ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
You should read this Management’s Discussion and Analysis in conjunction with the Consolidated Financial Statements and Related Notes.
Overview
China United Insurance Service, Inc. (“China United”, ”CUIS” or the “Company”) is a Delaware corporation organized on June 4, 2010 by Mao Yi Hsiao, a Taiwanese citizen, as a listing vehicle for ZLI Holdings Limited (“CU Hong Kong”) to be quoted on the Over the Counter Bulletin Board (the “OTCBB”). CU Hong Kong, a wholly owned Hong Kong-based subsidiary of China United, was founded by China United on July 12, 2010 under Hong Kong laws. On October 20, 2010, CU Hong Kong founded a wholly foreign owned enterprise, Zhengzhou Zhonglian Hengfu Business Consulting Co., Ltd. (“CU WFOE”) in Henan province in the People’s Republic of China (“the PRC”).
On January 16, 2011, China United issued 20,000,000 shares of common stock, $0.00001 par value per share, to several non US persons for $300,000 in cash invested in the Company’s subsidiaries. The issuance was made pursuant to an exemption from registration contained in Regulation S under the Securities Act of 1933, as amended. The consideration was paid as of June 30, 2012. On January 28, 2011, the Company increased the number of authorized shares from 30,000,000 shares of common stock to 100,000,000 shares of common and 10,000,000 shares of preferred stock.
Henan Law Anhou Insurance Agency Co., Ltd. (“Henan Anhou”, formerly known as Zhengzhou Anhou Insurance Agency Co., Ltd.) was incorporated in the PRC on August 20, 2003. Henan Anhou provides insurance agency services in the PRC. On August 16, 2010, Ms. Zhu Shuqin contributed RMB8,000,000 ($1,175,440) in cash to Henan Anhou and controlled 80% of Henan Anhou shares.
Sichuan Kangzhuang Insurance Agency Co., Ltd. (“Sichuan Kangzhuang”) was founded on July 10, 2006 in Sichuan province in the PRC and provides insurance agency services in the PRC. On August 23, 2010, at Sichuan Kangzhuang’s general meeting of shareholders, its shareholders voted to sell their shares to Henan Anhou for RMB532,622 ($78,318). On September 6, 2010, the equity transfer agreements were signed between Henan Anhou and each shareholder of Sichuan Kangzhuang.
Jiangsu Law Insurance Broker Co., Ltd. (“Jiangsu Law”) was founded on September 19, 2005 in Jiangsu Province in the PRC and provides insurance brokerage services in the PRC. On August 12, 2010, at Jiangsu Law’s general meeting of shareholders, its shareholders voted to sell their shares to Henan Anhou for RMB518,000 ($75,475) and Henan Anhou increased Jiangsu Law’s paid-in capital to RMB10,000,000 ($1,355,000) from RMB5,180,000 ($625,113) on January 18, 2011 to meet the PRC paid-in capital requirements for insurance brokerage companies. On September 28, 2010, the equity transfer agreements were signed between Henan Anhou and each shareholder of Jiangsu Law.
Due to PRC legal restrictions on foreign ownership and investment in insurance agency and brokerage businesses in China, especially those on qualifications and capital requirements of the investors, we operate our business primarily through our Consolidated Affiliated Entities (“CAE”) in China. We do not hold equity interests in our CAE. However, through the variable interest entities (“VIE”) Agreements with these CAE and their respective shareholders, we effectively control, and are able to derive substantially all of the economic benefits from, these CAE.
Our CAE in China are VIE through which all of our insurance services are operated. It is through the VIE Agreements that we have effective control of the CAE, which allows us to consolidate the financial results of the CAE in our financial statements. If Henan Anhou and its shareholders fail to perform their obligations under the VIE Agreements, we could be limited in our ability to enforce the VIE Agreements that give us effective control. Furthermore, if we are unable to maintain effective control of our CAE, we would not be able to continue to consolidate the CAE’s financial results with our financial results. During the three months ended September 30, 2013, 92.94% and 7.06% of our revenues in our consolidated financial statements were derived from our Taiwan Subsidiaries and CAE, respectively. For more information see “Risk Factors-Risks Related to Our Corporate Structure.”
On January 17, 2011, CU WFOE and Henan Anhou and its shareholders entered into a series of VIE Agreements pursuant to which CU WFOE has executed effective control over Henan Anhou through these contractual arrangements.
On August 24, 2012, the Company acquired all of the issued and outstanding shares of Action Holdings Financial Limited (“AHFL”), a limited liability company (“LLC”) incorporated under the laws of British Virgin Islands on April 30, 2012, together with its subsidiaries in Taiwan. Subsequent to the acquisition, AHFL became a 100% owned subsidiary of the Company.
