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. Our financial statements are prepared in U.S. dollars and in accordance with U.S. GAAP.
Cautionary Note Regarding Forward-Looking
Statements
This Quarterly Report
on Form 10-Q contains “forward-looking statements” within the meaning of the safe harbor provisions of the U.S. Private Securities
Litigation Reform Act of 1995. Because they discuss future events or conditions, forward-looking statements may include words such as
“anticipate,” “believe,” “estimate,” “intend,” “could,” “should,”
“would,” “may,” “seek,” “plan,” “might,” “will,” “pursue,”
“expect,” “predict,” “project,” “goals,” “strategy,” “future,”
“likely,” “forecast,” “potential,” “continue,” negatives thereof or similar references
to future periods. Examples of forward-looking statements include, among others, statements we make regarding business strategies, macro-economic
and sector-specific trends, future cash flows, financing plans, plans and objectives of management and any other statements which are
not statements of historical facts.
Forward-looking statements
are neither historical facts nor assurances of future performance. Instead, they are based only on our current beliefs, expectations and
assumptions regarding the future of our business, future plans and strategies, projections, anticipated events and trends, the economy
and other future conditions. Because forward-looking statements relate to the future, they are subject to inherent uncertainties, risks
and changes in circumstances that are difficult to predict and many of which are outside of our control. Our actual future results and
financial condition may differ materially from those indicated in the forward-looking statements. Therefore, you should not rely on any
of these forward-looking statements. Important factors that could cause our actual results and financial condition to differ materially
from those indicated in the forward-looking statements include, among others, legal and regulatory changes in the jurisdictions in which
we operate, volatility or decline in our stock price, potential fluctuation of our quarterly and annual financial and operational results,
rapid adverse changes in markets, decline in demand for our goods and services, insufficient revenues to cover our operating costs and
such other factors as identified in “Item 1A. Risk Factors” described in our most recent annual report on Form 10-K.
Readers are urged to
carefully review and consider the various disclosures made by us in this report and our other filings with the SEC. These reports attempt
to advise interested parties of the risks and factors that may affect our business, financial condition and results of operations and
prospects. The forward-looking statements made in this report speak only as of the date hereof and we disclaim any obligation, except
as required by law, to provide updates, revisions or amendments to any forward-looking statements to reflect changes in our expectations
or future events.
Unless otherwise indicated
by the context, references to the “Company, “we,” “us,” “our” in this report are to the combined
business of Microalliance Group Inc., a Nevada corporation, and its consolidated subsidiaries.
Overview
The
Company is primarily engaged in offering two types of products: coffee and liquor. The Company, through its subsidiaries in China, develops,
produces, markets and sells flagship “coffee tea” products, which are innovative specialty coffee products with Chinese black
tea’s taste, as well as black coffee products and other coffee products. We sell our coffee products wholesale to retail partners
and corporate customers, and we also sell directly to consumers in the PRC via our e-commerce channels. We commit to build the first
brand of “coffee tea” culture in the PRC. As of the date of this report, we have entered into franchise agreements with a
large number of franchisees relating to the distribution, marketing and sale of our coffee products. Our coffee product offerings consist
of five different coffee products.
Our
liquor products are sold across China through sales agents, distributors and franchisees. Our licensed “Nainiang Liquor”
retail stores have opened in a dozen of cities in China, such as Beijing, Shanghai, Shenzhen, Xiamen, Chongqing, Chengdu, Kunming, Foshan,
Zhaoqing, Huangshan, Jingzhou and Baoding, to mainly market and sell our proprietary brand liquor products to consumers. We supply the
licensed retail stores with our liquor products and maintain quality and uniformity throughout the licensed stores by requiring uniform
retail prices, providing continual trainings, periodic field visits by our marketing personnel and holding annual and special meetings
of franchisees. Such retail stores launch marketing initiatives like tasting events to increase our brand awareness and promote sales.
We currently sell six liquor products, including featured “coffee spirit” products and vintage “Baijiu” products.
