10-Q: QDM International Reports Q3 Loss Amid Soaring Referral Costs

QDM International experienced a net loss in the third quarter of 2025 despite significant revenue growth, driven by a sharp increase in referral fees and regulatory changes in Hong Kong.

Summary

• QDM International Inc. (QDM) reported a net loss of $1,113,358 for the three months ended September 30, 2025, compared to a net income of $488,706 for the same period in 2024.
• Revenue for the three months ended September 30, 2025, increased by 299.5% to $3,970,674 from $993,917 in the prior year.
• Cost of sales surged by 4,412.1% to $4,946,977 for the three months ended September 30, 2025, primarily due to higher referral fees paid to referrers, reaching approximately 90% of commissions.
• For the six months ended September 30, 2025, net income increased by 14.2% to $1,082,947, with revenue growing by 286.4% to $7,565,671.
• The Hong Kong Insurance Authority (IA) adopted a 50% benchmark for referral fees on certain participating policies, effective October 1, 2025, which QDM plans to comply with by reducing its rates to 40-50%.
• The company's disclosure controls and procedures were deemed not effective as of September 30, 2025, due to material weaknesses in internal control over financial reporting, including lack of segregation of duties, risk assessment, formal documentation, and an audit committee.
• CEO Huihe Zheng converted 531,886 shares of Series C Preferred Stock into 58,507 shares of common stock on September 22, 2025, resulting in no Series C Preferred Stock outstanding.
• Mr. Zheng, who holds 82.1% of the company's aggregate voting power, entered into a shareholder agreement on October 1, 2025, agreeing not to sell his Series B Preferred Stock and waiving co-sales rights, with the company agreeing to repurchase these shares for $0.001 each upon a change of control.

Sentiment

Score: 3

Explanation: The company shows strong revenue growth, but the significant net loss in the most recent quarter due to unsustainable referral fees, coupled with severe internal control weaknesses and substantial regulatory compliance risks, indicates a highly concerning financial and operational position. The long-term viability of its business model is under threat from regulatory changes.

Positives

• Revenue for the three months ended September 30, 2025, increased significantly by 299.5% to $3,970,674 compared to $993,917 in the prior year.
• Revenue for the six months ended September 30, 2025, increased by 286.4% to $7,565,671 compared to $1,958,182 in the prior year.
• Net income for the six months ended September 30, 2025, increased by 14.2% to $1,082,947 compared to $948,086 in the prior year.
• Net cash provided by operating activities for the six months ended September 30, 2025, was approximately $4.3 million, a substantial increase from $1.0 million in the same period of 2024.
• Cash and cash equivalents increased to $12,519,196 as of September 30, 2025, from $8,557,305 as of March 31, 2025.
• The company's subsidiary, YeeTah, was in compliance with Hong Kong's minimum paid-up share capital and net assets requirements as of September 30, 2025.

Negatives

• The company reported a net loss of $1,113,358 for the three months ended September 30, 2025, a significant decline from a net income of $488,706 in the same period of 2024.
• Cost of sales for the three months ended September 30, 2025, increased by 4,412.1% to $4,946,977, leading to a gross loss of $976,303.
• Gross profit margin decreased by approximately 113.6% for the three months ended September 30, 2025, and by 59.1% for the six months ended September 30, 2025, primarily due to increased referral fees.
• Operating loss for the three months ended September 30, 2025, was $1,325,822, compared to an operating income of $610,516 in the prior year.
• The company's disclosure controls and procedures were concluded to be not effective as of September 30, 2025, due to material weaknesses in internal control over financial reporting.
• The company advanced $256,410 to CEO Huihe Zheng during the six months ended September 30, 2025, for a proposed bonus that was later cancelled, though the amount was repaid post-period.

Risks

• Failure to comply with Hong Kong regulations on referral arrangements and the new 50% benchmark for referral fees could lead to regulatory sanctions, including suspension or revocation of the insurance broker license.
• Past referral practices, including paying fees above the 50% benchmark and business involving Mainland China visitors, may be subject to review, investigation, or enforcement action by the Insurance Authority (IA).
• Efforts to reduce referral fees to comply with IA expectations may adversely affect referrer motivation and behavior, potentially leading to a decline in referral-generated business and profitability.
• Material weaknesses in internal control over financial reporting, including lack of proper segregation of duties, risk assessment process, formal documentation, and an audit committee, could adversely affect the ability to record, process, summarize, and report financial information.
• Political uncertainty and social unrest in Hong Kong, along with Chinese government laws, could impact the market for services.
• Changes in applicable laws or regulations in Hong Kong related to or impacting the business pose a risk.
• The ability to attract customers, further enhance brand recognition, and hire/retain qualified management and key employees is crucial for future growth.

Future Outlook

The company expects referral fee rates in the market to gradually normalize following the Hong Kong Insurance Authority's adoption of a 50% benchmark. It has decreased its referral fee rates to a range of approximately 40% to 50% since October 2025 to align with this guidance, which is expected to lower referral-related commission costs. However, this reduction may also affect the volume of business generated through referrers. The company plans to remediate material weaknesses in internal controls by hiring qualified accounting personnel, providing training, formulating U.S. GAAP accounting policies, establishing SOX compliance assessment, and forming an audit committee.

