong, Sinotop Beijing and the sole shareholder of Sinotop Beijing (the “Shareholder”), dated March 9, 2010, the Shareholder granted to Sinotop Hong Kong an irrevocable proxy, for the maximum period of time permitted by law, all of its voting rights as a shareholder of Sinotop Beijing.  The Shareholder may not transfer any of its equity interest in Sinotop Beijing to any party other than Sinotop Hong Kong.  The Voting Rights Proxy Agreement may not be terminated except upon the written consent of all parties, or unilaterally by Sinotop Hong Kong upon 30 days’ notice.
 
Jinan Broadband
 
The corporate structure for our broadband business consists of:
 

 
●
a Cooperation Agreement, dated as of December 26, 2006, between CB Cayman and Jinan Parent (the “December 2006 Cooperation Agreement”);
 
●
a Cooperation Agreement dated as of January 2007, between Jinan Broadband and Networks Center (the “January 2007 Cooperation Agreement”); and
 
●
two Exclusive Service Agreements, dated December 2006 and March 2007, between Jinan Broadband, Jinan Parent and Networks Center (collectively, the “Exclusive Service Agreements”).

Pursuant to the December 2006 Cooperation Agreement, CB Cayman and Jinan Parent set up a joint venture, Jinan Broadband.  CB Cayman contributed in cash and owns a 51% controlling interest, and   Jinan Parent contributed the assets in exchange of 49% ownership in Jinan broadband.   Jinan Broadband is a corporate joint venture with a term of 20 years.  Jinan Broadband is considered as a VIE based on ASC 810-10-25-38 due to the fact that CB Cayman has a controlling financial interest in Jinan Broadband and therefore deemed to be the primary beneficiary based on the terms stipulated in the December 2006 Cooperation Agreement below:

 
●
CB Cayman appointed 3 directors and Jinan Parent appointed 2 directors;
 
●
The general manager and financial manager are appointed by CB Cayman; and
 
●
CB Cayman is entitled to receive 51% of net profit/loss of Jinan Broadband.

Pursuant to the January 2007 Cooperation Agreement, Networks Center, the PRC governmental agency which controls Jinan Parent, affirmed the arrangement set forth in the December 2006 Cooperation Agreement which provided that all of the pre-tax revenues of Jinan Broadband would be assigned to our WFOE for 20 years.

Under the terms of the Exclusive Service Agreements, Jinan Broadband is obligated to provide certain technical services needed by Jinan Parent and is entitled to receive 100% of the pre-tax revenue of access services from Jinan Parent as a service charge in exchange.
 
Shandong Media
 
Effective July 1, 2012, we deconsolidated Shandong Media due to a decrease in ownership from 50% to 30% (see Note 11 below for additional details related to the deconsolidation).

On March 7, 2008, we entered into the Shandong Cooperation Agreement with the Shandong Newspaper Entities.  The Shandong Cooperation Agreement provided for, among other terms, the creation of a joint venture entity in the PRC, Shandong Media, that would own and operate the television program guide, newspaper and magazine publishing businesses previously owned and operated by the Shandong Newspaper Entities pursuant to exclusive licenses.  In addition, Shandong Media entered into an exclusive advertising agency agreement and an exclusive consulting services agreement with the Shandong Newspaper Entities and another third party, Music Review Press, which requires that the Shandong Newspaper Entities and Music Review Press shall appoint Shandong Media as their exclusive advertising agent and provider of technical and management support for a fee.
 
Under the terms of the Shandong Cooperation Agreement and related pledge and trust documents, the Shandong Newspaper Entities contributed their entire Shandong newspaper business and transferred certain employees to Shandong Media in exchange for a 50% stake in Shandong Media, with the other 50% of Shandong Media to be owned directly by Jinan Zhong Kuan and indirectly by our WFOE in the PRC in the second quarter of 2008, with the joint venture becoming operational in July of 2008.  In exchange, therefore, the Shandong Cooperation Agreement provided for total initial consideration from us of approximately $1.5 million (approximately 10 million RMB).  As part of the transaction, and to facilitate our subsidiary’s ownership and control over Shandong Newspaper under PRC law, through our WFOE in the PRC, this acquisition was completed in accordance with a pledge and loan agreement, pursuant to which all of the shares of Shandong Media which we acquired are held in trust on our behalf by a nominee holder, as security for a loan to Shandong Media’s parent seller.

On January 19, 2012, through Jinan Zhong Kuan, we entered into a Memorandum of Understanding with the Shandong Newspaper Entities pursuant to which we expressed the intention to amend the terms of the Shandong Cooperation Agreement to transfer an aggregate of 20% of our ownership interest in Shandong Media to the Shandong Newspaper Entities. Shandong Media received notice of approval by the PRC State Administration for Industry & Commerce to effect the changes made in the Articles of Association and complete the transaction. The equity transfer ownership was effective as of July 1, 2012, and we have deconsolidated Shandong Media and recorded our 30% ownership under the equity method of accounting.
 

We are entitled to 100% of the pre-tax income of Jinan Zhong Kuan, in two ways which are discussed below.  First, there are two individual owners of Jinan Zhong Kuan which hold all of the equity in that company in trust for the benefit of CB Cayman, pursuant to trustee arrangements entered into with them in 2008.  The trustee arrangements relieve the individual shareholders from any responsibilities for the day-to-day operations of the company and any liability arising from their role as equity holders.  All actions taken by them as shareholders will be in accordance with instructions provided by CB Cayman.  The trustee arrangements provide that, in consideration for an up-front fee paid by CB Cayman, and monthly cash payments thereafter, the equity holders of Jinan Zhong Kuan will hold the equity of Jinan Zhong Kuan in trust for, and only for the benefit of, CB Cayman.  We believe CB Cayman’s right to receive 100% of the dividends paid on the equity held in trust for it by the two individuals is appropriate under PRC transfer pricing rules, which are found in Arts. 41-48 of the PRC Enterprise Income Tax Law and Arts. 109-123 of the Implementing Regulations thereunder, and complies with the “arm’s length principle” mandated by Art. 41 of the Enterprise Income Tax Law, because those individuals have no responsibilities and take no risk in connection with their role as trustee shareholders other than to vote when requested and as directed by CB Cayman.
 
As a practical matter, however, there are not likely to be any dividends paid on the equity of Jinan Zhong Kuan, because all of its pre-tax income is required to be paid over to the WFOE under the terms of an exclusive services agreement entered into in January 2008. Under the terms of the exclusive services agreement, the WFOE is obligated to provide all management, technical and support services needed by Jinan Zhong Kuan and is entitled to receive 100% of the pre-tax income of Jinan Zhong Kuan in exchange. Jinan Zhong Kuan has no income other than profit distributions from Shandong Media.  Jinan Zhong Kuan and our WFOE are related parties, and all of the risk and burden of the operations of Jinan Zhong Kuan is shifted to the WFOE under the exclusive services agreement, and therefore all of the economic benefit is shifted to the WFOE, as well.  If the PRC tax authorities were to disagree with our position regarding the pricing under the exclusive services agreement between Jinan Zhong Kuan and the WFOE, there is no potential for past-due tax liability with respect to Jinan Zhong Kuan because, as noted above, Jinan Zhong Kuan has never recognized any profits.
 