Our “coffee spirit” products are independently innovated by us and unique in China, with premium quality, good taste and
large profit margin. Our “Baijiu” (a type of Chinese liquor made from whole grain with alcohol content from 40-60%) products
have excellent quality and we own a large stock of vintage Baijiu whose value grows as they age. As of June 30, 2022, we had RMB125,285,000
(approximately $18.7 million) of such vintage Baijiu in stock based on the historical purchase cost. The liquor market size is massive
which generates more revenues than the coffee business.
COVID-19
Impact
Our
coffee factory in Dongguan as well as offices, contracted liquor producers and licensed “Nainiang Liquor” retail stores in
Shenzhen were temporarily closed due to COVID-19 resurgences and local containment measures beginning the first quarter of 2022. Consumer
demand for liquor products has dropped during lockdown periods as a result of social distancing policies and reduced gatherings. In addition,
our plan to expand internationally has largely stalled due to the COVID-19 pandemic. It remains difficult to predict the full impact
of the COVID-19 pandemic on the broader economy and our coffee and liquor business in particular.
Critical
Accounting Policies and Use of Estimates
We
prepare our consolidated financial statements in conformity with U.S. GAAP, which requires management to make certain estimates and to
apply judgments. We base our estimates and judgments on historical experience, current trends and other factors that management believes
to be important at the time the financial statements are prepared. On a regular basis, we review our accounting policies and how they
are applied and disclosed in our condensed consolidated financial statements. Actual results could differ from those estimates made by
management.
We
believe that of our significant accounting policies, which are described in Note 3 to our consolidated financial statements, the following
accounting policies involve a greater degree of judgment and complexity. Accordingly, these are the policies we believe are the most
critical to aid in fully understanding and evaluating our financial condition and results of operations.
Revenue
Recognition
The
Company’s revenues primarily include Company sales, franchise fees and income and revenues from transactions with franchisees.
Product
sales
Product
sales represent the sale of “coffee tea” and “spirit” products. Such revenue is recognized net of value-added
taxes, upon delivery at such time that title passes to the customers.
Franchise
fees and income
Franchise
fees and income primarily include upfront franchise fees, such as initial fees, pre-opening assistance to operate spirit stores, subsequent
training provided to franchisees and renewal fees. The Company has determined that the services provided in exchange for upfront franchise
fees are highly interrelated with the franchise rights. The franchise rights are accounted for as rights to access the Company’s
symbolic intellectual property in accordance with ASC 606, and the Company recognizes upfront franchise fees received from a franchisee
as revenue when performance obligations are satisfied in accordance with the franchise agreement or the renewal agreement. The franchise
agreement term is typically 3 years.
Revenues
from transactions with franchisees
Revenues
from transactions with franchisees consist primarily of sales of spirit products. The Company sells and delivers spirit products to the
franchisees. The performance obligations arising from such transactions are considered distinct from the franchise agreement as they
are not highly dependent on the franchise agreement and the customer can benefit from the procurement service on its own. Revenue is
recognized upon transfer of control over ordered items, generally upon delivery to the franchisees.
In
determining the amount and timing of revenue from contracts with customers, the Company exercises significant judgment with respect to
collectability of the amount; however, the timing of recognition does not require significant judgment, as it is based on either the
franchise term or the date of product shipment, none of which require estimation.
The
Company does not incur a significant amount of contract acquisition costs in conducting its franchising activities. The Company believes
its franchising arrangements do not contain a significant financing component.
The
Company’s revenue recognition policy is compliant with ASC 606, Revenue from Contracts with Customers, and revenue is recognized
when a customer obtains control of promised goods and is recognized in an amount that reflects the consideration that the Company expects
to receive in exchange for those goods. In addition, the standard requires disclosure of the nature, amount, timing, and uncertainty
of revenue and cash flows arising from contracts with customers. The amount of revenue that is recorded reflects the consideration that
the Company expects to receive in exchange for those goods. The Company applies the following five-step model in order to determine this
amount:
| (i) | identification
of the goods and services in the contract; |
| (ii) | determination
of whether the goods and services are performance obligations, including whether they are distinct in the context of the contract; |
| (iii) | measurement
of the transaction price, including the constraint on variable consideration; |
| (iv) | allocation
of the transaction price to the performance obligations; and |
| (v) | recognition
of revenue when (or as) the Company satisfies each performance obligation. |
The
Company only applies the five-step model to contracts when it is probable that the Company will collect the consideration it is entitled
to in exchange for the goods or services it transfers to the customer. Once a contract is determined to be within the scope of ASC 606
at contract inception, the Company reviews the contract to determine which performance obligations the Company must deliver and which
of these performance obligations are distinct. The Company recognizes as revenues the amount of the transaction price that is allocated
to the respective performance obligation when the performance obligation is satisfied or as it is satisfied. Generally, the Company’s
performance obligations are transferred to customers at a point in time, typically upon delivery or service being rendered.