AHFL holds 65.95% of the issued and outstanding shares of Law Enterprise Co., Ltd. (“Law Enterprise”), a company limited by shares incorporated under the laws of Taiwan on January 30, 1996. Law Enterprise holds (i) 100% Law Insurance Broker Co., Ltd. (“Law Broker”), a company limited by shares incorporated in Taiwan on October 9, 1992; (ii) 97.84% of Law Risk Management & Consultant Co., Ltd. (“Law Management”), a company limited by shares incorporated in Taiwan on December 5, 1987; and (iii) 96% of Law Insurance Agent Co., Ltd. (“Law Agent” collectively with “Law Enterprise”, “Law Broker” and “Law Agent”, the “Taiwan Subsidiaries”, each a “Taiwan Subsidiary”), a LLC incorporated in Taiwan on June 3, 2000.
Law Enterprise is a holding company of its operating subsidiaries in Taiwan. Law Broker primarily engages in insurance brokerage and insurance agency service business across Taiwan, while Law Management and Law Agent are not active. We operate our Taiwan business primarily through Law Broker.
Below is a diagram of our corporate structure as of September 30, 2013.
Due to recent stock transfers, the ownership of Henan Anhou has changed since the end of our fiscal quarter.
For a full description of the changes please see the disclosures contained under the heading “OTHER INFORMATION” contained in Part II, Item 5 of this Quarterly Report on Form 10-Q.
As of September 30, 2013, through our CAE, we had two insurance agencies, one brokerage and 37 service outlets with 888 full-time sales professionals, 37 part-time sales professionals and 67 administrative staff in Henan, Sichuan and Jiangsu provinces in China. In addition, through Law Insurance Broker Co., Ltd., we had 22 sales and service outlets (including the headquarters) with 1,476 full-time sales professionals, 345 part-time sales professionals and 151 administrative staff in Taiwan.
Critical Accounting Policies
The preparation of financial statements in conformity with Accounting Principles generally accepted in the United States of America (“US GAAP”) 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 dates of the consolidated financial statements and the amounts of revenues and expenses during the period. Management makes these estimates using the best information available when they are made. However, actual results could differ materially from those estimates. While there are a number of significant accounting policies affecting the Company’s financial statements; the Company believes the following critical accounting policies involve the most complex, difficult and subjective estimates and judgments The Company has not made any material changes in the methodology used in these accounting polices during the past two years.
Principles of consolidation
The accompanying consolidated financial statements include the accounts of China United and its subsidiaries. The results of operations of AHFL and subsidiaries are included since August 31, 2012 the date of acquisition for accounting convenience. All significant intercompany transactions and balances were eliminated in consolidation.
Accounts receivable
The Company reviews its accounts receivable on a regular basis to determine if a bad debt allowance is necessary. Management reviews the composition of accounts receivable and analyzes the age of receivable outstanding, customer concentrations, customer credit worthiness, current economic trends and changes in customer payment patterns to evaluate the necessity of making such allowance. No allowance was deemed necessary as of September 30, 2013 or June 30, 2013.
Revenue recognition
The Company’s revenue is from insurance agency and brokerage services. The Company, through its subsidiaries, sells insurance products to customers, and obtains commissions from the respective insurance companies according to the terms of each insurance company service agreement. The Company recognizes revenue when the following have occurred: persuasive evidence of an agreement between the insurance company and insured exists, services were provided, the fee for such services is fixed or determinable and collectability of the fee is reasonably assured. Insurance agency services are considered complete, and revenue is recognized, when an insurance policy becomes effective. The customers are entitled to a 10-day cancellation period from the date of the issuance of the policies, in which the customers can cancel the contract without any fees. For the three months ended September 30, 2013 and 2012, policy cancellations were $47,591 and $32,998, respectively.
The Company pays commissions to its sub-agents when an insurance product is sold by the sub-agent. The Company recognizes commission revenue on a gross basis. The commissions paid by the Company to its sub-agents are recorded as costs of revenue.
Income taxes
The Company utilizes ASC Topic 740 “Income Taxes”, which requires recognition of deferred tax assets and liabilities for the expected future tax consequences of events that were included in the financial statements or tax returns. Under this method, deferred income taxes are recognized for the tax consequences in future years of differences between the tax bases of assets and liabilities and their financial reporting amounts at each period end based on enacted tax laws and statutory tax rates applicable to the periods in which the differences are expected to affect taxable income. Valuation allowances are established, when necessary, to reduce deferred tax assets to the amount expected to be realized.
