IDEANOMICS, INC. - Quarter Report: 2014 September (Form 10-Q)

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

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

For the quarterly period ended September 30, 2014

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

For the transition period from __________ to __________

Commission File Number:000-19644

YOU ON DEMAND HOLDINGS, INC.
(Exact name of registrant as specified in its charter)

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)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes [X]      No [   ]

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes [X]      No [   ]

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

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes [   ]      No [X]

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date: 23,734,859 shares as of November 13, 2014.

QUARTERLY REPORT ON FORM 10-Q
OF YOU ON DEMAND HOLDINGS, INC.
FOR THE PERIOD ENDED SEPTEMBER 30, 2014

TABLE OF CONTENTS

References

Except as otherwise indicated by the context, references in this report to (i) the “Company,” “YOU On Demand,” “we,” “us,” and “our” are to the business of YOU On Demand Holdings, Inc., a Nevada corporation, and its consolidated subsidiaries and variable interest entities; (ii) “CB Cayman” are to our wholly-owned subsidiary China Broadband, Ltd., a Cayman Islands company; (iii) “Sinotop Hong Kong” are to YOU On Demand (Asia) Limited (formerly known as Sinotop Group Limited), a Hong Kong company wholly-owned by CB Cayman; (iv) “YOD WFOE” are to YOU On Demand (Beijing) Technology Co., Ltd., a PRC company wholly-owned by Sinotop Hong Kong; (v) “Sinotop Beijing” or “Sinotop” are to Beijing Sino Top Scope Technology Co., Ltd, a PRC company controlled by Sinotop Hong Kong through contractual arrangements; (vi) “Zhong Hai Video” are to Zhong Hai Shi Xun Information Technology Co., Ltd., a PRC company 80% owned by Sinotop Beijing; (vii) “Hua Cheng” are to Hua Cheng Hu Dong (Beijing) Film and Television Communication Co., Ltd., a PRC company 39% owned by Sinotop Beijing and 20% owner of Zhong Hai Video; (viii) “WFOE” are to our wholly-owned subsidiary Beijing China Broadband Network Technology Co., Ltd., a PRC company, which was sold effective March 25, 2014; (ix) “Jinan Zhong Kuan” are to Jinan Zhong Kuan Dian Guang Information Technology Co. Ltd., a PRC company controlled through contractual arrangements, which was dissolved effective March 25, 2014; (x) “Jinan Broadband” are to our 51% owned subsidiary Jinan Guangdian Jia He Broadband Co. Ltd, a PRC company, which was sold effective July 31, 2013; (xi) “Jinan Parent” are to Jinan Guangdian Jia He Digital Television Co., Ltd., a PRC Company; (xii) “SEC” are to the United States Securities and Exchange Commission; (xiii) “Securities Act” are to Securities Act of 1933, as amended; (xiv) “Exchange Act” are to the Securities Exchange Act of 1934, as amended; (xv) “PRC” and “China” are to People’s Republic of China; (xvi) “Renminbi” and “RMB” are to the legal currency of China; (xvii) “U.S. dollar,” “$” and “US$” are to United States dollars; and (xviii) “VIEs” refers to either our current variable interest entity (Sinotop Beijing), to our deconsolidated variable interest entity (Jinan Zhong Kuan) or to our discontinued variable interest entity (Jinan Broadband).

PART I — FINANCIAL INFORMATION

Item 1. Financial Statements.

YOU ON DEMAND HOLDINGS, INC., ITS SUBSIDIARIES AND VARIABLE INTEREST ENTITY
INDEX TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE PERIOD ENDED SEPTEMBER 30, 2014

YOU On Demand Holdings, Inc., Its Subsidiaries and Variable Interest Entity
UNAUDITED CONSOLIDATED BALANCE SHEETS

See notes to unaudited consolidated financial statements.

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YOU On Demand Holdings, Inc., Its Subsidiaries and Variable Interest Entity
UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS

See notes to unaudited consolidated financial statements.

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YOU On Demand Holdings, Inc., Its Subsidiaries and Variable Interest Entity
UNAUDITED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS

See notes to unaudited consolidated financial statements.

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YOU On Demand Holdings, Inc., Its Subsidiaries and Variable Interest Entity
UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS

See notes to unaudited consolidated financial statements.

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YOU On Demand Holdings, Inc., Its Subsidiaries and Variable Interest Entity
UNAUDITED CONSOLIDATED STATEMENT OF EQUITY
For the Nine Months Ended September 30, 2014

See notes to unaudited consolidated financial statements.