For
all reporting periods, the Company has not disclosed the value of unsatisfied performance obligations for all product revenue contracts
with an original expected length of one year or less, which is an optional exemption that is permitted under the adopted rules.
| |
For the three months ended June 30, | |
Revenue | |
2022 | | |
2021 | |
Product sales | |
$ | 1,893,954 | | |
$ | 5,290,589 | |
Franchise fees and income | |
| 22,679 | | |
| 98,805 | |
Revenues from transactions with franchisees | |
| 2,113,643 | | |
| 4,068,993 | |
| |
$ | 4,030,276 | | |
$ | 9,458,387 | |
| |
For the six months ended June 30, | |
Revenue | |
2022 | | |
2021 | |
Product sales | |
$ | 4,326,491 | | |
$ | 5,436,720 | |
Franchise fees and income | |
| 481,305 | | |
| 146,146 | |
Revenues from transactions with franchisees | |
| 5,820,769 | | |
| 8,286,779 | |
| |
$ | 10,628,565 | | |
$ | 13,869,645 | |
Contract liabilities | |
As of June 30, 2022 | | |
As of December 31, 2021 | |
Deferred revenue related to prepaid coffee and liquor products | |
$ | 43,982 | | |
$ | 20,881 | |
Deferred revenue related to upfront franchise fees | |
| 740,130 | | |
| 716,634 | |
| |
$ | 784,112 | | |
$ | 737,515 | |
Contract
liabilities primarily consist of deferred revenue related to prepaid spirit products and upfront franchise fees. Deferred revenue related
to prepaid spirit products represents advance from franchisees for future supply of products which is expected to be recognized as revenue
in the next 12 months. Deferred revenue related to upfront franchise fees represents the training service to be delivered over the term
of franchise agreement that as of June 30, 2022, we expect to recognize revenue of $211,259 within the next 12 months.
We
have elected, as a practical expedient, not to disclose the value of remaining performance obligations associated with the franchise
agreement in exchange for franchise right and related training services. The remaining duration of the performance obligation is the
remaining contractual term of each franchise agreement. Revenue from training services provided to franchisees is recognized upon the
conduct and delivery of training.
Concentrations
of Credit Risk
Financial
instruments that potentially expose us to significant concentration of credit risk consist primarily of cash and cash equivalents and
accounts receivable. As of June 30, 2022 and December 31, 2021, substantially all of our cash and cash equivalents were deposited with
financial institutions with high-credit ratings and quality. The following customers had an accounts receivable balance greater than
10% of total accounts receivable at June 30, 2022 and December 31, 2021.