Management Comments

• The increase in revenue was mainly due to the expansion of our collaboration with insurance partners, an increase in the number of insurance policies that generate commissions, and an increase in commission rate.
• The increase in cost of sales was primarily due to higher referral fees paid to referrers, with rates increasing to approximately 90% for the three months ended September 30, 2025, and applied retroactively.
• In light of recent circulars issued by the Hong Kong Insurance Authority, including the adoption of a 50% benchmark for referral fees, we expect that referral fee rates in the market will gradually normalize.
• We have decreased our referral fee rates to a range of approximately 40% to 50%, at or below the benchmark level, since October 2025, which is expected to lower our referral-related commission costs going forward, although it may also affect the volume of business generated through referrers.
• Our disclosure controls and procedures were not effective as of September 30, 2025, due to material weaknesses in our internal control over financial reporting, including lack of proper segregation of duties and risk assessment process, lack of formal documentation, and lack of an audit committee.

Industry Context

The Hong Kong insurance industry is undergoing significant regulatory changes, particularly concerning referral arrangements and fees. The Insurance Authority's (IA) circulars, including the 50% benchmark for referral fees, aim to curb non-compliant business models that incentivize unlicensed selling, especially to Mainland China visitors. This regulatory shift impacts companies like QDM International, which historically relied on high referral fees (up to 90%) and referrals from Mainland China. The industry is expected to see a normalization of referral fee rates as participants adjust to these new requirements, potentially leading to changes in distribution channels and business volumes for brokers.

Comparison to Industry Standards

• The company's historical referral fee rates, reaching approximately 90% of commissions, significantly exceeded the Hong Kong Insurance Authority's (IA) newly adopted 50% benchmark for referral fees on certain participating policies, effective October 1, 2025.
• The IA's guidance explicitly targets business models that pay 'inordinately high, sales-contingent referral fees that absorb most of the commission,' indicating that QDM's past practices were outside the expected industry standard for compliant operations.
• The company's commitment to reduce referral fees to a range of 40% to 50% from October 2025 demonstrates an effort to align with the IA's benchmark, which is a critical step towards meeting regulatory expectations in the Hong Kong insurance brokerage sector.
• The identified material weaknesses in internal control over financial reporting (lack of segregation of duties, risk assessment, formal documentation, and an audit committee) fall short of robust corporate governance standards expected of publicly traded companies, especially compared to larger, more established financial services firms globally.

Corporate Governance

Legal Proceedings

• The company is not currently a party to any material legal or administrative proceedings, but acknowledges that litigation or regulatory actions in the ordinary course of business could result in substantial cost and diversion of resources.

Related Party Transactions

• During the six months ended September 30, 2025, the company advanced $256,410 to CEO Huihe Zheng in connection with a proposed cash bonus. This proposed bonus was subsequently cancelled, and the full amount was repaid to the company on November 5, 2025.
• On October 9, 2024, the company issued 6,000,000 Series B Preferred Stock to CEO Huihe Zheng at $0.10 per share in exchange for the cancellation of $600,000 of debt owed by the company to Mr. Zheng. As a result, Mr. Zheng beneficially owns 82.1% of the aggregate voting power.
• On September 22, 2025, CEO Huihe Zheng converted 531,886 shares of Series C Preferred Stock into 58,507 shares of common stock.

Stakeholder Impact

• **Shareholders**: Experience a net loss in the most recent quarter and face significant regulatory and internal control risks, potentially impacting share price and long-term value. The CEO's increased voting power and control through preferred stock and the shareholder agreement could limit influence of other shareholders.
• **Employees**: Increased general and administrative expenses due to hiring more employees and increased travel, suggesting growth in workforce.
• **Customers**: Potential impact on service delivery or product offerings if changes in referral arrangements affect the company's ability to attract and serve clients, particularly those from Mainland China.
• **Referrers**: Will experience a significant reduction in referral fees (from ~90% to 40-50%), which may decrease their motivation to refer clients to QDM, potentially diverting business to competitors.
• **Regulators (Hong Kong Insurance Authority)**: The company's past practices and current remediation plans are under scrutiny, with potential for sanctions if compliance is not fully achieved.

Next Steps

• Implement measures to improve internal controls over financial reporting, including hiring qualified accounting personnel, providing U.S. GAAP and SEC reporting training, formulating accounting policies and procedure manuals, establishing Sarbanes-Oxley compliance assessment, and forming an audit committee.
• Continue to reduce referral fee rates to a range of approximately 40% to 50% from October 2025 to comply with the Hong Kong Insurance Authority's 50% benchmark.
• Strengthen internal controls to ensure all regulated activities are performed by licensed technical representatives to mitigate regulatory risks.
• Monitor the impact of reduced referral fees on business volume and explore alternative distribution channels.

Key Dates

Recommendation

Despite strong revenue growth, the company reported a significant net loss in the most recent quarter due to an unsustainable increase in referral fees. The identified material weaknesses in internal control over financial reporting, coupled with substantial regulatory risks related to non-compliant referral practices and the new 50% benchmark from the Hong Kong Insurance Authority, pose severe threats to the company's operational stability and license. While management plans to address these issues, the immediate financial deterioration and governance concerns warrant a cautious stance. The high concentration of voting power with the CEO and related party transactions also add to the risk profile. Investors should consider selling given the significant uncertainties and potential for adverse regulatory actions and continued financial underperformance.

Keywords

Insurance Brokerage, Hong Kong, SEC 10-Q, Financial Results, Referral Fees, Regulatory Compliance, Internal Controls, Stock Split, Corporate Governance, QDM International