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YOU ON DEMAND HOLDINGS, INC., ITS SUBSIDIARIES AND VARIABLE INTEREST ENTITY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

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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 interest in Sinotop Beijing 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

Effective July 31, 2013, we have deconsolidated Jinan Broadband due to the disposition of all of our ownership. The corporate structure for our broadband business consisted of:

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 owned 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 was considered as a VIE based on ASC 810-10-25-38 due to the fact that CB Cayman had 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 as described below:

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.

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During the second quarter of 2014, Shandong Lushi Media Co., Ltd (“Shandong Media”), a PRC company 30% owned by Sinotop Beijing, initiated the process to increase their registered capital from RMB5,044,200 to RMB9,330,000. The purpose of the financing activity was to allow Shandong Media to develop a multi-media platform to expand its current business into the Internet space. In August 2014, the Company invested cash of RMB1,285,800 (approximately $209,000) into Shandong Media to maintain our 30% equity ownership.

During the nine months ended September 30, 2014, our acquired intangible asset was comprised of software, which was recognized over the weighted-average amortization period of 5.0 years.

We recorded amortization expense related to our finite lived intangible assets of approximately $70,000 and $234,000 for the three and nine months ended September 30, 2014, respectively, and $85,000 and $414,000, for the three and nine months ended September 30, 2013, respectively.

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

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.

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.

The fair value of the warrant liabilities at September 30, 2014 were valued using the Black-Scholes Merton method as an estimate for the Monte Carlo Simulation method which was the method used at year end, December 31, 2013. The following assumptions were incorporated:

Our contingent consideration liability was settled on July 1, 2014 (see Note 9). The fair value of the option portion of our contingent consideration liability at December 31, 2013 was valued using the Black-Scholes Merton model which incorporated the following assumptions:

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The following tables present the fair value hierarchy for those assets and liabilities measured at fair value on a recurring basis at September 30, 2014 and December 31, 2013, respectively:

The table below reflects the components effecting the change in fair value for the nine months ended September 30, 2014:

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 term and expected dividend yield. Significant increases or decreases in any of those inputs in isolation would result in a significantly different fair value measurement.

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The Series D Preferred Stock when issued was a hybrid instrument comprised of a (i) a preferred stock and (ii) an option to convert the preferred stock into shares of our common stock (the “Conversion Option”). The Conversion Option derived its value based on the underlying fair value of the shares of our common stock as did the Series D Preferred Stock, and therefore it was clearly and closely related to the underlying preferred stock. Since the Series D Preferred Stock could have been ultimately redeemed at the option of the holder, the carrying value of the shares, net of unamortized discount and accumulated dividends, was classified as temporary equity.

The Company paid issuance costs of approximately $849,000 in cash and issued warrants to the placement agent to purchase 228,571 shares of our common stock at $1.75 per share. The fair value of the warrants was calculated using the Black-Scholes Merton model with the following assumptions: expected life of 5 years, expected dividend rate of 0%, volatility of 70% and an interest rate of 1.60% . The exercise price of the warrants was $1.75. The warrants were valued at $247,995 at the date of issuance. The Series D Preferred Stock was recorded net of issuance costs of $1,097,041 at the issuance date, as a charge to additional paid-in capital, due to our deficit in retained earnings during the period ended December 31, 2013.

The Company recognized a beneficial conversion feature discount on the Series D Preferred Stock at its intrinsic value, which was the fair value of the common stock at the commitment date for the Series D Preferred Stock investment, less the effective conversion price. As such, the Company recognized approximately $183,000 of beneficial conversion feature as a deemed dividend and increase in Series D Preferred Stock on the date of issuance since these shares were convertible at the issuance date. Subsequently, the Company converted the Series D Preferred Stock to Series E Preferred Stock which was binding and legally enforceable by both parties on January 31, 2014 which established a new “commitment date” pursuant to ASC 470-20. As such the previously recognized beneficial conversion feature of $183,000 related to our Series D Preferred Stock was reversed and the Company recognized $2,651,429 of beneficial conversion feature as a deemed dividend related to the exchange of Series D Preferred Stock to Series E Preferred Stock. Further, the Company was obligated to pay cumulative dividends of 4% per annum. In the first quarter of 2014, we paid in full the total cumulative dividends due of $92,054.

$2.0 Million Convertible Note

On November 4, 2013, the Company issued a convertible note to C Media in $2,000,000 principal amount (the “Bridge Note”). The Bridge Note had an annual interest rate of 4% and a maturity date of January 5, 2015. Upon the closing of a financing pursuant to the terms of the Series D Purchase Agreement by and between the Company and C Media, dated as of July 5, 2013, as amended as of November 4, 2013 (as discussed below) in which C Media would invest funds in the Company in exchange for shares of the Series E Preferred Stock, the principal amount and all unpaid interest of the Bridge Note would be automatically converted into shares of Series E Preferred Stock at a conversion price equal to the per share purchase price paid for the Series E Preferred Stock by C Media. If the Bridge Note was not converted into shares of Series E Preferred Stock within 30 days following the issuance of the Bridge Note (or, in the event that all of the conditions to the Series E Financing contained in the Series E Purchase Agreement (defined below) would have been satisfied except the condition set forth in Section 6.1(i)(ii) of the Series E Purchase Agreement, then, at C Media’s option, by January 31, 2014 (the “Optional Extension Date”)), the principal amount and all accrued and unpaid interest under the Bridge Note would, at C Media’s option, be converted into shares of the Company’s Series D Preferred Stock at a conversion price of $1.75 per share. In connection with the issuance of the Bridge Note, we recorded debt issuance costs of $370,008 to current assets to be amortized over the period of the earliest possible conversion date which was January 31, 2014. As such we recorded interest expense of $128,879 and $241,129 during 2014 and 2013, respectively. The issuance costs included cash paid of $241,936 and the issuance of warrants to the placement agent to purchase 114,285 shares of common stock at $1.75 per share. 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 70% and an interest rate of 1.36% . The exercise price of the warrants was $1.75. The warrants were valued at $128,072 at the date of issuance.

Amendment to Series D Stock Purchase Agreement

On November 4, 2013, in connection with the issuance of the Bridge Note, the Company and C Media entered into Amendment No. 1 to the Series D Purchase Agreement (the “Series D Amendment”). Pursuant to the original Series D Purchase Agreement, dated July 5, 2013, the Company and C Media agreed, among other things, that each party would act in good faith and with fair dealing to finalize an agreement for the purchase and sale of shares of Series E Preferred Stock pursuant to the terms of a Series E Purchase Agreement on or before October 31, 2013. Pursuant to the Series D Amendment, the parties agreed that each party would act in good faith and with fair dealing to finalize the Series E Purchase Agreement on or before the 30^th day following the issuance of the Bridge Note.

Also in connection with the Series D Amendment, C Media executed a waiver and consent with the Company as of October 31, 2013 agreeing, among other things, to waive its right to redeem its Series D Preferred Stock as of October 31, 2013 until the 30^th day following the issuance of the Bridge Note or the Optional Extension Date.

On December 4, 2013, C Media exercised its Optional Extension Option which extended the date to January 31, 2014.

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The Company has reserved its authorized but unissued common stock for possible future issuance in connection with the following:

Stock Options

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. As of September 30, 2014, options available for issuance is 1,821,142 shares.

Stock option activity for the nine months ended September 30, 2014 is summarized as follows:

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In the first quarter of 2014, the Company granted 22,435 options to board members for services provided in 2013. The weighted average grant-date fair value of options granted was $2.91. The total intrinsic value of options exercised during the nine months ended September 30, 2014 was $8,553. There were no options granted or exercised for the same period in 2013.

The following table summarizes information concerning outstanding and exercisable options as of September 30, 2014:

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

As of September 30, 2014, the Company had total unrecognized compensation expense related to options granted of approximately $446,000 which will be recognized over a remaining service period of 2.62 years.

Warrants

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

As of September 30, 2014, the weighted average exercise price of the warrants was $2.20 and the weighted average remaining life was 3.64 years. The following table outlines the warrants outstanding and exercisable as of September 30, 2014 and December 31, 2013:

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Licensed Content Commitment

The Company is committed to paying content costs through 2016 as follows:

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Cautionary Note Regarding Forward Looking Statements

This Form 10-Q contains “forward-looking” statements that involve risks and uncertainties. You can identify these statements by the use of forward-looking words such as "may", "will", "expect", "anticipate", "estimate", "believe", "continue", or other similar words. You should read statements that contain these words carefully because they discuss our future expectations, contain projections of our future results of operations or financial condition or state other "forward-looking" information. We believe that it is important to communicate our future expectations to our investors. However, these forward-looking statements are not guarantees of future performance and actual results may differ materially from the expectations that are expressed, implied or forecasted in any such forward-looking statements. There may be events in the future that we are unable to accurately predict or control, including weather conditions and other natural disasters which may affect demand for our products, and the product–development and marketing efforts of our competitors. Examples of these events are more fully described in the Company’s 2013 Annual Report under Part I. Item 1A. Risk Factors.

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

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

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

Overview

We are a multi-platform media company that principally operates in China through our subsidiaries and VIE. We provide integrated value-added service solutions business for the delivery of video on demand (“VOD”) and enhanced premium content to digital cable providers, IPTV (Internet Protocol Television) providers, Over-the-Top (“OTT”) providers and mobile manufacturers.

On July 30, 2010, we acquired Sinotop Hong Kong through our subsidiary, CB Cayman. Through a series of contractual arrangements, Sinotop Hong Kong controls Sinotop Beijing, a corporation established in the People’s Republic of China (“PRC”) which is the 80% owner of Zhong Hai Video, our primary operating company.

Our Discontinued Broadband Business

Prior to July 31, 2013, through Jinan Broadband, we provided to our customers 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, was 49% owned by Jinan Parent and 51% owned by our wholly owned subsidiary, WFOE. Effective July 31, 2013, we sold our 51% interest in Jinan Broadband to Shandong Broadcast Network Limited. Jinan Broadband is accounted for as discontinued operations in the unaudited consolidated financial statements included in this quarterly report on Form 10-Q.

Principal Factors Affecting Our Financial Performance

Our operating results are primarily affected by the following factors:

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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 since inception.

Cayman Islands

CB Cayman was incorporated in the Cayman Islands. Under the current law of the Cayman Islands, CB Cayman 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 Enterprise Income Tax 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.

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Consolidated Results of Operations

Comparison of Three Months Ended September 30, 2014 and 2013

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Revenue

Revenue for the three months ended September 30, 2014, totaled $645,000, as compared to $95,000 for 2013. The increase in revenue of approximately $550,000 was attributable to the growth of our VOD business.

Gross Loss

Our gross loss for the three months ended September 30, 2014 was $228,000, as compared to $617,000 during the same period in 2013. The decrease in gross loss of approximately $389,000, or 63%, was mainly due to increased revenue related to our VOD business. Our cost of revenue is primarily comprised of content licensing fees. Our content license agreements with production companies incorporate minimum guaranteed payment levels. As our operations are just evolving, revenues from operations do not yet meet the threshold at which they exceed those costs.

Selling, General and Administrative Expenses

Our selling, general and administrative expenses for the three months ended September 30, 2014, increased approximately $134,000 to $1,861,000, as compared to $1,727,000 for the three months ended September 30, 2013.

Salaries and personnel costs are the primary components of selling, general and administrative expenses. For the three months ended September 30, 2014 salaries and personnel costs accounted for 47% of our selling, general and administrative expenses. For the three months ended September 30, 2014, salaries and personnel costs totaled $866,000, a decrease of $6,000, as compared to $872,000 for the same period of 2013 due to staff reductions made as part of our cost savings initiatives.

The other major components of our selling, general and administrative expenses include technology, marketing, business development, rent expenses and regulatory expenses. For the three months ended September 30, 2014, these costs totaled $770,000, a net increase of $497,000, or 182%, as compared to $273,000 for the same period in 2013, due primarily to increases in the compensation paid to our board members and increased costs in technology and rent expense.

Professional Fees

Professional fees are generally related to public company reporting and governance expenses as well as legal fees related to expansion of our VOD business. Our costs for professional fees increased $36,000, or 46%, to $114,000 for the three months ended September 30, 2014, from $78,000 during 2013. The increase in professional fees was primarily due to legal fees incurred during the expansion in our VOD business. This increase was partially offset by the decrease in accounting service fees due to timing in accounting services related to our transition to a new audit firm.

Depreciation and Amortization

Our depreciation and amortization expense decreased $30,000, or 19%, to $125,000 in the three months ended September 30, 2014, from $155,000 during 2013. The decrease was primarily due to full amortization of certain software in the beginning of 2014 and write-off of certain office equipment in year end of 2013.

Change in Fair Value of Warrant Liabilities

Certain of 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 $282,000 and a loss of $7,000 for the three months ended September 30, 2014 and 2013, respectively. The changes are primarily due to fluctuations 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 since the contingency was not solely based on the Company’s operations. 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 loss of $48,000 and $16,000 for the three months ended September 30, 2014 and 2013, respectively. The changes are primarily due to fluctuations in our closing stock price. The earn-out provisions were fully met on July 1, 2014 and the contingency was thereby resolved on that date.

Discontinued Operations

Effective July 31, 2013, we sold our 51% interest in Jinan Broadband to Shandong Broadcast Network Limited in order to focus on our core VOD business and help with cash flow needs. As such, Jinan Broadband is accounted for as discontinued operations in our unaudited consolidated financial statements included in this report.

Net Loss Attributable to Non-controlling Interest

Hua Cheng has a 20% non-controlling interest in Zhong Hai Video and as such we allocate 20% of the operating loss of Zhong Hai Video to Hua Cheng. During the three months ended September 30, 2014, $169,000 of our operating loss from Zhong Hai Video was allocated to Hua Cheng, as compared to $193,000 during the same period of 2013.

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Comparison of Nine Months Ended September 30, 2014 and 2013

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Revenue

Revenue for the nine months ended September 30, 2014, totaled $965,000, as compared to $147,000 for the same period in 2013. The increase in revenue of approximately $818,000 was attributable to the growth of our VOD business.

Gross Loss

Our gross loss for the nine months ended September 30, 2014 was $1,641,000, as compared to $2,204,000 during the same period in 2013. The decrease in gross loss of approximately $563,000, or 26%, was mainly due to increased revenue related to our VOD business. Our cost of revenue is primarily comprised of content licensing fees. Our content license agreements with production companies incorporate minimum guaranteed payment levels. As our operations are just evolving, revenues from operations do not yet meet the threshold at which they exceed those costs.

Selling, General and Administrative Expenses

Our selling, general and administrative expenses for the nine months ended September 30, 2014, decreased approximately $85,000, to $5,772,000, as compared to $5,857,000 for the nine months ended September 30, 2013.

Salaries and personnel costs are the primary components of selling, general and administrative expenses. For the nine months ended September 30, 2014 salaries and personnel costs accounted for 46% of our selling, general and administrative expenses. For the nine months ended September 30, 2014, salaries and personnel costs totaled $2,690,000, a decrease of $310,000, or 10%, as compared to $3,000,000 for the same period of 2013 due to staff reductions made as part of our cost savings initiatives.

The other major components of our selling, general and administrative expenses include technology, marketing, business development, rent expenses and regulatory expenses. For the nine months ended September 30, 2014, these costs totaled $2,322,000, a net increase of $1,084,000, or 88%, as compared to $1,238,000 in 2013, due primarily to increases in the compensation paid to our board members and increased costs in technology and rent expense.

Professional Fees

Professional fees are generally related to public company reporting and governance expenses as well as legal fees related to expansion of our VOD business. Our costs for professional fees decreased $98,000, or 21%, to $376,000 for the nine months ended September 30, 2014, from $474,000 during 2013. The decrease in professional fees was due to reductions in both consulting fees and timing in accounting services related to our transition to a new audit firm.

Depreciation and Amortization

Our depreciation and amortization expense decreased $206,000, or 33%, to $415,000 in the nine months ended September 30, 2014, from $621,000 during 2013.The decrease was mainly due to full amortization of non-compete agreement as of January 31, 2013, and, to a lesser extent, write-off of certain office equipment.

Interest Expense, Net

Our interest expense increased $2,257,000 to $2,346,000 for the nine months ended September 30, 2014, from $89,000 during 2013, primarily due to (1) the amortization of debt issuance costs related to the issuance of the $2.0 million convertible note and (2) the recognition of the beneficial conversion feature of $2,126,000 related to the modification of the $3.0 million convertible note as discussed in Note 11 of the unaudited consolidated financial statements included in this report.

Change in Fair Value of Warrant Liabilities

Certain of 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 loss of $656,000 and $37,000 for the nine months ended September 30, 2014 and 2013, respectively. The changes are primarily due to increases 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 since the contingency was not solely based on the Company’s operations. 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 loss of $161,000 and $99,000 for the nine months ended September 30, 2014 and 2013, respectively. The changes are primarily due to increases in our closing stock price. The earn-out milestones were all achieved on July 1, 2014 and the contingency was thereby resolved on that date.

Gain on Sale of Subsidiary and Loss of a VIE

Effective March 25, 2014, we deconsolidated our ownership in WFOE and Jinan Zhong Kuan. As such, we recorded a gain of $755,000 on the sale of WFOE and a loss of $27,000 on dissolution of Jinan Zhong Kuan as discussed in Note 3 of our unaudited consolidated financial statements included in this report.