When tax returns are filed, it is likely some positions taken would be sustained upon examination by the taxing authorities, while others are subject to uncertainty about the merits of the position taken or the amount of the position that would be ultimately sustained. The benefit of a tax position is recognized in the financial statements in the period during which, based on all available evidence, management believes it is more likely than not that the position will be sustained upon examination, including the resolution of appeals or litigation processes, if any. Tax positions taken are not offset or aggregated with other positions. Tax positions that meet the more-likely-than-not recognition threshold are measured as the largest amount of tax benefit that is more than 50% likely of being realized upon settlement with the applicable taxing authority. The portion of the benefits associated with tax positions taken that exceeds the amount measured as described above is reflected as a liability for unrecognized tax benefits in the accompanying balance sheets along with any associated interest and penalties that would be payable to the taxing authorities upon examination. Interest associated with unrecognized tax benefits are classified as interest expense and penalties are classified in selling, general and administrative expenses in the statements of operations and other comprehensive income (loss). As of September 30, 2013 and June 30, 2013, the Company did not have any uncertain tax positions.
The Company was not subjected to income tax examinations by taxing authorities during the current and past fiscal years. During the three months ended September 30, 2013 and 2012, the Company did not recognize any interest or penalties.
Impairment of Long-Lived Assets
In accordance with ASC Topic 360,
“Property, Plant and Equipment”
, the Company reviews the carrying values of long-lived assets whenever facts and circumstances indicate that the assets may be impaired. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future net undiscounted cash flows expected to be generated by the asset. If an asset is considered impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the asset exceeds the fair value (“FV”). Assets to be disposed of are reported at the lower of the carrying amount or FV, less costs of disposal.
Goodwill
Goodwill arose from the acquisition of Sichuan Kangzhuang. Goodwill is the excess of the cost of an acquisition over the FV of the net assets acquired. Goodwill is tested for impairment annually or more frequently if events or changes in circumstances indicate that it might be impaired, using the prescribed two-step process under US GAAP. The first step screens for potential impairment of goodwill to determine if the FV of the reporting unit is less than its carrying value, while the second step measures the amount of goodwill impairment, if any, by comparing the implied FV of goodwill to its carrying value.
Results of Operations for the Three Months Ended September 30, 2013 and 2012
Three Months Ended September 30, 2013 Compared to Three Months Ended September 30, 2012
Our results of operations for the three months ended September 30, 2013 contains the results for three months ended September 30, 2013 of AHFL. The majority of AHFL’s result is generated by Law Broker, its subsidiary in Taiwan. Acquisition of AHFL enabled us to expand our business to Taiwan. Our results of operations for the three months ended September 30, 2012 contains the results for one month for the period ended September 30, 2012 of AHFL.
Revenues
Revenues increased by $4,575,641, or 142%, from $3,219,300 for the three months ended September 30 2012 to $7,794,941 for the three months ended September 30, 2013. The increase in revenues was mainly attributable to our new operations in Taiwan after August 24, 2012 that occurred as a result of our acquisition of AHFL.
As a distributor of insurance products, we derive our revenue primarily from commissions and fees paid by insurance companies, typically calculated as a percentage of premiums paid by our customers to the insurance companies. We generate revenue primarily through our sales force, which consists of individual sales agents in our distribution and service network. The acquisition of AHFL enabled us to reach the untapped market in Taiwan. For the three months ended September 30, 2013, our business in Taiwan generated $7,244,926 of revenue, which accounts for 93% of our total revenue.
Cost of revenue and gross profit
The cost of revenue for the three months ended September 30, 2013 increased by $4,040,670 or 187%, to $6,206,292 compared to $2,165,622 for the three months ended September 30, 2012. Over 90% of the cost of revenue is commissions paid to our sales agents. Therefore the cost of revenue increased as our sales increased. For the three months ended September 30, 2013, $5,850,622 of our cost of revenue belonged to the Taiwan business we acquired.
Gross profit for the three months ended September 30, 2013 increased by $534,971, or 51%, to $1,588,649 compared to $1,053,678 for the three months ended September 30, 2012. The gross profit ratio decreased to 20% for the three months ended September 30, 2013 from 33% for the three months ended September 30, 2012. The decrease was mainly because Law Broker increased the portion of commission paid to sub-agent
by paying a special bonus.
Selling expenses
Selling expenses were mainly comprised of marketing promotion for Law Broker. For the three months ended September 30, 2012, such expenses were included in general and administrative expenses.
General and administrative expenses
General and administrative (“G&A”) expenses principally comprise of salaries and benefits for our administrative staff, office rental expenses, travel expenses, depreciation and amortization, entertainment expenses, and office supply expenses for our administrative staff.
For the three months ended September 30, 2013, G&A expenses were $2,346,327, increased by $1,316,056, or 128%, compared to $1,030,271 for the three months ended September 30, 2012. The increase in expenses is due to the overall growth of our business and expansion to Taiwan. For the three months ended September 30, 2013, $1,894,786 of our G&A expenses belonged to the Taiwan business we acquired.
Other income
Other income for the three months ended September 30, 2013 was mainly rental income of sub-leased spare offices and garage.
Income tax
CU WFOE, the Company’s subsidiary, and the VIEs in the PRC, are governed by the Income Tax Law of the PRC concerning the private-run enterprises, which are generally subject to tax at 25% on income reported in the statutory financial statements after appropriated adjustments. Except for Jiangsu Law, according to the requirement of local tax authorities, the tax basis is deemed as 10% of total revenue, instead of net income. The tax rate of Jiangsu Law is also 25%.
According to tax regulations by Chinese tax authorities effective January 1, 2008, commissions paid to sub-agents in excess of 5% of the commission revenue were not tax deductible. According to China State Administration of Taxation #15 Announcement in 2012, effective from 2011, such commissions can be fully deducted. Also, such tax payable over the past five years can be adjusted. Therefore, during the three months ended September 30 2013, we reversed the tax payable of $57,359 accrued before for such deductible commissions and credited as income tax benefit.
The Company’s subsidiaries in Taiwan are governed by the Income Tax Law of Taiwan, and are generally subject to tax at 17% of income reported in the statutory financial statements after appropriate adjustments.
Liquidity and Capital Resources
Net cash provided by operating activities during the three months ended September 30, 2013 was $5,978,330, including $8,477,163 advance payment received from AIATW. Net cash used in operating activities during the three months ended September 30, 2012 was $2,068,606. The increase was mainly contributed by our Taiwan business.
Net cash used in investing activities was $692,348 during the three months ended September 30, 2013. The net cash provided by investing activities was $12,755,795 for the three months ended September 30 2012, which was the combined effect of cash acquired in acquisition of AHFL and the purchase of marketable securities.
For the three months ended September 30, 2013, net cash used in financing activities was $6,444,825, including the $5,309,377 loans to unrelated third parties. Net cash provided by financing activities was $90,942 in the three months ended September 30, 2012.
Intercompany Loan and Loans to Unrelated Third Parties
On June 9, 2013, AHFL entered into a Loan Agreement (the “Company Loan Agreement”) with CU Hong Kong.
Under the Company Loan Agreement, AHFL agreed to provide a loan to the CU Hong Kong with the principal amount equal to the US Dollar equivalent of RMB40,000,000 ($6,532,716). The term for such was 10 years which could be extended upon the agreement of the parties. The amount of such loan was remitted to the account of CU Hong Kong on August 30, 2013.
In August 2013, the CU Hong Kong entered into several Loan Agreements (collectively, the “Investor Loan Agreements”) with the following unrelated parties: Able Capital Holding Co., Ltd., a limited liability company established and registered in Hong Kong, Mr. Chen Li and Ms. Yue Jing, both PRC citizens (collectively, the “Investor Borrowers”).
Under the Investor Loan Agreements, the Investor Borrowers loaned cash from CU Hong Kong for their investment in Anhou and CU Hong Kong agreed to provide certain loans to each of the Investor Borrowers with an aggregate principal amount equal to the US Dollar equivalent of RMB40,000,000 ($6,532,716). The term for such loans was ten 10 years which could be extended upon the agreement of the parties. Pursuant to the Investor Loan Agreements, each of the Investor Borrowers covenants to enter into certain Variable Interest Entities Agreements with Anhou, CU WFOE and certain existing shareholders of Anhou. The proceeds received from the said loans by the Investor Borrowers shall be solely used to increase the registered capital of Anhou, and CU Hong Kong may determine the repayment methods including transferring of the Investor Borrowers’ corresponding registered capital in Anhou or through other manner as full payment of the loans subject to terms and conditions therein in the event that the Investor Borrowers fails to repay the loan in currency to CU Hong Kong.
The specific amounts loaned to the Investor Borrowers were as follows:
Able Capital Holding Co., Ltd.: RMB29,500,000 ($4,817,896)
Mr. Chen: RMB3,000,000 ($489,949)
Ms. Yue: RMB7,500,000 ($1,224,871)
Recent development of relevant laws and background of the loans
On April 27, 2013, the China Insurance Regulatory Commission (“CIRC”) issued the Decision on Revising the Provisions of the Supervision and Administration of Specialized Insurance Agencies (the “Decision on Revising the Agency Provisions”), pursuant to which, CIRC mandated any insurance agency established subsequent to the Decision on Revising the Agency Provisions to meet a minimum registered capital requirement of RMB50 million
($8,165,895)
. On May 16, 2013
, CIRC issued Notice for Further Clarification on Related Issues of Access to Professional Insurance Intermediary Market (the “Notice”), pursuant to which, professional insurance agencies established prior to the issuance of the Decision on Revising the Agency Provisions, with registered capital less than RMB50 million ($8,165,895), can continue to operate its existing business within the provinces where they have a registered office or branch office, but shall not set up any new branches in any provinces where it has no registered office or a branch office.
As of the date hereof, Anhou, a professional insurance agency with a PRC nationwide license, has a registered capital of RMB10 million ($1,633,179). The registered office and branch offices of Anhou currently are all in Henan province. To better implement its expansion strategies, Anhou intends to increase its registered capital to RMB50 million ($8,165,895) to meet the requirement of CIRC so that it can set up new branches in any province beyond its current operations in Mainland China.
Due to certain restrictions on direct foreign investment in insurance agency business under current PRC legal regime, Anhou has sought certain investments made by the
Investor
Borrowers and they may need funds through individual loans. Upon the completion of the contemplated increase of registered capital of Anhou, each Investor Borrowers shall, or cause their designated persons to, enter into the Variable Interest Entities Agreement with CU WFOE, Anhou and other parties so as to consolidate any additional VIE interest generated from the said registered capital increase into the Company.
Registered Capital Increase
On September 26, 2013, several new PRC individual investors, namely Wang Yanyan, Chen Zhaohui, Yue Jing, Hou Weizhe, Zhang Yong, Chen Li (“Anhou New Investors”) and the original shareholders of Henan Law Anhou Insurance Agency Co., Ltd. (“Anhou”), namely, Zhu Shuqin, Wei Qun, Fang Qunlei and Chen Yanxia (“Anhou Original Shareholders”) entered into a shareholders resolution of Anhou (the “Capital Increase Resolution”), pursuant to which, Anhou Original Shareholders and Anhou New Investors agreed to increase the registered capital of Anhou to RMB50 million ($8,165,895), among which, Wang Yanyan would invest RMB10 million ($1,633,179), accounting for 20%, Chen Zhaohui would invest RMB10 million ($1,633,179), accounting for 20%, Yue Jing would invest RMB7.5 million ($1,224,871), accounting for 15%, Hou Weizhe will invest RMB5 million ($816,589), accounting for 10%, Zhang Yong will invest RMB4.5 million ($734,930), accounting for 9%, and Chen Li will invest RMB3 million ($489,949), accounting for 6%, of the registered capital of Anhou.
Due to PRC legal restrictions on foreign ownership and investment in the insurance agency businesses in China, particularly those based on qualifications as well as capital requirements of the investors, Able Capital Holding Co., Ltd., a limited liability company established and registered in Hong Kong, delegated four PRC individuals, namely Wang Yanyan, Chen Zhaohui, Hou Weizhe and Zhang Yong, to invest in Anhou on its behalf.
On October 24, 2013, Anhou completed the registration with local Administration Industry and Commerce (“AIC”) on the above-mentioned capital increase. The new business license was issued to Anhou on October 25, 2013.
On a going forward basis, the Company’s primary requirements for cash over the next 12 months consist of:
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providing insurance agency services to its existing clients in its existing branches;
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developing new clients;
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promoting sales activities;
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opening more branches in China; and
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expanding business scale in China, through mergers & acquisitions.
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Due to related parties
The related parties listed below loaned money to the Company for working capital. Due to related parties consisted of the following as of September 30, 2013 and June 30, 2013 (audited):
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September 30, 2013
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June 30, 2013
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Due to Mr. Mao (Principal Shareholder of the Company)
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$
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100,961
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$
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71,487
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Due to Ms. Zhu (Shareholder of Henan Anhou)
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502,115
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1,099,331
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Due to Mr. Zhu (Legal Representative of Jiangsu Law)
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2,252
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-
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Due to Mrs. Li (Director of CUIS)
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-
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566,478
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Total
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$
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605,328
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$
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1,737,296
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Off Balance Sheet Arrangements
As of September 30, 2013, the Company had no off balance sheet arrangements.