The Company, through CB Cayman, is the sole owner of the WFOE, and exercises the overall voting power over the WFOE.  In addition, through the various contractual agreements between CB Cayman, the trustees, the WFOE and Jinan Zhong Kuan, as discussed above, Jinan Zhong Kuan is considered a VIE.  As the Company bears all risks and is entitled to all benefits relating to the investment in Jinan Zhong Kuan, the Company is a primary beneficiary of Jinan Zhong Kuan and is required to consolidate Jinan Zhong Kuan under the variable interest model.  With respect to Shandong Media, it cannot finance its own activities without the cash contribution from Jinan Zhong Kuan.  In addition, apart from its equity interest in Shandong Media, Jinan Zhong Kuan has the obligation to bear expected losses and receive expected returns through the exclusive services agreement, which entitles Jinan Zhong Kuan to all net profits of Shandong Media.
 
5.
Content Accounting

The Company obtains content through content license agreements and revenue sharing agreements with studios and distributors. The license agreement may or may not be recognized in licensed content.

When the license fee is not known or reasonably determinable for a specific title, the title does not meet the criteria for recognition in licensed content in accordance with ASC 920-350-25-2. We expense as costs of revenues the greater of revenue sharing costs incurred through the end of the reporting period or the proportionate value of total minimum license fees expensed on a straight-line basis over the term of each license agreement. As the Company expenses license fees on a straight-line basis, it may result in deferred or prepaid license fees. Prepaid license fees are classified as an asset on the consolidated balance sheets as licensed content and deferred license fees are classified as a liability on the consolidated balance sheets as deferred license fees.  Commitments for license agreements that do not meet the criteria for recognition in licensed content are discussed in Note 21 to the consolidated financial statements.
 
6.
Warner Bros. License Agreement

On July 1, 2011, the Company, through its Chinese joint venture Zhong Hai Video entered into a Transactional Video on Demand and Pay-Per-View License Agreement (the “WB Agreement”) with CAV Warner Home Entertainment Co., Ltd. (“CAVW”), Warner Bros. Home Entertainment Group’s joint venture in China. Pursuant to the WB Agreement, Zhong Hai Video was granted a license under copyright for a total term of fifty-four months beginning on July 1, 2011. The contract is subject to annual minimum payments.
 

In connection with the WB Agreement, the Company issued 200,000 warrants to Warner Bros. Entertainment Inc. exercisable at a price per share of $6.60 for a term of five years beginning on May 12, 2011. These warrants are subject to a right of redemption exercisable by the Company in the event the closing price of the Company's common stock shall equal or exceed $13.20 per share for twenty consecutive trading days. In accordance with ASC 505-50, Equity-based Payments to Non-employees, the fair value of equity instruments issued in the acquisition of goods or services should be recognized in the same manner as if an enterprise had paid cash. As such, the Company estimated the fair value of the warrants granted using the Black-Scholes Merton model at $676,462 and capitalized the amount as licensed content. The Black-Scholes Merton model incorporated the following assumptions: risk-free interest rate of 1.89%, expected volatility of 60.0%, expected life of 5.0 years and expected dividend yield of 0%. The Company began amortizing this asset during the third quarter of 2011 and recognized approximately $150,000 and $75,000 (which is included in cost of revenue) during the years ended December 31, 2012 and 2011, respectively.
 
7.
Property and Equipment

During 2012, we reviewed the equipment assets at our Jinan Broadband subsidiary and determined that an additional impairment should be recorded based on the estimated realizable values. We initially reserved a portion of these assets in 2010.  During 2012, we recorded an additional estimated impairment of $840,000 related to the facilities and machinery assets. The assets being impaired are considered to have no salvageable value.

   
December 31,
    
December 31,
  
   
2012
    
2011
  
             
Furniture and office equipment
   $ 3,202,000     $ 2,088,000  
Facilities and machinery
     15,779,000       16,724,000  
Leasehold improvements
     178,000       310,000  
Vehicles
     54,000       30,000  
Total property and equipment
     19,213,000       19,152,000  
Less:  accumulated depreciation
     (15,114,000 )     (14,053,000 )
Net carrying value
   $ 4,099,000     $ 5,099,000  

We recorded depreciation expense of approximately $2,052,000 and $2,505,000 for the years ended December 31, 2012 and 2011, respectively.

8.
Goodwill and Intangible Assets

The Company has intangible assets primarily relating to the acquisitions of Jinan Broadband and Sinotop Hong Kong. The Company amortizes its intangible assets that have finite lives. As discussed in Note 10, the Company determined during 2011 that AdNet’s remaining assets would no longer be used. As such, the Company recognized an impairment loss related to AdNet’s software technology in the amount of $189,241 during the quarter ended June 30, 2011. For Jinan Broadband, we reclassified $159,132 from fixed assets to software and licenses during the quarter ended June 30, 2012.
 
 
A roll forward of our intangible assets activity from December 31, 2011 to December 31, 2012 is as follows:
 
   
Balance at
                
Deconsolidation
    
Foreign
    
Balance at
  
   
December 31,
          
Amortization
    
of Shandong
    
Currency
    
December 31,
  
   
2011
    
Additions
    
Expense
    
Media
    
Transl Adj
    
2012
  
Amortized intangible assets:
                                    
Service agreement
   $ 1,310,892     $ -     $ (85,960 )   $ -     $ 291,231 (1)   $ 1,516,163  
Publication rights
     400,953       -       (12,150 )     (388,803 )     -       -  
Customer relationships
     76,579       -       (5,890 )     (70,689 )     -       -  
Operating permits
     600,147       -       (18,186 )     (581,961 )     -       -  
Charter / Cooperation agreements
     2,560,616       -       (137,792 )     -       -       2,422,824  
Noncompete agreement
     1,576,256       -       (1,455,004 )     -       -       121,252  
Software and licenses
     240,015       586,733       (191,212 )     (4,066 )     (789 )     630,681  
Website development
     250,000       100,000       (116,989 )     -       967       233,978  
Total amortized intangible assets
   $ 7,015,458     $ 686,733     $ (2,023,183 )   $ (1,045,519 )   $ 291,499     $ 4,924,898  
                                                 
Unamortized intangible assets:
                                                
Website name
     134,290       -       -       -       -       134,290  
Goodwill
     6,105,478       -       -       -       -       6,105,478  
Total unamortized intangible assets
   $ 6,239,768     $ -     $ -     $ -     $ -     $ 6,239,768  
 
 
(1)
Cumulative foreign currency translation adjustment related to our Jinan Service Agreement
 
In accordance with ASC 250, we recorded amortization expense related to our intangible assets of approximately $2,030,000 and $1,919,000 during 2012 and 2011, respectively.
 
The following table outlines the amortization expense for the next five years and thereafter:
 
   
Jinan
    
Sinotop
              
Years ending December 31,
  
Broadband
    
Hong Kong
    
Sinotop
    
Total
  
2013
   $ 155,284     $ 259,041     $ 277,062     $ 691,387  
2014
     148,779       137,791       241,604       528,174  
2015
     133,745       137,791       97,700       369,236  
2016
     113,952       137,791       95,298       347,041  
2017
     106,398       137,791       26,830       271,019  
Thereafter
     984,170       1,733,871       -       2,718,041  
Total amortization to be recognized
   $ 1,642,328     $ 2,544,076     $ 738,494     $ 4,924,898  
 
9. 
Equity Method Investments
 
The Company’s investments in companies that are accounted for on the equity method of accounting consist of the following: (1) 30% interest in Shandong Media, a print based media business; and (2) 39% interest in Hua Cheng, a company established to provide integrated value-added service solutions for the delivery of VOD and enhanced premium content for cable providers.
 

   
2012
    
2011
  
Condensed income statement information:
            
             
Net sales
   $ 1,862,223     $ -  
                 
Gross margin
   $ 419,696     $ -  
                 
Net loss
   $ (258,450 )   $ (36,849 )
                 
Company's equity in net income (loss)
   $ 67,675     $ (14,371 )
                 
                 
Condensed balance sheet information:
                
                 
Current assets
   $ 3,018,413     $ 1,364,720  
Noncurrent assets
   $ 577,291     $ 177,960  
Total assets
   $ 3,595,704     $ 1,542,680  
                 
Current liabilities
   $ 1,578,030     $ 10  
Noncurrent liabilities
   $ 182,151     $ -  
Equity
   $ 1,835,523     $ 1,542,670  
Total liabilities and equity
   $ 3,595,704     $ 1,542,680  
 
10.
Deconsolidation of AdNet

We acquired AdNet during the first half of 2009. Due to the shift of our business model to the VOD business, as of December 31, 2009 we permanently suspended day-to-day operations of AdNet. Subsequently, we continued to maintain the technology and assets of AdNet, which we planned to use in our VOD business.

Due to recent continuing advancements in other advertising technologies, the Company determined that AdNet’s remaining assets would no longer be used to support the VOD business. As such, on August 3, 2011, the Company provided a thirty-day notice of its termination of the VIE arrangement with AdNet, which served to relinquish the Company’s control and any right to economic benefit, as well as release the Company of any future liability, upon effectiveness of such termination on September 2, 2011.

Accordingly, as of June 30, 2011, the Company recognized a loss on the impairment of AdNet’s remaining assets in the amount of $212,180. Upon the effectiveness of termination during the third quarter of 2011, the Company deconsolidated AdNet’s liabilities and recognized a gain of $470,041 in accordance with ASC 810-10-40, Deconsolidation of a Subsidiary.
 
11.
Deconsolidation of Shandong Media Joint Venture

In connection with the Shandong Newspaper Cooperation Agreement, based on certain financial performance thresholds we were required to make an additional payment of RMB 5,000,000 (approximately US $791,900) to Shandong Media. In January 2012, the Company, through Jinan Zhong Kuan, signed a Memorandum of Understanding (“MOU”) with Shandong Broadcast and Modern Movie, our partners in our Shandong Media joint venture company, whereby upon execution of a formal agreement, the Company was relieved of its obligation to make the additional payment of RMB 5,000,000 (approximately US $791,900) described above in exchange for payment of RMB 1,000,000 (approximately US$158,300) to Shandong Media and the transfer of 20% of the Company’s 50% ownership interest in Shandong Media to Shandong Broadcast and Modern Movie. In April 2012, Jinan Zhong Kuan made payment of RMB 1,000,000 to Shandong Broadcast in connection with the signed MOU.
 

Shandong Media has received notice of approval by the PRC State Administration for Industry & Commerce (“AIC”) to effect the changes made in the Articles of Association (“AOA”) and complete the transaction. The equity transfer ownership is effective as of July 1, 2012 and we have deconsolidated Shandong Media and recorded our 30% ownership under the equity method of accounting in accordance with ASC 810-10-40, Deconsolidation of a Subsidiary. We valued the 30% investment in Shandong Media at fair value based on historical and forecasted performance utilizing discounted cash flow methodology. Due to current performance and risks associated with future cash flow we valued Shandong Media at $0.00 as of the date of deconsolidation. As part of the deconsolidation we have removed the net assets associated with Shandong and recognized a gain of $141,814 on such deconsolidation.

Also in accordance with ASC 810-10-40, Deconsolidation of a Subsidiary, we will maintain a balance for our 30% investment in Shandong Median not to go below $0.00. Based on our valuation for our 30% ownership and the net loss from Q3 our balance is currently negative and as such is recorded as a $0.00 balance on our financial statements.
 
12.
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.

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

Annually we review the valuation techniques used and determine if the fair value measurements are still appropriate and evaluate and adjust the unobservable inputs used in the fair value measurements based on current market conditions and third party information.  There were no changes in the valuations techniques during the current year.

The fair value of the warrant liabilities at December 31, 2012 was valued using the Monte Carlo Simulation method which incorporated the following assumptions: risk-free rate of interest .777%, expected volatility of 75%, expected life of 4.67 years and expected dividend yield of 0%.

The fair value of the option portion of our contingent purchase consideration liabilities at December 31, 2012 was valued using the Black-Scholes Merton model and at December 31, 2011 it was valued using the Monte Carlo simulation method, which is based on valuation theories underlying the Black-Scholes Merton model. Estimated probabilities related to achieving the earn-out milestones were incorporated into our December 31, 2011 valuation. In addition, our valuation incorporates the following assumptions:
 

   
December 31,
    
December 31,
  
   
2012
    
2011
  
   
(Black-Scholes)
    
(Monte Carlo)
  
Risk-free interest rate
     0.45 %     0.41 %
Expected volatility
     75 %     75 %
Expected life
  
3.5 years
    
4 years
  
Expected dividend yield
     0 %     0 %

The following tables present the fair value hierarchy for those assets and liabilities measured at fair value on a recurring basis at December 31, 2012 and 2011, respectively:

   
December 31, 2012
        
   
Fair Value Measurements
    
 
  
   
Level 1
    
Level 2
    
Level 3
    
Total Fair Value
  
Assets
                        
Available-for-sale securities
   $ 2,229     $ -     $ -     $ 2,229  
Investment in unconsolidated entities (Shandong Media)
     -       -       -       -  
                                 
Liabilities
                                
Warrant liabilities
   $ -     $ -     $ 878,380     $ 878,380  
Contingent purchase price consideration, current (see Note 13)
     -       -       368,628       368,628  
Contingent purchase price consideration, noncurrent (see Note 13)
     -       -       368,628       368,628  
 
   
December 31, 2011
        
   
Fair Value Measurements
    
 
  
   
Level 1
    
Level 2
    
Level 3
    
Total Fair Value
  
Assets
                        
Available-for-sale securities
   $ 2,229     $ -     $ -     $ 2,229  
                                 
Liabilities
                                
Contingent purchase price consideration, current (see Note 13)
   $ -     $ -     $ 1,091,571     $ 1,091,571  
Contingent purchase price consideration, noncurrent (see Note 13)
     -       -       2,267,518       2,267,518  

   
Level 3 Assets and Liabilities
  
   
For the Years Ended December 31, 2011 and 2012
  
                                     
   
1/1/2011
    
Unrealized
(gain) / loss
    
12/31/2011
    
Purchases, sales
 and issuances
and settlements
    
Unrealized
(gain) / loss
    
12/31/2012
  
                                     
Liabilities:
                                    
Warrant Liability
   $ -       -     $ -       1,525,682       (647,302 )   $ 878,380  
Contingent purchase price consideration
   $ 3,362,105       (3,016 )   $ 3,359,089       (1,308,390 )     (1,313,443 )   $ 737,256  
 
 
F-19
 
Quantitative Information about Level 3 Fair Value Measurements
  
                 
   
Fair Value at
  
Valuation
Unobservable
      
   
12/31/2012
  
Techniques
Inputs
  
Input
  
                 
Warrant Liability
   $ 878,380  
Monte Carlo Simulation Method
Risk Free rate of interest
     0.777 %
                     
           
Expected volatility
     75 %
                     
           
Expected life (years)
     4.67  
                     
           
Expected dividend yield
     0 %
                     
Contingent consideration
   $ 737,256  
Black-Scholes Merton Model
Risk Free rate of interest
     0.540 %
                     
           
Expected volatility
     75 %
                     
           
Expected life (years)
     3.5  
                     
           
Expected dividend yield
     0 %

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

With the adoption of ASU 2011-04, there were no changes in valuation technique and related inputs resulting from the adoption of the new requirements.