| |
March 31, 2022 | | |
December 31, 2021 | |
| |
Amount | | |
% | | |
Amount | | |
% | |
Customer A | |
$ | - | | |
| - | % | |
$ | 1,540,197 | | |
| 51 | % |
Customer B | |
| - | | |
| - | % | |
| 1,472,059 | | |
| 49 | % |
Customer C | |
| 1,115,791 | | |
| 68.4 | % | |
| - | | |
| - | % |
Customer D | |
| 512,397 | | |
| 31.5 | % | |
| - | | |
| - | % |
| |
$ | 1,628,188 | | |
| 99.9 | % | |
$ | 3,012,256 | | |
| 100 | % |
We
did not have customers constituting 10% or more of the net revenues in the six months ended June 30, 2022. We had two customers constituting
10% or more of the net revenues in the six months ended June 30, 2021 as follows:
| |
2022 | | |
2021 | |
| |
Amount | | |
% | | |
Amount | | |
% | |
Customer A | |
$ | - | | |
| - | % | |
$ | 867,850 | | |
| 20 | % |
Customer B | |
| - | | |
| - | % | |
| 435,070 | | |
| 10 | % |
| |
$ | - | | |
| - | % | |
$ | 1,302,920 | | |
| 30 | % |
Recently
Issued and Adopted Accounting Pronouncements
In
June 2016, the FASB issued ASU 2016-13, Financial Instruments — Credit Losses (Topic 326), Measurement of Credit Losses on Financial
Statements. This ASU requires a financial asset (or group of financial assets) measured at amortized cost basis to be presented at the
net amount expected to be collected. The allowance for credit losses is a valuation account that is deducted from the amortized cost
basis of the financial asset(s) to present the net carrying value at the amount expected to be collected on the financial asset. This
Accounting Standards Update affects entities holding financial assets and net investment in leases that are not accounted for at fair
value through net income. The amendments affect loans, debt securities, trade receivables, net investments in leases, off balance sheet
credit exposures, reinsurance receivables, and any other financial assets not excluded from the scope that have the contractual rights
to receive cash. For smaller public business entities, the amendments in this Update are effective for fiscal years beginning after January
1, 2023, including interim periods within those fiscal years. All entities may adopt the amendments in this Update through a cumulative-effect
adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is effective (that is, a modified-retrospective
approach). We are currently evaluating the impact of the adoption of this pronouncement on its consolidated financial statements.
We
review new accounting standards as issued. We have not identified any other new standards that we believe will have a significant impact
on our financial statements.
Results
of Operations
The
following discussion should be read in conjunction with the condensed consolidated financial statements of Microalliance Group Inc. attached
hereto for the three and six months ended June 30, 2022 and 2021.
Comparison
of Three Months Ended June 30, 2022 and 2021
Revenue
We generated $4,030,276 in revenue for the three months ended June
30, 2022 compared to $9,458,387 for the three months ended June 30, 2022. There was a decrease in total revenues of $5,428,111 or 57.4%
compared with the three months ended June 30, 2021, mainly due to the outbreaks of additional variants of COVID-19 which are more transmissible
(like the Omicron variant and the two sub-variants: BA.1 and BA.2.) or result in more severe sickness (like the Delta variant) having
caused negative impacts to our business since January 2022. The Chinese government has been taking actions to contain COVID-19 such as
re-imposing previously lifted measures or putting in place additional restrictions including the Shenzhen and Shanghai lockdowns to slow
the spread of COVID-19. Especially the full-scale lockdown in Shanghai since the end of March for ‘societal zero-Covid’ pursuit
to track every Omicron case has led to the dramatic drop in our revenue as Shanghai is our major market which represents around 30%-40%
of our total revenue. In addition, the closure of Shanghai has seen many Chinese are losing their incomes and their lifestyle has changed
such that their spending on tea and liquor products are dramatically reduced. We expect the Chinese economy and our business will only
be gradually recovering from recent surges of COVID-19 cases near the end of 2022.
Cost
of Revenue
Cost of revenue was $1,350,080 for the three months ended June 30,
2022 compared to $2,775,753 for the three months ended June 30, 2021, a decrease in cost of revenue by $1,425,673 or 51.4%. The cost of
revenue consists of the cost of raw materials and cost of manufactured goods sold to customers, including labor cost, rental expense,
research and development costs, etc. The decrease was relatively in line with the decrease in revenue.
Gross
profit
Gross profit for the three months ended June
30, 2022 was $2,680,196 compared with $6,682,634 for the three months ended June 30, 2021. The gross profit margin was 66.5% for the
three months ended June 30, 2022 compared to 70.7% for the three months ended June 30, 2021. Such decrease was due to a lower margin
for the liquor products, which comprise a larger portion of our sales during the three months ended June 30, 2022 as compared with the
same period of 2021.
Operating
Expenses
Selling
and marketing expenses
Our selling expenses for the three months ended June 30, 2022 and 2021
were $176,083 and $136,865, respectively. The selling and marketing expenses increased was $39,218 or 28.7%. Selling expenses consist
primarily of salary and welfare for sales staff, advertising expense and exhibition expense. Although our revenue dropped, the labor costs
and other fixed costs have been rising due to inflation, which led to the increase of selling and marketing expenses.