Discontinued Operations

Effective July 31, 2013, we sold our 51% interest in Jinan Broadband to Shandong Broadcast Network Limited in order to focus on our core VOD business and help with cash flow needs. As such, Jinan Broadband is accounted for as discontinued operations in our unaudited consolidated financial statements included in this report.

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Net Loss Attributable to Non-controlling Interest

Hua Cheng has a 20% non-controlling interest in Zhong Hai Video and as such we allocate 20% of the operating loss of Zhong Hai Video to Hua Cheng. During the nine months ended September 30, 2014, $697,000 of our operating loss from Zhong Hai Video was allocated to Hua Cheng, as compared to $835,000 during the same period of 2013.

Dividends on Preferred Stock

For the nine months ended September 30, 2014, in connection with the issuance of Series E Preferred Stock, we recorded dividends of approximately $16,402,000. This amount is comprised of (1) recognition of a deemed dividend for a beneficial conversion feature discount of $16,571,000, (2) reversal of a deemed dividend for the beneficial conversion feature discount of $183,000 related to the extinguishment of the Series D Preferred Stock and (3) cash dividends paid of $14,000 for January 2014, which is part of the total cash dividend paid, amounting to $92,054, in the nine months ended September 30, 2014.

Liquidity and Capital Resources

As of September 30, 2014, we had cash and cash equivalents of approximately $13,045,000. Approximately $3,873,000 was held in our Hong Kong entity and $8,212,000 was held in our China entities. The Company has no plans to repatriate these funds. As of September 30, 2014, we had working capital of approximately $8,099,000.

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

Operating Activities

Cash used in operating activities increased for the nine months ended September 30, 2014 compared to 2013 primarily due to increased content license payments and increased operational costs arising from our transition into our VOD business. Our content license agreements with production companies incorporate minimum guarantee payments, most of which increase year-over-year.

Investing Activities

Cash used in investing activities for the nine months ended September 30, 2014 was primarily used for investment in Shandong Lushi Media Co., Ltd (“Shandong Media”), a PRC company 30% owned by Sinotop Beijing, and, to a lesser extent, the acquisition of property and equipment. In August 2014, we invested US$209,000 (approximately RMB1.29 million) in Shandong Media to maintain our 30% equity ownership. Cash used in investing activities for the nine months ended September 30, 2013 was used for the acquisition of property and equipment and investments in intangibles.

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Financing Activities

The Company must continue to rely on debt and equity to pay for ongoing operating expenses in order to execute its business plan.

In January 2014, we received investment net proceeds of approximately $16,614,000 from the sale of the Series E Preferred Stock and we received approximately $996,000 from the exercise of warrants and options from certain investors and employees.

In addition, we believe 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 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.

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. As of September 30, 2014, the Company has an accumulated operating loss of approximately $92.3 million. The unaudited 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.

Effects of Inflation

Inflation and changing prices could have 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.

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 and Significant Judgments and Estimates

The discussion and analysis of our financial condition and results of operation are based upon our unaudited consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. Note 2 to the consolidated financial statements in our 2013 Annual Report includes a summary of our most significant accounting policies.

The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of assets and liabilities. On an ongoing basis, we evaluate our estimates and judgments, including those related to revenue recognition, inventories, income taxes, interest expenses, deemed dividend, stock-based compensation and contingent liabilities. Management bases its estimates on historical experience and on various other factors that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. Periodically, we review our critical accounting estimates with the Audit Committee of our Board of Directors.

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Item 3. Quantitative and Qualitative Disclosures about Market Risk

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

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

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

As required by Rule 13a-15 under the Exchange Act, our management, including our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of September 30, 2014. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that as of September 30, 2014 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.

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.

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PART II – OTHER INFORMATION

Item 1. Legal Proceedings

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

Item 1A. Risk Factors

In addition to the other information set forth in this report, you should carefully consider the factors discussed in Part I, "Item 1A. Risk Factors" in our 2013 Annual Report which could materially affect our business, financial condition or future results. The risks described in our Annual Report on Form 10-K are not the only risks facing our Company. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition or future results.

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

There were no unregistered sales of equity securities during the fiscal quarter ended September 30, 2014.

Item 3. Defaults Upon Senior Securities

There were no defaults upon senior securities during the fiscal quarter ended September 30, 2014.

Item 4. Mine Safety Disclosures

Not applicable.

Item 5. Other Information

None.

Item 6. Exhibits

See Exhibit Index.

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