In accordance with our deconsolidation of Shandong Media, we recorded the fair value of our 30% equity investment. Utilizing forecasts based on recent historical performance we computed a discounted cash flow valuation of $0.00.

13.
Sinotop Contingent Consideration

In connection with the acquisition of Sinotop Hong Kong on July 30, 2010, if specified performance milestones are achieved, Weicheng Liu (“Mr. Liu” or “the Seller”) will be entitled to earn up to (i) an additional 403,820 shares of common stock of the Company, (ii) three-year warrants to purchase 571,275 shares of the Company’s common stock, equivalent to 5.0% of the total number of shares of the Company’s common stock underlying all outstanding warrants as of immediately following the closing of the July 2010 financing and (iii) a four-year option to purchase 80,000 shares of the Company’s common stock which was equal to 5% of the total number of shares of the Company’s common stock underlying all outstanding options of the Company granted to individuals employed by the Company as of September 1, 2010 (collectively, the securities referred to in clauses (i), (ii) and (iii) are referred to herein as the “Earn-Out Securities”). The milestones are as follows: Sinotop Hong Kong will ensure that (i) at the end of the first earn-out year (July 1, 2012), at least 3 million homes will have access to the Company’s VOD services, (ii) at the end of the second earn-out year (July 1, 2013), at least 11 million homes will have access to the Company’s VOD services, and (iii) at the end of the third earn-out year (July 1, 2014), at least 30 million homes will have access to the Company’s VOD services.

Subsequent to the acquisition of Sinotop, the Company underwent a warrant exchange that converted the three-year warrants to be potentially earned under clause (ii) above to 332,002 shares of common stock. As such, the Earn-Out Securities subject to the achievement of the specified performance milestones were 735,822 shares of common stock and a four-year option to purchase 80,000 shares of common stock.
 

The Company recorded a contingent consideration obligation related to the Earn-Out Securities at the time of acquisition which totaled $2,750,966, representing the fair value of the estimated payment of the full earn-out. The contingent consideration is classified as a liability because the earn-out securities do not meet the fixed-for-fixed criteria under ASC 815-40-15 for equity classification. Further ASC 815-40-15 requires us to re-measure the contingent consideration obligation at the end of every reporting period with the change in value reported in the consolidated statements of operations and, accordingly, we reported a gain of $1,313,443 and $3,016, for the years ended December 31, 2012 and 2011, respectively.

At the end of the first earn-out year (July 1, 2012), the first milestone was achieved with over 3 million homes having access to our VOD services. As such, we issued 245,274 shares of our common stock and 26,667 options to Mr. Liu.

The following is a summary of the earned purchase price consideration and the estimated fair value of the contingent consideration obligation for the acquisition of Sinotop Hong Kong at December 31, 2012 and 2011, respectively.

   
January 1,
                
December 31,
  
   
2012
    
Earned
    
Change in
    
2012
  
Class of consideration
  
Fair Value
    
Fair Value
    
Fair Value
    
Fair Value
  
Common shares
   $ 3,147,109     $ (1,226,369 )   $ (1,209,446 )   $ 711,294  
Stock options
     211,980       (82,021 )     (103,997 )     25,962  
Total earned and contingent consideration
   $ 3,359,089     $ (1,308,390 )   $ (1,313,443 )   $ 737,256  

   
January 1,
                
December 31,
  
   
2011
    
Earned
    
Change in
    
2011
  
Class of consideration
  
Fair Value
    
Fair Value
    
Fair Value
    
Fair Value
  
Common shares
   $ 3,175,902     $ -     $ (28,793 )   $ 3,147,109  
Stock options
     186,203       -       25,777       211,980  
Total earned and contingent consideration
   $ 3,362,105     $ -     $ (3,016 )   $ 3,359,089  
 
The following table represents the estimated fair value of the current and the noncurrent portion of the consideration liability for the acquisition of Sinotop Hong Kong at December 31, 2012.

   
As of December 31, 2012
  
   
Number of
    
Current
    
Noncurrent
    
Total
  
   
Instruments
    
Liability
    
Liability
    
Liability
  
Shares July 2013
     245,274     $ 355,647     $ -     $ 355,647  
Shares July 2014
     245,274       -       355,647       355,647  
Total Common Shares
     490,548     $ 355,647     $ 355,647     $ 711,294  
                                 
Options July 2013
     26,667     $ 12,981     $ -     $ 12,981  
Options July 2014
     26,666       -       12,981       12,981  
Total Options
     53,333     $ 12,981     $ 12,981     $ 25,962  
                                 
Total Shares and Options
     543,881     $ 368,628     $ 368,628     $ 737,256  
 
 
   
As of December 31, 2011
  
   
Number of
    
Current
    
Noncurrent
    
Total
  
   
Instruments
    
Liability
    
Liability
    
Liability
  
Shares July 2012
     245,274     $ 1,027,391     $ -     $ 1,027,391  
Shares July 2013
     245,274       -       1,066,573       1,066,573  
Shares July 2014
     245,274       -       1,053,145       1,053,145  
Total Common Shares
     735,822     $ 1,027,391     $ 2,119,718     $ 3,147,109  
                                 
                                 
Options July 2012
     26,667     $ 64,180     $ -     $ 64,180  
Options July 2013
     26,667       -       71,620       71,620  
Options July 2014
     26,666       -       76,180       76,180  
Total Options
     80,000     $ 64,180     $ 147,800     $ 211,980  
                                 
Total Shares and Options
     815,822     $ 1,091,571     $ 2,267,518     $ 3,359,089  

14.
Related Party Transactions

Jinan Broadband

Payable to Jinan Parent

As of December 31, 2012, our payable to Jinan Guangdian Jiahe Digital Television Co., Ltd. (“Jinan Parent”) increased approximately $1,000, due to currency fluctuations. At December 31, 2012 and December 31, 2011, approximately $144,000 and $143,000, respectively, remained due to Jinan Parent. This amount represents the remaining balance due from the initial acquisition which is unsecured, interest free and has no fixed repayment terms.

Revenue

During the years ended December 31, 2012 and 2011, Jinan Broadband generated $147,000 and $158,000, respectively, of value-added service revenue from an affiliate, Jinan Radio and Television Networks Center (“Networks Center”). Networks Center is the owner of Jinan Parent who has a 49% ownership interest in Jinan Broadband.
 
Cost of Revenue

During the years ended December 31, 2012 and 2011, Jinan Broadband incurred service fees to Networks Center of approximately $35,000 and $47,000, respectively. To minimize administrative fees and maintain a low headcount at Jinan Broadband, Networks Center collects customer payments on behalf of Jinan Broadband and then remits the funds to Jinan Broadband. Networks Center charges Jinan Broadband a 2% service fee on the payments collected.