General
and administrative expenses
By
far the most significant component of our operating expenses for both the three months ended June 30, 2022 and 2021 was general and administrative
expenses of $427,388 and $293,764, respectively. The following table sets forth the main components of our general and administrative
expenses for the three months ended June 30, 2022 and 2021.
| |
2022 | | |
2021 | |
| |
Amount (US$) | | |
% of Total | | |
Amount (US$) | | |
% of Total | |
General and administrative expense: | |
| | |
| | |
| | |
| |
Consultancy fee | |
$ | 176,332 | | |
| 41 | % | |
$ | 125,121 | | |
| 42 | % |
Salary and welfare | |
| 109,644 | | |
| 26 | % | |
| 37,653 | | |
| 13 | % |
Rental expenses | |
| 56,487 | | |
| 13 | % | |
| 81,242 | | |
| 27 | % |
Research and development costs | |
| - | | |
| - | % | |
| 22,265 | | |
| 8 | % |
Office expenses | |
| 11,162 | | |
| 3 | % | |
| 4,336 | | |
| 1 | % |
Travel and accommodations | |
| 18,230 | | |
| 4 | % | |
| 7,399 | | |
| 3 | % |
Entertainment | |
| 22,829 | | |
| 5 | % | |
| 2,386 | | |
| 1 | % |
Others | |
| 32,704 | | |
| 8 | % | |
| 13,362 | | |
| 5 | % |
Total general and administrative expenses | |
$ | 427,388 | | |
| 100 | % | |
$ | 293,764 | | |
| 100 | % |
General
and administrative expenses increased by $133,624 or 45.5% from $293,764 for the three months ended June 30, 2021 to $427,388 for the
three months ended June 30, 2022. The increase was mainly due to the increase in legal and professional fees and the increase in labor
costs. We have more headcount since we acquired Nainiang Liquor on June 3, 2021.
Net
Profit
We reported a net profit of $4,895,420 for the three months ended June
30, 2021 compared to a net profit of $1,526,476 for the three months ended June 30, 2022, a decrease of $3,368,944 or 68.8%. The decrease
was primarily attributable to the fact that our revenue has decreased significantly, whereas the selling and administrative expenses increase
due to some expenses being fixed costs in nature.
Comparison
of Six Months Ended June 30, 2022 and 2021
Revenue
We
generated $10,628,565 in revenue for the six months ended June 30, 2022 compared to $13,869,645 for the six months ended June 30, 2021.
There was a decrease in total revenues of $3,241,080 or 23.4% compared with the six months ended June 30, 2021.
The decrease was mainly due to the outbreaks of additional variants
of COVID-19 which are more transmissible (like the Omicron variant and the two sub-variants: BA.1 and BA.2.) or result in more severe
sickness (like the Delta variant) having caused negative impacts to our business since January 2022. The Chinese government has been taking
actions to contain COVID-19 such as re-imposing previously lifted measures or putting in place additional restrictions including the Shenzhen
and Shanghai lockdowns to slow the spread of COVID-19. Especially the full-scale lockdown in Shanghai since the end of March for ‘societal
zero-Covid’ pursuit to track every Omicron case has led to the dramatic drop in our revenue as Shanghai is our major market which
represents around 30%-40% of our total revenue. In addition, the closure of Shanghai has seen many Chinese are losing their incomes and
their lifestyle has changed such that their spending on tea and liquor products are dramatically reduced. We expect the Chinese economy
and our business will only be gradually recovering from recent surges of COVID-19 cases near the end of 2022.
Cost
of Revenue
Cost of revenue was $3,180,777 for the six months ended June 30, 2022
compared to $3,710,918 for the six months ended June 30, 2021. The decrease of cost of revenue was $530,141 or 14.3%. The cost of revenue
consists of the cost of raw materials and cost of manufactured goods sold to customers, including labor cost, rental expense, research
and development costs, etc. The decrease was not in line with the decrease in revenue because of the acquisition of Nainiang Liquor on
June 3, 2021 such that we incurred significant labor costs for the six months ended June 30, 2022 due to the increase of headcount through
the business acquisition. Depending on the development of the COVID-19 situation in China, we will explore possibilities to streamline
our manpower and will evaluate the impact of any redundancy plans.