General and Administrative Expense

During the years ended December 31, 2012 and 2011, Jinan Broadband paid sales agency fees of approximately $69,000 and $31,000, respectively, to Networks Center for revenue collection on behalf of Jinan Broadband and network maintenance.

Accounts Payable

As of December 31, 2012 and 2011, respectively, Jinan Broadband had accounts payable to Networks Center of approximately $270,000 and $268,000, respectively, relating to maintenance, network leasing and facility rental fees. Jinan Broadband’s operation is located in a building that is owned by Networks Center. As such, Jinan Broadband shares the cable network usage with Networks Center. Additionally, Jinan Broadband utilizes Networks Center’s staff to provide cable network maintenance support to their customers. As such, Network Center charges Jinan Broadband fees for these services and usage of their facility.
 

Accrued Expense

Jinan Broadband had accrued network maintenance fees and network leasing fees to Networks Center of approximately $1,087,000 and $47,000 as of December 31, 2012 and 2011, respectively.

Sinotop

Amount due from Non-controlling Interest
Subsequent to our acquisition of Sinotop Hong Kong in July 2010, Sinotop and Hua Cheng entered into a variable interest entity agreement to form and operate Zhong Hai Video with equity ownership interests of 80% and 20%, respectively, of total registered capital of RMB 50 million. Sinotop contributed RMB 10 million and had a commitment to fund the remaining RMB 30 million. At December 31, 2011, Hua Cheng had not made its capital contribution of RMB 10 million. Accordingly, we recorded an amount due from non-controlling interest in the amount of $1,572,699.

During the third quarter of 2012, Zhong Hai Video reduced the total registered capital from RMB 50 million (USD 7,903,000) to RMB 12.5 million (USD 1,871,000).  Following the registered capital  reduction, Hua Cheng contributed a software management system valued at RMB 2,519,700 (USD 398,000) and Sinotop no longer had a commitment to fund the remaining RMB 30 million as noted above.   As of December 31, 2012 there is no amount due from our non-controlling interest.

Cost of Revenue

During the year ended December 31, 2012 Zhong Hai Video paid licensed content fees to Hua Cheng  Film and Television Digital Program Co., Ltd., a related party, of RMB 1,000,000 (USD 159,000).

15. 
Retail Financing, December 2012
 
On December 14, 2012, we entered into an underwriting agreement with Chardan Capital Markets LLC, as representative of several underwriters, and National Securities Corporation, as qualified independent underwriter (collectively, the “Underwriters”) in connection with the offer and sale by the Company of 1,800,000 shares of the Company’s common stock, par value $0.001 per share, at a price to the public of $1.50 per share.  The Company received net proceeds from this offering of $2,193,738, after deducting underwriting discounts and commissions.  The shares were offered and sold under a prospectus supplement and related prospectus filed with the U.S. Securities and Exchange Commission pursuant to the Company’s shelf registration statement on Form S-3 (File No. 333-183689).  The offering closed on December 19, 2012.
 
16.
Private Financing, August 2012

On August 30, 2012, we entered into a Securities Purchase Agreement with certain accredited investors, pursuant to which the Company offered the Investors the option to purchase either (i) Class A Units, with each Class A Unit consisting of one share of the Company’s common stock, par value $0.001 per share and (b) a common stock purchase warrant (each a “Warrant,” and, collectively, the “Warrants”) to purchase one share of Common Stock at an exercise price of $4.25 per share, or (ii) Class B Units, with each Class B Unit consisting of one share of the Company’s Series C Preferred Stock, par value $0.001 per share, and a Warrant. The per unit price for each of the Class A Units and the Class B Units was $4.00.

On August 30, 2012, the Company closed the transactions contemplated by the Purchase Agreement and issued and sold to Investors (i) an aggregate of 646,250 Class A Units (consisting of an aggregate of 646,250 shares of Common Stock and Warrants to purchase 646,250 shares of Common Stock), and (ii) an aggregate of 250,000 Class B Units (consisting of an aggregate of 250,000 shares of Series C Preferred Stock and Warrants to purchase 250,000 shares of Common Stock). The Company received aggregate gross proceeds of $3,585,000.

The proceeds from the sale were allocated to Common Stock, Series C Convertible, Preferred Stock, warrants and beneficial conversion features based on the relative fair value of the securities in accordance with ASC 470-20-30. The value of the Common Stock and Series C Preferred stock was based on the closing price paid by investors. The fair value of the warrants was calculated using the Black-Scholes model with the following assumptions: expected life of 5 years, expected dividend rate of 0%, volatility of 75% and an interest rate of .66%. The exercise price of the warrants is $4.25.
 

The Company recognized a beneficial conversion feature discount on Series C Convertible Preferred Stock at its intrinsic value, which was the fair value of the common stock at the commitment date for Series C Convertible Preferred Stock investment, less the effective conversion price. The Company recognized approximately $342,000 of beneficial conversion feature as an increase in additional paid in capital in the accompanying consolidated balance sheet on the date of issuance of Series C Convertible Preferred Stocks since these shares were convertible at the issuance date.  The Series C Preferred Stock have been classified as temporary equity as of December 31, 2012, based on their conversion characteristics.   The Series C Preferred Stock is not deemed to be an embedded derivative instrument to be bifurcated since it’s indexed to its own stock.
 
In accordance with FASB ASC 815-40-15-5, “Determining Whether an Instrument (or Embedded Feature) is Indexed to an Entity’s Own Stock”, the warrants have been characterized as derivative liabilities to be re-measured at the end of every reporting period with the change in 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.  As of December 31, 2012, the warrant liability was re-valued using a Monte Carlo valuation as disclosed in Note 12, Fair Value Measurement, and was adjusted to its new fair value of approximately $878,000 as determined by the Company, resulting in a gain of approximately $647,000.

As a result of the Negative Clawback provisions included in the warrant agreement we have reset the exercise price from $4.25 per share to $1.50 per share.  The fair value calculation on our warrant liability includes this reset.

The Purchase Agreement contains customary representations, warranties and covenants. In addition, the Company agreed to a negative clawback provision. Under the Negative Clawback, if at any time after the closing the Company consummates an underwritten public offering with respect to the purchase and sale of Common Stock or preferred stock (collectively, “Additional Securities”) of the Company resulting in a price per share of such Additional Securities (after giving effect to the conversion of any preferred stock to be issued in the Subsequent Public Financing) of less than $4.00, then, simultaneously with the closing of such Subsequent Public Financing, the Company shall be obligated to issue to each Investor of Class A Units only, for no additional consideration, that number of Common Shares as is equal to (i) the number of Common Shares that would have been issuable to such Class A Investor at closing if the Per Unit Purchase Price were equal to the greater of (A) the Public Financing Price and (B) $2.50, minus (ii) the number of Common Shares issued to the Class A Investor at the closing.  As a result of our December 2012 retail financing the Company adjusted the number of shares in accordance with the negative clawback provisions and has recorded a charge to operations of $659,000 for the issuance of additional shares.  As of December 31, 2012, the Company has accrued such charge which is included in other current liabilities since it’s subject to shareholders’ approval which is expected in 2013.

The holder of shares of Series C Preferred Stock will not have the right to vote and will not have full voting rights and powers equal to the voting rights and powers of holders of the Company’s Common Stock. In addition, the holders of Series C Preferred Stock will not be entitled to convert any shares of Series C Preferred Stock into shares of the Common Stock if, after giving effect to the conversion, such holder would hold in excess of 9.99% of the Company’s outstanding Common Stock. Each share of Series C Preferred Stock is convertible, at any time at the option of the holder, into such number of shares of common stock equal to the product of (i) the number of shares of Series C Preferred Stock to be converted, multiplied by (ii) $4.00 divided by (iii) the conversion price, which is equal to the lesser of (x) $4.00 and (y) the price per share paid by investors in a Subsequent Public Financing; provided , however , that the conversion price shall not, in any event, be less than $2.50. Notwithstanding the foregoing, the conversion price shall equal $4.00, and there shall be no adjustment to the conversion price resulting from the price per share paid by investors in a Subsequent Public Financing, until the provisions of the Certificate regarding the adjustment to the conversion price are approved by shareholders holding a majority of the outstanding voting securities of the Company.  As a result of our December 2012 retail financing, we have adjusted the conversion price of the Preferred C Shares to the floor of $2.50 and as such have reflected the additional value amounting to $924,000 as a deemed dividend in the consolidated statement of operations.

Lastly, the Company paid issuance costs of approximately $119,000 and issued shares and warrants valued at approximately $515,000 to the placement agent related to the August 2012 financings.
 

17.
Private Financings, June 2011

On June 3, 2011, we completed a private placement transaction with FIL Investment Management (Hong Kong) Limited (“Fidelity”), professional fiduciary for various accounts from time to time. Pursuant to a securities purchase agreement between us and Fidelity, we issued to funds managed by Fidelity and its affiliates an aggregate of 979,213 shares of our common stock at a per share price of $6.60, resulting in aggregate gross proceeds to the Company of $6,462,806. Pursuant to the securities purchase agreement with Fidelity, we could not, during the six month period following the closing, without the prior written consent of Fidelity, issue any shares of our common stock, including securities that were exercisable or convertible into common stock except for (i) up to 1,958,426 shares of our common stock at a per share price equal to or greater than $6.60, (ii) shares of our common stock upon the exercise, exchange or conversion of our securities which were outstanding prior to the closing, (iii) shares of our common stock upon the exercise, exchange or conversion of callable warrants to purchase up to 666,667 shares of our common stock, with a per share exercise price equal to or greater than $6.60, and (iv) pursuant to our Stock Incentive Plan, options to purchase up to an aggregate of 440,000 shares of our common stock to new and existing employees in the normal course of business.

In connection with the private placement transaction with Fidelity, we entered into a registration rights agreement with Fidelity pursuant to which we were obligated to file a registration statement with the U.S. Securities and Exchange Commission within thirty days following the closing to register the shares of common stock issued to Fidelity. The registration statement was filed on June 29, 2011 and declared effective on July 8, 2011.

On June 7, 2011, we completed a private placement transaction with a group of twenty-seven accredited investors. Pursuant to a securities purchase agreement between us and the investors, we issued to the investors an aggregate of 675,000 shares of our common stock at a per share price of $6.60, resulting in aggregate gross proceeds of $4,455,000. The offer and sale of the shares to the accredited investors was made in compliance with the securities purchase agreement with Fidelity.

The Company paid issuance costs of $822,167 related to the June 2011 financings.

Stock Purchase Right

In connection with the June 3, 2011 private placement, we granted to Fidelity a right of first refusal during the six month period following the closing to purchase up to ten percent of the number of shares of common stock offered to other investors, as permitted in the securities purchase agreement, at a per share price of $6.60 and on identical terms as set forth in the securities purchase agreement.

In connection with the June 7, 2011 private placement, Fidelity had the right to purchase up to 75,000 shares of our common stock, or up to ten percent of the number of shares sold to the accredited investors, at a per share price of $6.60. On June 7, 2011, we agreed to modify the right with Fidelity to extend the right to purchase these shares until December 3, 2011 at a price of $6.60 per share. We valued this right at approximately $155,000 based on the Black-Scholes Merton model and recorded it as a right to purchase shares expense in connection with the placement. On December 4, 2011, we granted Fidelity an extension of this right to purchase for an additional six months and valued this right at approximately $39,000 and in June 2012, we granted another six month extension and valued this right at approximately $44,000. Both valuations were based on the Black-Scholes Merton model and were recorded as a right to purchase shares expense in connection with the placement.  As of December 31, 2012, this right of first refusal has expired.

18.
Net Loss Per Common Share

Basic net loss per common share attributable to YOU On Demand shareholders is calculated by dividing the net loss attributable to YOU On Demand shareholders by the weighted average number of outstanding common shares during the period. Diluted net loss per common share includes the weighted average dilutive effect of stock options, warrants and series preferred stocks.

For the years ended December 31, 2012 and 2011, the number of securities convertible into common shares not included in diluted EPS because the effect would have been anti-dilutive consists of the following:
 

   
2012
    
2011
  
Warrants
     1,348,975       358,579  
Stock purchase right
     -       75,000  
Options
     1,585,401       1,383,567  
Series A Preferred Stock
     933,333       933,333  
Series B Preferred Stock
     1,048,907       1,368,907  
Series C Preferred Stock
     250,000       -  
Total
     5,166,616       4,119,386  

At December 31, 2012 and 2011, the Company has reserved 8,330,529 and 7,551,641 shares of its authorized but unissued common stock for possible future issuance in connection with the following:

   
2012
    
2011
  
Exercise of stock warrants
     1,348,975       358,579  
Exercise of stock purchase right
     -       75,000  
Exercise and future grants of stock options
     4,051,986       4,080,000  
Exercise of preferred stock
     2,382,240       2,302,240  
Issuance of restricted stock grants
     56,780       -  
Contingent issuable shares in connection with Sinotop acquisition
     490,548       735,822  
Total
     8,330,529       7,551,641  

19.
Share-Based Payments

Stock Options

As of December 31, 2012, the Company has 1,585,401 options and 1,348,975 warrants outstanding to purchase shares of our common stock.

The following table provides the details of the approximate total share based payments expense during the years ended December 31, 2012 and 2011:
 
   
2012
    
2011
    
Stock option amortization
   $ 766,000     $ 599,000  
(a)
Stock issued for services
     572,000       10,000  
(b)
Stock warrants issued for services
     39,000       25,000    
Right to purchase shares
     44,000       194,000  
(see note 17)
    $ 1,421,000     $ 828,000    
 
(a)
The Company accounts for its stock option awards 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. The Black-Scholes Merton model incorporated the following assumptions for the options granted in 2012 and 2011: risk-free interest rate of 1.73% to 3.43%, expected volatility of 60% and 75%, expected life of 10.0 years and expected dividend yield of 0%.

(b)
In the second quarter of 2012, the Company appointed two new “independent” (as defined under the NASDAQ listing requirements) members to the Board of Directors. In connection with the appointment we granted each of our three “independent” directors 10,000 restricted shares to be vested quarterly over one year.

 
During 2012, the Company granted 196,620 shares to certain consultants and Directors for services. As of December 31, 2012, there were 181,620 shares vested. We recorded the common shares at the closing price on the issue date and expensed to consulting, marketing and technology services $294,000 during the year ended December 31, 2012.  We recorded $278,000 to prepaid expense to be recognized for services provided in 2013.  During the year ended December 31, 2011, we recorded $10,000 for other consulting services.

Effective as of December 3, 2010, our Board of Directors approved the YOU On Demand Holdings, Inc. 2010 Stock Incentive Plan (“the 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.

Stock option activity from commencement of plan through December 31, 2012 is summarized as follows:
 
   
Options
    
Weighted Average
  
   
Outstanding
    
Exercise Price
  
Approved plan
     4,000,000        
               
Outstanding at December 31, 2010
     1,285,567     $ 3.00  
Granted
     111,333       4.91  
Exercised
     -       -  
Canceled
     (13,333 )     3.00  
Outstanding at December 31, 2011
     1,383,567          
Granted
     227,567       4.48  
Exercised
     (1,347 )     3.80  
Canceled
     (24,386 )     5.38  
Outstanding at December 31, 2012
     1,585,401     $ 3.54  
                 
Options exercisable as of December 31, 2012 (vested)
     1,067,404     $ 3.32  
                 
Options available for issuance at December 31, 2012
     2,414,599          
 
As of December 31, 2012, there was no aggregate intrinsic value of shares outstanding and exercisable since our closing stock price was below all of the exercise prices.
 
The following table summarizes information concerning outstanding and exercisable options as of December 31, 2012:
 
           
Weighted Average
                    
           
Remaining
                    
     
Number
    
Contractual Life
    
Weighted Average
    
Number
    
Weighted Average
  
Range of Exercise Prices
    
Outstanding
    
(Years)
    
Exercise Price
    
Exerciseable
    
Exercise Price
  
$3 - $4       1,338,000       8.17     $ 3.04       1,000,570     $ 3.03  
$4 - $8       243,168       8.95       6.43       62,601       6.63  
$8 - $33       0       0       0.00       0       0  
$33 - $34       2,000       0.46       33.75       2,000       33.75  
$34 - $45       900       0.20       45.00       900       45.00  
$45 - $75       1,333       5.20       75.00       1,333       75.00  
        1,585,401       8.09     $ 3.43       1,067,404     $ 3.32  
 
As of December 31, 2012, there were 1,585,401 options outstanding with 1,067,404 options exercisable.
 

The following table summarizes the status of options which contain vesting provisions:

         
Weighted
  
         
Average
  
         
Grant Date
  
   
Options
    
Fair Value
  
Non-vested at January 1, 2012
     675,209     $ 3.33  
Granted
     200,900       4.58  
Vested
     (336,837 )     3.46  
Canceled
     (20,219 )     5.30  
Non-vested at December 31, 2012
     519,053     $ 3.66  

As of December 31, 2012 the Company had total unrecognized compensation expense related to options granted of approximately $1,407,000 which will be recognized over a remaining service period of 4.0 years.

Warrants

In connection with the Company’s Share Exchange, capital raising efforts in 2007, the Company’s January 2008 Financing of Convertible Notes and Class A Warrants, the April 2010 Convertible Note, the July 2010, June 2011, August 2012 and December 2012 financings, the WB Agreement and a service agreement, the Company issued warrants to investors and service providers to purchase common stock of the Company. As of December 31, 2012, the weighted average exercise price was $14.42 and the weighted average remaining life was 3.92 years. The following table outlines the warrants outstanding as of December 31, 2012 and December 31, 2011:

   
2012
    
2011
            
   
Number of
    
Number of
            
   
Warrants
    
Warrants
    
Exercise
  
Expiration
  
Warants Outstanding
  
Outstanding
    
Outstanding
    
Price
  
Date
  
Share Exchange Consulting Warrants ($45.00 exercise price)
     59,664       59,664     $ 45.00  
1/11/2013
  
2007 Private Placement Broker Warrants ($45.00 exercise price)
     8,533       8,533     $ 45.00  
1/11/2013
  
2007 Private Placement Investor Warrants ($150.00 exercise price)
     53,333       53,333     $ 150.00  
1/11/2013
  
July 2010 Sinotop Acquisition Warrants ($45.00 exercise price)
     17,049       17,049     $ 45.00  
1/11/2013
  
July 2010 Sinotop Acquisition Warrants ($150.00 exercise price)
     13,333       13,333     $ 150.00  
1/11/2013
  
May 2011 Warner Brothers Warrants ($6.60 excercise price)
     200,000       200,000     $ 6.60  
5/11/2016
  
June 2011 Fidelity Right to Purchase ($6.60 exercise price)
     -       75,000     $ 6.60  
12/3/2012
  
2011 Service Agreement Warrants ($7.20 exercise price)
     20,000       6,667     $ 7.20  
6/15/2016
  
2012 August Financing Warrants ($4.25 exercise price)
     977,063       -     $ 4.25  
8/30/2017
 (1)
      1,348,975       433,579              

 
(1)
As a result of the negative clawback provisions included in our warrant agreements associated with our August 2012 private financings, the exercise price of $4.25 per share is expected to be reset to $1.50 per share after shareholder approval.

20.
Income Taxes

 
(A)
Corporate Income Tax (“CIT”)
 
YOD was incorporated in Nevada and is subject to U.S. federal and state income tax.
 
 
CB Cayman was incorporated in Cayman Islands as an exempted company and is not subject to income tax under the current laws of Cayman Islands.
 
Sinotop Hong Kong was incorporated in HK as a holding company.  The statutory income tax rate in HK is 16.5%.
 
All of the Company’s income is generated in the PRC.  WFOE, YOD WFOE, Sinotop Beijing, Zhong Hai Video, Jinan Zhongkuan, Jinan Broadband are PRC entities.  The income tax provision of these entities is calculated at the applicable tax rates on the taxable income for the periods based on existing legislation, interpretations and practices in the PRC.
 
In accordance with the Corporate Income Tax Law of the PRC (“CIT Law”), effective beginning on January 1, 2008, enterprises established under the laws of foreign countries or regions and whose “place of effective management” is located within the PRC territory are considered PRC resident enterprises and subject to the PRC income tax at the rate of 25% on worldwide income. The definition of “place of effective management” refers to an establishment that exercises, in substance, and among other items, overall management and control over the production and business, personnel, accounting, and properties of an enterprise.  If the Company’s non-PRC incorporated entities are deemed PRC tax residents, such entities would be subject to PRC tax under the CIT Law.  Since our non-PRC entities have accumulated loss, the application of this tax rule will not result in any PRC tax liability.
 
The CIT Law imposes a 10% withholding income tax, subject to reduction based on tax treaty where applicable, for dividends distributed by a foreign invested enterprise to its immediate holding company outside China. Under the PRC-HK tax treaty, the withholding tax on dividends is 5% provided that a HK holding company qualifies as a HK tax resident as defined in the tax treaty.  No provision has been made for U.S income taxes on the earnings generated by the Company’s foreign subsidiaries since the Company plans to permanently reinvest all such earnings outside the U.S.
 
The provision for income tax expense (benefit) consists of the following components:
 
   
2012
    
2011
  
Income (loss) before tax
   $ (16,640,490 )   $ (13,011,772 )
Current tax expense (benefit)
                
United States
   $ (21,875 )   $ 1,620  
PRC/Hong Kong
     -          
      (21,875 )     1,620  
                 
Deferred tax (benefit) expense other than the benefit of net operating losses
                
United States
     -       -  
PRC/Hong Kong
     (270,830 )     (193,781 )
      (270,830 )     (193,781 )
                 
Deferred tax (benefit) of net operating losses
                
United States
     -          
PRC/Hong Kong
     (60,380 )     (177,546 )
      (60,380 )     (177,546 )
                 
Total income tax (benefit) expense
   $ (353,085 )   $ (369,707 )
 
A reconciliation of the expected income tax derived by the application of the 34% U.S. corporate income tax rate to the Company's loss before income tax benefit is as follows:
 
 
   
2012
    
2011
  
             
Net loss before income taxes
   $ (16,640,490 )   $ (13,011,772 )
                 
Expected income tax benefit at 34%
     (5,657,767 )     (4,424,002 )
                 
Nondeductible expenses
     480,620       379,915  
Non-taxable gain on deconsolidation of Shandong Media
     (25,536 )     -  
Non-taxable gain on AdNet       -        (563,319 ) 
Non-taxable change in warrant liabilities
     (220,083 )     -  
Non-taxable (gain) loss on contingent consideration
     (446,571 )     -  
Rate-differential on foreign income invested indefinitely
     1,228,607       1,180,646  
Increase in valuation allowance
     4,286,768       2,960,535  
Change in estimates - offset by changes in valuation allowance above
     22,752       -  
Removal of deferred tax assets relating to pre-merger NOLs
     2,280,194       -  
Change in valuation allowance related to pre-merger NOLs
     (2,280,194 )     -  
Other changes in estimates
     -       94,898  
Unrecognized tax benefits
     (21,875 )     1,620  
                 
Income tax expense (benefit)
   $ (353,085 )   $ (369,707 )

 
Deferred income taxes are recognized for future tax consequences attributable to temporary differences between the carrying amounts of assets and liabilities for financial statement purposes and income tax purposes using enacted rates expected to be in effect when such amounts are realized or settled. Significant components of the Company’s deferred tax assets and liabilities at December 31, 2012 and 2011 are as follows:
 
   
2012
    
2011
  
Deferred tax assets
            
             
U.S. NOL - pre-stock exchange transaction
   $ -     $ 2,280,194  
U.S. NOL - subsequent to stock exchange transaction
     5,134,195       3,365,208  
Foreign NOL
     2,105,960       1,064,145  
Deferred revenue
     429,346       439,521  
Reserve for returns
     -       21,502  
Fixed assets cost basis
     1,604,393       1,468,092  
Costs capitalized for tax
     10,452       -  
Accrued payroll
     21,675       8,500  
Accrued expenses
     905,265       -  
Deferred rent
     390       -  
Expenses prepaid for tax
     6,902       -  
Inventory reserves
     160,000       150,927  
Allowance for doubtful accounts
     1,587       34,090  
Equity method investee
     -       4,927  
Investment in and advance to cost method investee
     33,724       -  
Nonqualified options
     207,443       109,214  
Marketable securities
     100,795       100,795  
AMT credits
     -       17,952  
Charitable contribution carryover
     757       680  
Capital loss carryover
     482,898       482,898  
Total deferred tax assets
     11,205,782       9,548,645  
                 
Less: valuation allowance
     (10,699,560 )     (9,057,657 )
                 
Deferred tax liabilities
                
                 
Basis in equity method investee
     (13,256 )     -  
Intangible assets
     (798,815 )     (1,279,729 )
Total deferred tax liabilities
     (812,071 )     (1,279,729 )
                 
Net deferred tax liability
   $ (305,849 )   $ (788,741 )
 
As of December 31, 2012, the Company had approximately $15.2 million of the U.S domestic cumulative tax loss carryforwards (which excludes the NOL carryforwards of approximately $1.7 million because of the uncertainty of the position being sustained) and approximately $8.7 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 year 2027 through 2032 and year 2013 to year 2017, respectively.  The non-recognition of the tax benefits, while reducing the net operating loss carryovers, gives rise to a capital loss carryover of $1,420,289.  Utilization of net operating losses may be subject to an annual limitation due to ownership change limitations provided in the Internal Revenue Code and similar state and foreign provisions.  This annual limitation may result in the expiration of net operating losses before utilization.
 
 
Realization of the Company’s net deferred tax assets is dependent upon the Company’s ability to generate future taxable income in appropriate tax jurisdictions to obtain benefit from the reversal of temporary differences and net operating loss carryforwards.  The valuation allowance increased by $641,903 (net of approximately $396,000 valuation allowance eliminated with the deconsolidation of Shandong Media) and $2,962,985 during the year ended December 31, 2012 and 2011, respectively. The increase was primarily related to increases in net operating loss carryovers, which the Company does not expect to realize.
 
 
(B)
Uncertain Tax Positions
 
Accounting guidance for recognizing and measuring uncertain tax positions prescribes a threshold condition that a tax position must meet for any of the benefit of uncertain tax position to be recognized in the financial statements.  The following is a reconciliation of the beginning and ending amounts of unrecognized tax benefits for the years ended December 31, 2012 and 2011:
 
   
2012
    
2011
  
Balance, beginning of year
   $ 21,875     $ 20,255  
Increase from prior year's tax positions
     884       1,620  
Reduction resulting from the lapse of the statute of limitations
     (22,759 )     -  
Balance, end of year
   $ -     $ 21,875  
 
As of December 31, 2012 and 2011, the Company did not accrue any material interest and penalties.
 
The Company's United States income tax returns are subject to examination by the Internal Revenue Service for at least 2009 and later years. Because of the uncertainty regarding the filing of tax returns for years before 2007, it is possible that the Company is subject to examination by the IRS for earlier years. All of the Chinese tax returns for the Chinese operating companies are subject to examination by the Chinese tax authorities for all periods from the companies' inceptions in 2007 through 2012 as applicable.
 
21. 
Commitments and Contingencies
 
The Company has employment agreements with certain employees that provide severance payments upon termination of employment under certain circumstances, as defined in the applicable agreements. As of December 31, 2012, the Company's potential minimum cash obligation to these employees was approximately $867,000.
 
 
The Company is committed to paying leased property costs related to our China offices through 2014 as follows:
 
   
Leased
  
   
Property
  
Years ending December 31,
  
Costs
  
2013
   $ 317,000  
2014
     17,000  
Total
   $ 334,000  
 
The Company is committed to paying  content costs through 2016 as follows:
 
   
Content
  
Years ending December 31,
  
Costs
  
2013
   $ 1,860,000  
2014
     2,161,000  
2015
     2,292,000  
2016
     1,031,000  
Total
   $ 7,344,000  
 
The Company is committed to paying service fees to certain consultants of $85,000 through 2013.
 
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. We are currently not aware of any such legal proceedings or claims that we believe will have a material adverse effect on our business, financial condition or operating results.
 
22. 
Defined Contribution Plan
 
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 5% 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 $62,000 and $46,000 for the years ended December 31, 2012 and 2011, respectively.
 
23. 
Subsequent Events
 
In January 2013, 7,866,800 Series B Preferred Shares were converted to 1,048,907 shares of common stock.  Also, in the first quarter of 2013, as discussed in Note 18 and pursuant to our vesting arrangements, we issued 28,390 shares to our independent board members and to certain consultants for services.
 
 
F-33