Gross
profit
Gross profit for the six months ended June 30,
2022 was $7,447,788 compared with $10,158,727 for the six months ended June 30, 2021. The decrease in gross profit margin from 70.1%
for the six months ended June 30, 2022 to 73.2% for the six months ended June 30, 2021 was due to a lower margin for the liquor products,
which comprise a larger portion of our sales during the six months ended June 30, 2022 as compared with the same period of 2021.
Operating
Expenses
Selling
and marketing expenses
Our selling expenses for the six months ended June 30, 2022 and 2021
was $363,697 and $173,344, respectively. Selling expenses consist primarily of salary and welfare for sales staff, advertising expense
and exhibition expense. The increase of selling and marketing expenses was $190,353 or 109.8%. Although our revenue dropped, the labor
costs and other fixed costs have been rising due to inflation, which led to the increase of selling and marketing expenses. In addition,
more expenses incurred during the six months ended June 30, 2022 as a result of the consolidation of the results of Nainiang Liquor through
the business acquisition on June 3, 2021.
General
and administrative expense
By
far the most significant component of our operating expenses for both the six months ended June 30, 2022 and 2021 was general and administrative
expenses of $944,333 and $561,564, respectively. The following table sets forth the main components of our general and administrative
expenses for the six months ended June 30, 2022 and 2021.
| |
For the six months ended June 30, | |
| |
2022 | | |
2021 | |
| |
Amount (US$) | | |
% of Total | | |
Amount (US$) | | |
% of Total | |
General and administrative expense: | |
| | |
| | |
| | |
| |
Consultancy fee | |
$ | 429,440 | | |
| 46 | % | |
$ | 216,851 | | |
| 39 | % |
Salary and welfare | |
| 210,201 | | |
| 22 | % | |
| 88,137 | | |
| 16 | % |
Rental expenses | |
| 160,886 | | |
| 17 | % | |
| 159,838 | | |
| 28 | % |
Research and development costs | |
| - | | |
| - | % | |
| 44,261 | | |
| 8 | % |
Office expenses | |
| 17,630 | | |
| 2 | % | |
| 13,211 | | |
| 2 | % |
Travel and accommodations | |
| 31,335 | | |
| 3 | % | |
| 12,617 | | |
| 2 | % |
Entertainment | |
| 26,408 | | |
| 3 | % | |
| 6,971 | | |
| 1 | % |
Others | |
| 68,433 | | |
| 7 | % | |
| 19,678 | | |
| 4 | % |
Total general and administrative expenses | |
$ | 944,333 | | |
| 100 | % | |
$ | 561,564 | | |
| 100 | % |
Increase
in general and administrative expenses by $382,769 or 68.2% from $561,564 for the six months ended June 30, 2021 to $944,333 for the
six months ended June 30, 2022. The increase was mainly due to the increase in legal and professional fees and the increase in labor
costs. We have more headcount since we acquired Nainiang Liquor on June 3, 2021.
Net
Profit
We incurred a net profit of $4,547,629 for the six months ended June
30, 2022 compared to $7,287,683 for the six months ended June 30, 2021, a decrease of $2,740,054 or 37.6%. The decrease was primarily
attributable to the fact that our revenue has decreased significantly, whereas the selling and administrative expenses increase due to
some expenses being fixed costs in nature.
Liquidity
and Capital Resources
|
|
June
30, |
|
|
December
31, |
|
Working capital: |
|
2022 |
|
|
2021 |
|
Total current assets |
|
$ |
32,123,859 |
|
|
$ |
30,383,395 |
|
Total current liabilities |
|
|
(1,454,534 |
) |
|
|
(2,731,608 |
) |
Working capital surplus |
|
$ |
30,669,325 |
|
|
$ |
27,651,787 |
|
As
of June 30, 2022, we had cash and cash equivalents of $470,727. To date, we have financed our operations primarily through our working
capital. The following table provides detailed information about our net cash flows for the six months ended June 30, 2022 and 2021: