Attached files
file | filename |
---|---|
EX-32.1 - EMERALD DAIRY INC | v179722_ex32-1.htm |
EX-31.1 - EMERALD DAIRY INC | v179722_ex31-1.htm |
EX-31.2 - EMERALD DAIRY INC | v179722_ex31-2.htm |
EX-32.2 - EMERALD DAIRY INC | v179722_ex32-2.htm |
UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
Washington,
D.C. 20549
FORM 10-K/A
(Amendment No.
1)
(Mark
One)
x
|
ANNUAL REPORT PURSUANT TO
SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
|
|
For
the fiscal year ended:
|
December 31,
2009
|
or
¨
|
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:
|
000-52174
|
EMERALD
DAIRY INC.
(Exact
name of registrant as specified in its charter)
Nevada
|
80-0137632
|
|
(State
or other jurisdiction of
incorporation
or organization)
|
(I.R.S.
Employer
Identification
No.)
|
|
11990
Market Street, Suite 205
Reston,
Virginia
|
20190
|
|
(Address
of principal executive offices)
|
(Zip
Code)
|
Registrant’s
telephone number, including area code:
|
(703)
867-9247
|
Securities
registered pursuant to Section 12(b) of the Act:
Title
of each class
|
Name
of each exchange on which registered
|
|
None
|
Not
Applicable
|
Securities
registered pursuant to Section 12(g) of the Act:
Common
Stock
(Title of
Class)
Indicate
by check mark if the registrant is a well-known seasonal issuer, as defined in
Rule 405 of the Securities Act.
¨ Yes x No
Indicate
by check mark if the registrant is not required to file reports pursuant to
Section 13 or Section 15(d) of the Act.
¨ Yes x No
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.
x Yes ¨ 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 ¨ No
Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K (§229.405 of this chapter) is not contained herein, and will not
be contained, to the best of registrant’s knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form
10-K or any amendment to this Form 10-K.
¨
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting
company. See the definitions of “large accelerated filer,”
“accelerated filer” and “smaller reporting company” in Rule 12b-2 of the
Exchange Act.
Large
accelerated filer ¨
|
Accelerated
filer ¨
|
Non-accelerated
filer ¨ (do
not check if a smaller reporting company)
|
Smaller
reporting company x
|
Indicate
by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act).
¨ Yes x No
As of
June 30, 2009, the aggregate market value of the voting and non-voting common
equity held by non-affiliates was approximately $26,029,405, based on the last
closing price of $1.65 per share, as quoted on the Over-the-Counter Bulletin
Board maintained by the Financial Industry Regulatory Authority.
As of
March 1, 2010, the registrant had 32,945,823 shares of common stock issued and
outstanding (not including an additional 1,944,444 shares of common stock
currently being held in treasury).
DOCUMENTS
INCORPORATED BY REFERENCE
None
EXPLANATORY NOTE
This
Amendment No. 1 to the Annual Report on Form 10-K (“Amended Form 10-K”) of
Emerald Dairy Inc. amends our Annual Report on Form 10-K for the year ended
December 31, 2009, filed with the Securities and Exchange Commission on
March 31, 2010 (the “Original Form 10-K”). This Amended Form
10-K is being filed solely to correct inadvertent typographical errors in the
Original Form 10-K.
Except
as described above, no other amendments are being made to the Original Form
10-K. This Amended Form 10-K does not reflect events occurring after
the Original Form 10-K or modify or update the disclosure contained therein in
any other way other than as required to reflect the amendments discussed
above.
The
Company has attached to this Amended Form 10-K updated certifications executed
as of the date of this Amended Form 10-K by the Chief Executive Officer and
Chief Financial Officer as required by Sections 302 and 906 of the Sarbanes
Oxley Act of 2002. These updated certifications are attached as
Exhibits 31.1, 31.2, 32.1 and 32.2 to this Amended Form 10-K.
EMERALD
DAIRY INC.
FORM
10-K
TABLE
OF CONTENTS
PAGE
|
|||||
PART I
|
|||||
Item
1.
|
Business
|
1
|
|||
Item
1A.
|
Risk
Factors
|
14
|
|||
Item
1B.
|
Unresolved
Staff Comments
|
26
|
|||
Item
2.
|
Properties
|
26
|
|||
Item
3.
|
Legal
Proceedings
|
26
|
|||
Item
4.
|
(Removed
and Reserved)
|
26
|
|||
PART II
|
|||||
Item
5.
|
Market
for Registrant’s Common Equity, Related Stockholder Matters and Issuer
Purchases of Equity Securities
|
27
|
|||
Item
6.
|
Selected
Financial Data
|
28
|
|||
Item
7.
|
Management’s
Discussion and Analysis of Financial Condition and
Results of Operations
|
29
|
|||
Item
7A.
|
Quantitative
and Qualitative Disclosures About Market Risk
|
47
|
|||
Item
8.
|
Financial
Statements and Supplementary Data
|
47
|
|||
Item
9.
|
Changes
in and Disagreements With Accountants on Accounting and Financial
Disclosure
|
48
|
|||
Item
9A(T).
|
Controls
and Procedures
|
48
|
|||
Item
9B.
|
Other
Information
|
51
|
|||
PART III
|
|||||
Item
10.
|
Directors,
Executive Officers and Corporate Governance
|
52
|
|||
Item
11.
|
Executive
Compensation
|
55
|
|||
Item
12.
|
Security
Ownership of Certain Beneficial Owners and Management and Related
Stockholder Matters
|
61
|
|||
Item
13.
|
Certain
Relationships and Related Transactions, and Director Independence
|
64
|
|||
Item
14.
|
Principal
Accounting Fees and Services
|
66
|
|||
Item
15.
|
Exhibits,
Financial Statement Schedules
|
67
|
|||
Signatures
|
70
|
- i
-
PART I
Item
1. Business.
Company
Background
We are
engaged, through our China-based indirect subsidiaries (described below) in the
manufacture and sale of milk powder, soybean powder and rice powder in the
People’s Republic of China (the “PRC”).
Our
predecessor filer, Micro-Tech Identification Systems, Inc. (“Micro-Tech”), was
incorporated pursuant to the laws of the State of Nevada on September 24, 1986.
For several years prior to the Reverse Merger (described below), Micro-Tech was
a “shell company,” as defined by Rule 405 of the Securities Act of 1933, as
amended (the “Securities Act”), and its primary business operations involved
seeking the acquisition of assets, property, or businesses that would be
beneficial to it and its shareholders.
On
October 9, 2007, American International Dairy Holding Co., Inc. (“AIDH”), a
Nevada corporation, became a wholly-owned subsidiary of Micro-Tech, when it
merged with Micro-Tech’s wholly-owned subsidiary, which was organized for that
purpose (the “Reverse Merger”). Immediately following the Reverse Merger,
Micro-Tech succeeded to the business of AIDH as its sole line of business, and
changed its name to Amnutria Dairy Inc. On January 25, 2008, we changed our name
from Amnutria Dairy Inc. to Emerald Dairy Inc.
AIDH was
organized pursuant to the laws of the State of Nevada on April 18, 2005, for the
purpose of acquiring the stock of Heilongjiang Xing An Ling Dairy, Co. Limited
(“XAL”), a company formed on September 8, 2003 pursuant to the laws of the PRC.
On May 30, 2005, AIDH acquired XAL. This transaction was treated as a
recapitalization of XAL for financial reporting purposes. The effect of this
recapitalization was rolled back to the inception of XAL for financial reporting
purposes.
Prior to
September 23, 2006, XAL owned approximately 57.7% of Heilongjiang Be’ian Nongken
Changxing Lvbao Dairy Limited Liability Company, a PRC company (“LvBao”), with
the remaining balance being held by AIDH’s sole shareholder. On September 23,
2006, the remaining 42.3% ownership in LvBao was transferred to XAL and was
treated as an additional capital contribution. The effect of this contribution
by the sole shareholder was rolled back to September 8, 2003 for financial
reporting purposes.
On May
22, 2008, AIDH formed a new wholly-owned subsidiary, Hailun Xinganling
Dairy Co., Ltd. (“HXD”), under the laws of the PRC. In July 2008, HXD commenced
construction of a new production facility in Hailun City, Heilongjiang Province,
PRC. We anticipate that the first production line of this new facility will be
operational in the second quarter of 2010, provided we are able to raise the
additional $2.0 million we believe will be required to complete the equipping of
the first production line in satisfaction with proposed more stringent
government manufacturing standards expected to be adopted in the near
future.
All of
our business is conducted through our wholly-owned Chinese subsidiaries, as
follows:
|
·
|
XAL
handles our promotion, sales and administrative
functions;
|
|
·
|
LvBao
handles production of our products at our production facility located in
Be’ian City, Heilongjiang Province, PRC;
and
|
|
·
|
Upon
completion and equipping of the first production line of our new facility
in Hailun City, Heilongjiang Province, PRC, HXD will handle additional
production of our products.
|
- 1
-
Our U.S.
offices are located at 11990 Market Street, Suite 205, Reston, Virginia 20190,
telephone number (703) 867-9247. Our corporate headquarters are located at 10
Huashan-lu, Xiangfang-qu, 9th Floor, Wanda Building, Harbin City, Heilongjiang
Province, PRC 150001.
Below is
a chart depicting our corporate organization:
Industry
The
Chinese government has recognized that the dairy industry is not only crucial to
reform the structure of agriculture in the country and increase the income of
farmers, but also that it is important to improve the diet, health, and overall
welfare of the Chinese people. In recent years, milk and dairy products have
gradually become an accepted daily necessity in the life of Chinese people. As a
result, the dairy market is one of the fastest growing markets in the PRC,
growing at a rate of 16% per year over the past six years according to the
National Bureau of Statistics of China.
Products
We are a
producer of milk powder, soybean powder and rice power in the PRC. Through our
network of over 1,100 salespeople, our products are distributed throughout 20
provinces in Mainland China, and sold in over 6,000 retail outlets.
- 2
-
Our
products are marketed under two brands:
|
·
|
“Xing
An Ling,” which is designed for high-end customers;
and
|
|
·
|
“Yi
Bai,” which is designed for middle and low-end
customers.
|
Our total
sales were approximately $44.7 million, $44.3 million and $29.6 million in the
fiscal years ended December 31, 2009, 2008 and 2007, respectively. Milk powder
sales, including subcontracting, accounted for 94.4%, 95.5% and 94.5% of our
total sales in the fiscal years ended December 31, 2009, 2008 and 2007,
respectively. Soybean powder sales accounted for 2.6%, 2.0% and 2.2% of total
sales in the fiscal years ended December 31, 2009, 2008 and 2007, respectively.
Rice powder sales accounted for 3.0%, 2.5% and 3.3% of total sales in the fiscal
years ended December 31, 2009, 2008 and 2007, respectively. No single customer
accounted for more than 5% of our total sales in the above mentioned
periods.
Milk
Powder Products
We target
one of the most attractive segments in the dairy market - milk powder. We have
milk powder products specifically geared towards different age groups and
demographics, as follows:
|
·
|
Formula
milk powder for infants aged 0-6 months old - Specifically designed to
provide babies with necessary nutrients such as calcium, selenium,
bioactive substance, and more than 20 vitamins and minerals essential for
an infant’s growth.
|
|
·
|
Formula
milk powder for babies 6-12 months old - Specifically designed to help
with the development of the brain, intestines, and body’s
immunity.
|
|
·
|
Formula
milk powder for young kids from 1-3 years old - Provides children with
comprehensive nutritional support at the critical period of their brains
development, and, with nucleotide contents close to breast milk’s level,
to help boost children’s immunity.
|
|
·
|
Formula
for 3-7 years old pre-schoolers - Geared toward children in the growth
acceleration period, when breast milk or infant food is gradually
substituted with adult foods.
|
|
·
|
Multi-dimensional
formula for pregnant women and breast-feeding mothers - Designed for
pregnant women who need to supplement themselves with maternal and infant
nutrition needed to ensure the health of both mother and
infant.
|
|
·
|
High
calcium milk powder for those 7-22 years old - Designed for the years one
spends as a student, it meets the daily nourishment supply standard set by
the Chinese Nourishment Academic
Association.
|
|
·
|
Zinc,
Ferrum and Calcium milk powder for the whole family - Produced in
accordance with scientific processes and test standards to supply the body
with much needed calcium, ferrum and
zinc.
|
|
·
|
High
calcium and sugar-free milk powder for the middle-aged and old-aged -
Based on the daily dietary nutrient supply standards of the middle-aged
and the physiological characteristics of the elderly, as recommended by
the Chinese Nutrition Institute.
|
|
·
|
Low
fat and high calcium milk powder for women - This product was developed in
accordance with a woman’s physiological characteristics and nutritional
needs, to keep woman body fit and
healthy.
|
- 3
-
Soy
Powder Products
We began selling soybean powder
products in fiscal 2006 as a substitute for milk powder, for consumers who do
not like milk powder, or are allergic to milk powder. We began as a reseller of
soybean powder products in fiscal 2006, but began producing soybean powder
in-house in fiscal 2007.
Rice Powder Products
We began
selling rice powder products in fiscal 2006 as a substitute for milk powder.
Prior to October 2007, we used a third party to produce rice powder products,
which were then resold by us under the “Xing An Ling” brand name. Commencing in
October 2007, we began producing rice powder in-house.
Production,
Supply and Distribution
Production
We believe that a lack of adequate
production capacity has been a significant impediment to our ability to increase
our revenue in recent years. Production capacity for 2007 reached approximately
7,000 tons, with annual revenue of approximately $29.6 million and net income of
approximately $3.6 million. In 2008, by adding a third shift to the existing two
shifts working schedule at our facility in Be’ian City, our production capacity
reached approximately 9,000 tons, with revenue of approximately $44.3 million
and net income of approximately $2.3 million. In 2009, while our new production
facility was being constructed, our annual production capacity continued at
approximately 9,000 tons, with revenue of approximately $44.7 million and net
income of approximately $4.2 million. When we complete the first production line
of our newly-constructed facility in Hailun City, our total production capacity
is expected to reach approximately 18,000 tons per annum. We anticipate that the
first production line of this new facility will be operational in the second
quarter of 2010, provided we are able to raise the additional $2.0 million we
believe will be required to complete the equipping of the first production line
in satisfaction with proposed more stringent government manufacturing standards
expected to be adopted in the near future.
Local farmers we purchase milk from
deposit fresh milk at third-party milking stations we utilize. The fresh milk is
stored in refrigerated tanks, and then trucked by the supplier’s trucking
service to one of our production facilities. When the refrigerated fresh milk
arrives at our production facility a sample is taken to be sure it meets our
product standards. If the sample passes inspection it goes to production, where
the necessary ingredients are added to the fresh milk to make formula. If it
fails inspection, it is rejected. The formula passes through a high pressure
gage, which sprays the formula out in a fine spray. A high temperature fan
instantly dries the formula turning it into milk powder. The milk powder is
first placed in large containers, and then packaged into customer friendly bags
or tins. After it has been packaged, the finished product gets trucked to retail
outlets for sale. Since we are located close to the milking stations, the entire
production process can be completed in approximately 30-35 hours. The time it
takes to go from processing the milk to retail sale of the finished product is
only an average of 45
days. Therefore, our warehousing cost is reduced and capital turnover
rate is enhanced.
We strictly supervise resources
allotment, purchasing inspection, raw materials check, sales, and customer
service, and have already established a consummate quality control process. Five
approved dairy experts supervise the whole production process to ensure that the
products comply with national standards. These experts are selected by us based
on their education and experience in the industry. We have established an
advanced bacteria-free laboratory to asses our products throughout the
production process. We established a professional sanitation, quality control
and quality management group to make the production comply with national food
& sanitation regulations. We also established sanitation, quality,
operation, management systems to improve the production and enforce worker’s
awareness of sanitation and quality. Each worker needs to go through a physical
check-up periodically and obtain a clean “health certificate.”
- 4
-
In 2004, we adopted a method to that
enables us to assess our inventory each month. As a result, inventories and
efficiency of our supply chain are optimized and the operation efficiency of
capital is maximized. This is due to the fact that inventories are controlled in
real time.
We established a cost-control center,
and formed cost-control systems on working procedure and on each cost-control
point. With an established original date for each batch of our product on
record, we request that each department control production expenses and time,
and take responsibility. Through cost calculation, we make quantity difference
analysis and price difference analysis, and compare and analyze each month’s
cost budgets with the prior month’s, so we can gradually cut costs.
Our packaging facility is designed
based on the GMP 600,000 level standard of the pharmacy industry. “GMP” refers
to the Good Manufacturing Practice Regulations promulgated by the U.S. Food and
Drug Administration under the authority of the Federal Food, Drug, and Cosmetic
Act. GMP regulations address issues including recordkeeping, personnel
qualifications, sanitation, cleanliness, equipment verification, process
validation, and complaint handling. Management believes our laboratory, which is
300 square meters in size, is constructed in accordance with GMP
standards.
In addition, the facility complies with
all HACCP standards. “HACCP,” or Hazard Analysis and Critical Central Point
(HACCP) (ISO 22000 Food Safety Management System), is a process control system
designed to identify and prevent microbial and other hazards in food production
and entire food chain. HACCP includes steps designed to prevent problems before
they occur and to correct deviations through a systematic way as soon as they
are detected. As a result, we have achieved an ideal environment for productions
and packaging. Our automated intelligent program-controlled packaging line,
which consists of some of the most advanced packaging equipment in the Chinese
dairy industry, is capable of tinned milk powder packaging. It effectively
reduces the touch of workers and avoids second-time contamination.
Supply
Our production is based in farms along
the Bei’an long river in Heilongjiang Province, located in the southwest of
Xiaoing’anling, 47 degrees north latitude. The land sits on one of the only
three black plates in the world, giving it the unique soil, vegetation, climate
and ecological environment best for the growth of cows. As a result, it is
recognized as one of the premium cow raising belts internationally. Bei’an’s
grassland area amounts to 285 acres, raising more than 41,000 cows, with the
milk production of 72,000
tons annually. By using such high-quality fresh milk as a raw material,
we are able to maintain our product as a natural, clean and green
food.
We have signed contracts with over
1,200 local farmers, giving us access to the milk of approximately 21,000 cows.
Pursuant to the standard raw milk purchase agreements we enter into with local
farmers:
|
·
|
The
term of raw milk purchase agreements is one
year.
|
|
·
|
Farmers
have the option to discontinue the agreements any time during the one-year
term by giving one-week notice.
|
|
·
|
We
are obligated to purchase from farmers the whole raw milk meeting certain
quality standards.
|
|
·
|
The
purchase price of raw milk is approximately $0.16 per lb., which
fluctuates depending on the market price of raw
milk.
|
|
·
|
If
there is a change in price, we must notify farmers within one week, or
risk losing them as suppliers.
|
The terms set forth above are the
standard terms within the Chinese dairy industry, which is regulated by the
Office of Milk Source (a department of city government). The price of raw milk
is market driven and is most-closely linked to the Heilongjiang Province
regional market. The price of raw milk is also closely monitored by the Office
of Milk Source. We settle our accounts with the farmers
regularly.
- 5
-
The entire milking process is done
automatically, without any human contact. The farmers raise their own cattle,
however, we share certain know how and technical support with the farmers to
help them increase the quality and capacity of their milk. This model not only
enhances the milk farmers’ enthusiasm and breeding capability, and stimulates
local economic development, but it also assures the milk volume, quality and the
stability of the supply. In addition, this allows us to track each cow’s health
and milking capacity.
Since no other large-scaled dairy
enterprise is located nearby, our milk source is relatively plentiful and
readily available.
We have approximately 100 cows of our
own, to meet a small amount of the total supply. These cows are mainly used to
provide scientific and quality service for dairy farmers including disease
control and treatment or other experiments. These cows also act as the examples
to the local farmers. At present, the available services include helping dairy
farmers improve farming methods, increasing milk yield, appointing experts to
lectures, popularizing the scientific knowledge, helping the farmers with the
cow’s brand choice, and strengthening disease surveillance and
control.
We currently utilize 48 milking stations, all of
which are owned and operated by third parties. We pay market price for using the
milking stations. For administrative purposes, we group these milking stations
into several service districts.
The major raw materials we use to
produce our products include fresh milk, whey, degrease powder, vegetable
protein, and vegetable oil esters. These components are obtained mainly from the
long-term partnerships. After years of development, we have formed steady,
complementary and cooperative relationships with our suppliers. As our sales
increase, more capital will be obtained to strengthen our negotiation leverage,
allowing us to acquire less expensive and quality raw materials more easily. The
procurement of raw materials is mainly done through bidding and other forms of
network transactions.
Product packages, packaging boxes,
packing cans, and other packaging materials are also mainly settled by the
long-term vendors.
We have found it relatively easy to
purchase all major raw materials we need from these suppliers, and have been
able to sell all the products we have produced. We believe the suppliers of our
raw materials and packaging materials will be able to keep up with our growth
for the foreseeable future.
In 2009,
Yu Ya We Trading Company, which supplies us with whey used in production of our
products, supplied us with approximately 11% of our raw materials. In 2008, no
single supplier accounted for more than 10% of our raw materials.
Distribution
We have a sales network consisting of
over 1,100 people, across 20 provinces in the PRC. Orders are initiated by sales
people depending on their customers’ needs, and are approved by their province
(regional) manager. Regional managers combine orders from various sales teams
and send orders to headquarters. After confirmation of the orders from the
regional managers, headquarters gives instructions to third party trucking
companies to distribute products, according to the combined orders, to regional
hub offices. We distribute our products from our headquarters to the sale
subsidiaries in a large combined order based on region, as compiled by the
regional manager.
We use three independent trucking
contractors to distribute our products to the 20 provinces in the PRC in which
we sell our products. We selected these trucking companies based on cost and
efficiency. There are many trucking companies available so that, if necessary,
any of the independent trucking contractors we currently use could easily be
replaced.
- 6
-
Railway transportation is also a major
means for the distribution of our products. It is usually used when the products
need to travel a long distance, because of the relatively low cost. However, its
speed is slower than that of the trucks, since the products first need to get to
Bei’an Station, before being distributed to their ultimate
destination.
Market
Opportunity
There are a total of 30 provinces in
mainland China. Our products are generally sold in 20 of the provinces, through
our 1,100-plus person sales network. Our sales are spread out, with no single
province accounting for more than 10% of our total sales. The 20 provinces in
which we sell our products are the major provinces along the pacific ocean and
in central China. The 10 provinces in which our products are not sold, are those
where the competition is too intense, or the potential customers are either too
poor or too disbursed to make it economically feasible.
The PRC’s population of 1.3 billion
offers a huge market for the developing dairy industry in the PRC. The dairy
industry is increasing much faster than the growth of the PRC’s gross domestic
product (GDP). According to the statistics from the Food and Agriculture
Organization of the United Nations (FAO), total Chinese milk production is the
seventh largest in the world. The dairy market is one of the fastest growing
markets in the PRC, growing at a rate of 16% per year over the past six years,
according to the National Bureau of Statistics of China. It is widely predicted
that the dairy industry in the PRC will continue at a growth rate of 15% per year. The “11th Five
Years Plan” urged that the average annual dairy consumption should reach 10 kg
per person and should reach 16 kg in 2015.
The average consumption of dairy per
person in the PRC is much lower than the world average. As a result, we believe
the Chinese dairy market has considerable potential for growth, especially if
the Chinese economy continues to experience significant growth.
According to the “China Food and
Nutrition Development outline (2001-2010)” approved by the Chinese State
Council, the dairy industry is one of the three food industries that should be
developed first. The outline suggests that by 2010, average consumption of dairy
per person should reach 16 kg, in which the average consumption of dairy per
person for rural habitants and those who live in cities and towns are 32kg and
7kg, respectively. Experts predict that the annual dairy output in the PRC will
be 20 million tons and 70 million tons in 2015 and 2030, respectively. Based
upon these predictions, we believe that over the next few years, the Chinese
dairy industry should continue to grow at a rapid pace and the consumption of
dairy will continue to increase as a result of the anticipated rise in living
standards and change in consumption behavior by the average Chinese
consumer.
According to the National Bureau of
Statistics of the PRC, about 15 million infants are born in the PRC each year.
Each 0-6 month old baby will need 27.2 kg. milk powder, for an annual total
demand of 90,000 tons. Each 6-12 month old baby will need 31 kg. milk powder,
for an annual total demand of 110,000 tons. But the current supply is just
80,000-100,000 tons, leaving much room for growth. According to the Dairy
Association of China, the infant formula market in the PRC, which is the market
we target, has grown even faster in recent years, at a rate of 20%-30% per year,
and has surpassed Japan, becoming the second largest infant formula dairy market
in the world, behind the U.S.
In mid-2008, a number of milk powder
products produced within the PRC were found to contain unsafe levels of
tripolycyanamide, also known as melamine, sickening thousands of infants. This
prompted the Chinese government to conduct a nationwide investigation into how
the milk powder was contaminated, and caused a worldwide recall of certain milk
powder products produced within the PRC. On September 16, 2008, the PRC’s
Administration of Quality Supervision, Inspection and Quarantine (AQSIQ)
revealed that it had tested samples from 175 dairy manufacturers, and published
a list of 22 companies whose products contained melamine. We passed the
emergency inspection and were not included on AQSIQ’s list. The contraction in
the Chinese milk powder industry caused by this crisis has lead to increased
demand for our products. However, we have not been able to increase our supply
to meet this demand, and will not be able to do so until the first production
line of our new facility commences operations.
- 7
-
Company
Strategy
As part of our plan to pursue the
market opportunities discussed above, we intend to effect the following
strategies:
Production Strategy
Through a combination of internal
growth in production capacity and strategic acquisitions we believe we will be
capable of producing 20,000-27,000 tons of milk powder annually by the end of
fiscal 2011. Our growth strategy for the next three years will be primarily
focused on internal growth by expanding production capacity and strengthening
sales efforts. As a step toward implementing this strategy, we commenced
construction of a new production facility in Hailun City, Heilongjiang Province,
PRC, in July 2008. Initially, this new facility will have one production line,
with the capacity to produce 9,000 tons of milk power annually. A second
production line can be added at this new facility, which, when completed, would
enable us to produce an additional 9,000 tons of milk powder per year, giving us
a total annual production capacity of 27,000 tons of milk powder. We anticipate
that production at this new facility will commence in the second quarter of
fiscal 2010, provided we are able to raise the additional $2.0 million we
believe will be required to complete the equipping of the first production line
in satisfaction with proposed more stringent government manufacturing standards
expected to be adopted in the near future. We anticipate that the cost to add a
second production line, would be an additional $15.0 million. We plan to raise
the funds needed for the new facility from the capital market through private or
public equity and/or debt offerings. There can be no assurance that that any
additional financing will become available to us, and if available, on terms
acceptable to us.
In addition, management will consider
making strategic acquisitions if opportunities become available. We have no
current agreements or plans for proposed acquisitions, and there can be no
assurance we will consummate any acquisitions in the future.
Prior to October 2007, we used a third
party to produce rice powder products which were then resold under the “Xing An
Ling” brand name. Commencing in October 2007, we began producing rice powder
in-house. Rice powder products accounted for approximately 3.0% and 2.5% of our
total revenue in 2009 and 2008, respectively. We expect that rice powder
products will continue to comprise approximately 3% of our total sales, unless
our sales network detects an increase in demand.
Similarly, we began reselling soy
powder products in fiscal 2006, and producing soy powder in-house in fiscal
2007. Soy powder products accounted for approximately 2.6% and 2.0% of our total
revenue in 2009 and 2008, respectively. We expect that soy milk powder products
will continue to comprise approximately 2% of our total sales, unless our sales
network detects an increase in demand.
Currently, there are no organic label
milk powder products in the mainland China market. In February 2008, we obtained
organic label certification from Guangdong Zhongjian Certification Co., Ltd. We
plan to create an organic label product line by the end of fiscal 2010. We will
need to test the market to determine demand for organic milk products.
Initially, we expect sales of organic milk powder to be minor. However, over the
long term, we believe that, similar to the growth of the organic milk market in
the U.S., organic milk products will be popular in the PRC. Over time, we
believe our proposed organic product line will help increase our
revenues.
Market Strategy
Brand
In the Chinese milk powder market,
positive brand image should help establish high customer recognition, strong
customer loyalty, and good product reputation, which we believe are key elements
to increase our sales revenue. Therefore, we have focused on establishing a
positive brand image. Our products are marketed under two
brands:
- 8
-
|
·
|
“Xing
An Ling,” which is designed for high-end customers;
and
|
|
·
|
“Yi
Bai,” which is designed for middle and low-end
customers.
|
Price
In the Chinese dairy market similar
products are often sold at widely differing prices. The gap between prices of
similar products could be as much as 10 times. At present, the consumers who
have the highest income often choose high-end dairy brands from foreign
companies, such as Nestle, Mead Johnson, and Dumex. Those customers who earn
less tend to choose lower-price brands such as Shengyuan and Nanshan.
Historically, our products were not as popular as some of our competitors’
because they were less expensive than similar competing products. To address
this, our new products are aimed at middle-end and high-end infant milk powder
market.
Sales Channel
We have over 1,100 people in our sales
network across 20 provinces covering more than 6,000 retail outlets (i.e.,
supermarkets) in the PRC. Over the past several years, no single customer
accounted for 5% or more of our total sales.
There are no limitations on the
geographic areas in China in which we can sell our products. There are a total
of 30 provinces in the PRC. The 20 provinces in which we sell our products are
the major provinces along the pacific ocean and in central China. The 10
provinces in which our products are not sold, are those where either, we would
not be able to compete due to intense competition, or the potential customers
are either too poor or too disbursed to make it economically
feasible.
Rather than using a wholesaler, our
sales people deal directly with the retail outlets. This business model has
higher sales expenses compared to traditional business model, where a wholesaler
is used. The reason for this is that each of our sales people can cover only so
many retail outlets and, therefore, we have to employ more sales people to
achieve the same sales volume. On the other hand, by selling directly to retail,
we can sell products at a higher margin than if we sold our products to a
wholesaler. We believe that the increased margins resulting from our direct to
retail market strategy more than offsets the additional sales expense we incur
by not using wholesalers. In addition, our sales people know the customers, so
they obtain better information on sales, demand, etc. We will continue to use
our current business model of selling directly to the retail outlets, without
use of a wholesaler, for the foreseeable future.
Promotion
We plan to:
|
·
|
Advertise
our products on the leading TV stations in important markets, publicize
product information and ideas by advertising in national or local
newspapers and magazines, and use our website and webpage advertisement to
attract internet users to introduce our products and
business;
|
|
·
|
Promote
our products by attending and holding exhibitions and seminars, presenting
promotional items and hand out
leaflets;
|
|
·
|
Teach
our “shopping guides,” who are generally women that give out free samples
of products in supermarkets and provide information on products, about our
products and how to promote our products by face to face communication and
illustration to end users; and
|
|
·
|
Invite
famous pediatricians to hold seminars on knowledge of nutrients and baby
tending for pregnant women, so as to promote our brand and attract
customers.
|
- 9
-
Currently,
we spend approximately 8%-12% of total revenues on advertising and promotional
efforts through out the year. We spent approximately $4.5 million, $5.4 million
and $3.0 million on advertising and promotion in fiscal 2009, 2008 and 2007,
respectively. We currently expect to spend an aggregate of approximately $6.0
million on advertising and promotion in fiscal 2010. The funds for advertising
and promotion generally come out of our earnings.
Our English-language website is located
at www.emeralddairy.com. The English-language website went live in May 2008. The
website includes a link to our Chinese-language website. The information on our
websites does not constitute part of this report.
Human Resources Strategy
We believe employing talented people is
the best competitive advantage we can have. Besides seeking to attract quality
employees from outside of our company, we will also continue to develop and
train our own sales team.
Competition
Currently, five state owned dairy
groups control more than half of the dairy market in the PRC. They are Mengniu
(in Inner Mongolia), Yili Industrial Group (in Inner Mongolia), Bright Dairy
& Food (in Shanghai), Sanyuan (in Beijing) and Wandashan (in Heilongjiang).
Over half of the top 20 dairy manufactures have entered China. Most of the dairy
producers provide infant milk powder. However, the high-end infant milk powder
is less than one-third
of the total output. In the past, the dairy producers mainly gave
discounts as the major competition tactic. Now, however, the producers are
beginning to focus on the raw milk source, brand, and sales
network.
Our competitors are divided into three
major categories:
|
·
|
Domestic
large-scale producers;
|
|
·
|
Foreign
producers; and
|
|
·
|
Domestic
middle & small-scale producers.
|
Most of the larger players in the
Chinese dairy industry have been concentrating in the first-tier cities such as
Beijing and Shanghai with high end milk powder products. We focus on penetrating
less-competitive second and third tier cities. We have a 1,100-plus person sales
network across 20 provinces in China, covering more than 6,000 retail outlets.
Our closest competitors are American Dairy, Inc. and Wondersun Dairy in terms of
products, price range and geographic coverage.
We believe that we have a competitive
advantage over our competitors because:
|
·
|
Our
production facilities are located close to the milking stations from which
we obtain it fresh milk and, therefore, the entire production process can
be completed in approximately 30-35 hours. The production facilities of
other multi-regional dairy enterprises are located up to two days’ drive
away from the milking stations they use. Therefore, it may take them up to
four days to process their milk
products.
|
|
·
|
Our
business model of selling directly to the retail outlets, as opposed to
selling to a wholesaler, allows us to sell our products at a higher margin
at retail. Our sales people know the customers, so they obtain better
information on sales trends and customer demands and requirements than our
competitors who sell their product to
wholesalers.
|
|
·
|
In
February 2008, we obtained organic label certification from the Guangdong
Zhongjian Certification Co., Ltd. Currently, there is no organic milk
powder product being sold in the Chinese market. We plan to create an
organic label product line by the end of fiscal 2010. Over the long term,
we believes that, similar to the growth of the organic milk market in the
U.S., organic milk products will be popular in the
PRC.
|
- 10
-
On the other hand, we are at a
competitive disadvantage because many of our current and potential competitors
have longer operating histories and greater name recognition, and possess
substantially greater financial, marketing and other competitive resources than
we do.
Intellectual
Property
We have obtained trademark
registrations for the use of our tradenames “Xing An Ling” and “Yi Bai”, which
have been registered with the Trademark Bureau of the State Administration for
Industry and Commerce with respect to our milk powder products. We believe our
trademarks are important to the establishment of consumer recognition of our
products. However, due to uncertainties in Chinese trademark law, the protection
afforded by our trademarks is uncertain and they may not provide adequate
protection. Moreover even if it is sufficient, in the event our trademarks or
trade names are challenged or infringed, we may not have the financial resources
to defend it against any challenge or infringement and such defense could in any
event be unsuccessful. Moreover, any events or conditions that negatively impact
our trademarks could have a material adverse effect on our business, operations
and finances.
Regulatory
Matters
We are regulated under both national
and county laws in China. The following information summarizes certain aspects
of those regulations applicable to us and is qualified in its entirety by
reference to all particular statutory or regulatory provisions.
Regulations at the national, province
and county levels are subject to change. To date, compliance with governmental
regulations has not had a material impact on our level of capital expenditures,
earnings or competitive position, but, because of the evolving nature of such
regulations, we are unable to predict the impact such regulation may have in the
foreseeable future.
As a manufacturer and distributor of
food products, we are subject to regulations of the PRC’s Agricultural Ministry.
This regulatory scheme governs the manufacture (including composition and
ingredients), labeling, packaging and safety of food. It also regulates
manufacturing practices, including quality assurance programs, for foods through
its current good manufacturing practices regulations, and specifies the
standards of identity for certain foods, including the products we sell, and
prescribes the format and content of many of the products we sell, prescribes
the format and content of certain nutritional information required to appear on
food products labels and approves and regulates claims of health benefits of
food products.
In addition, the PRC’s Agricultural
Ministry authorizes regulatory activity necessary to prevent the introduction,
transmission or spread of communicable diseases. These regulations require, for
example, pasteurization of milk and milk products. We and our products are also
subject to province and county regulations through such measures as the
licensing of dairy manufacturing facilities, enforcement of standards for its
products, inspection of our facilities and regulation of its trade practices in
connection with the sale of dairy products.
- 11
-
To date,
we have received the following licenses to produce our products, which are
significant for the reasons set forth below:
License
|
Issuer
|
Effective Period
|
Significance
|
|||
Infant
& Baby Formula Milk Powder Production Permit
|
State
General Administration of Quality Supervision and Inspection and
Quarantine of the People’s Republic of China
|
April
2005 -
May
2010 (1)
|
Only
current license holders are permitted to produce formula milk powder in
the PRC. The Government is not currently issuing any additional
licenses. We expect that its license will be automatically
renewed.
|
|||
Organic
Production Certification
|
Guangdong
Zhongjian Certification Co., Ltd.
|
November
2009 - July 2010 (2)
|
This
certification will allow us to begin producing and selling organic milk
powder products. There are currently no organic milk powder
products in the PRC. We look to become a leader in this market, and have
first-mover advantage.
|
|||
ISO
22000 / HACCP Certification
|
Beijing
New Century Certification Co. Ltd.
|
September
2007 - September 2010 (2)
|
The
ISO 22000 international standard specifies the requirements for a food
safety management system. ISO 22000 integrates the principles of the
Hazard Analysis and Critical Control Point (HACCP) system and application
steps developed by the Codex Alimentarius Commission. Hazard analysis is
the key to an effective food safety management system.
|
|||
ISO
9001 Certification
|
Beijing
New Century Certification Co. Ltd.
|
September
2007 - September 2010 (2)
|
ISO
9000 is a family of standards for quality management systems. ISO 9000 is
maintained by ISO, the International Organization for Standardization and
is administered by accreditation and certification bodies. ISO 9001 (which
is one of the standards in the ISO 9000 family) includes a set of
procedures that cover the establishment and monitoring all key processes
in a business. Only a company or organization that has been
independently audited and certified to be in conformance with ISO 9001 may
publicly state that it is “ISO 9001 certified.”
|
|||
Certificate
of Conformity of Quality System Certification
|
|
Standardization
Administration of the People's Republic of China
|
|
September
2005 - September 2010 (2)
|
|
This
certification is only given to companies that meet an international
standard of quality control and production. Consumers in the PRC give a
more positive reception to products that meet international
standards.
|
|
(1)
|
We
are in the process of renewing our Infant & Baby Formula Milk Powder
Production Permit. We have no reason to believe this permit
will not be renewed.
|
|
(2)
|
We
plan to start the renewal process for these certifications in the near
future. We have no reason to believe this permit will not be
renewed.
|
Employees
As of the date hereof, we have 1,376
employees. Of these, 1,168 are in sales, 173 are in manufacturing and 35 are in
management and administration. None of the our employees is subject to a
collective bargaining agreement. We consider our relationship with our employees
to be good.
- 12
-
Available
Information
We file various reports with the
Securities and Exchange Commission (“SEC”), including Annual Reports on Form
10-K, Quarterly Reports on Form 10-Q and Current Reports on Form 8-K, which are
available though the SEC's electronic data gathering, analysis and retrieval
system (“EDGAR”) by accessing the SEC's home page (http://www.sec.gov). The
documents are also available to be read or copied at the SEC’s Public Reference
Room located at 100 F Street, NE, Washington, D.C., 20549. Information on the
Public Reference Room may be obtained by calling the SEC at
1-800-SEC-0330.
We also
make available free of charge through our website (www.emeralddairy.com) our
Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on
Form 8-K, and, if applicable, amendments to those reports filed or furnished
pursuant to the Securities Exchange Act of 1934, as amended (the “Exchange Act”)
as soon as reasonably practicable after we electronically file such material
with, or furnish it to, the SEC.
- 13
-
Item
1A. Risk Factors.
Risk
Factors
We are subject to certain risks and
uncertainties as described below. These risks and uncertainties may not be the
only ones we face. There may be additional risks that we do not presently know
of, or that we currently consider immaterial. All of these risks could adversely
affect our business, financial condition, results of operations and cash flows.
Our business and operations may be adversely affected if any of such risks are
realized. All investors should consider the following risk factors before
deciding to purchase or sell our securities.
Risks
Related to Our Business
Unstable
market conditions may have serious adverse consequences on our
business.
In 2008
and 2009, general worldwide economic conditions declined resulting in a more
volatile and costly business climate. Although all of our business operations
are currently conducted in the PRC, our general business strategy, as well as
our results of operations and financial condition, may be adversely affected by
unpredictable and unstable market conditions. If the current equity and credit
markets deteriorate, or do not improve from current levels, it may make it
difficult, if not impossible, for us to obtain debt or equity financing on
acceptable terms at a time when we wish to do so. While we believe we have
adequate capital resources to meet current working capital and capital
expenditure requirements for the next twelve months, a radical economic downturn
or increase in our expenses could require additional financing on less than
attractive rates or on terms that are excessively dilutive to existing
stockholders. Failure to secure any necessary financing in a timely manner and
on favorable terms could have a material adverse effect on our growth strategy,
financial performance and stock price and could require us to delay or abandon
our expansion plans. These factors may have a material adverse effect on our
results of operations, financial condition or cash flows and could cause the
price of our common stock to decline significantly.
Our
products may not achieve or maintain market acceptance.
We market
our products in the PRC. Dairy product consumption in the PRC has historically
been lower than in many other countries in the world. Growing interest in milk
products in the PRC is a relatively recent phenomenon which makes the market for
our products less predictable. Consumers may lose interest in our products. As a
result, achieving and maintaining market acceptance for our products will
require substantial marketing efforts and the expenditure of significant funds
to encourage dairy consumption in general, and the purchase of our products in
particular. There is substantial risk that the market may not accept or be
receptive to our products. Market acceptance of our current and proposed
products will depend, in large part, upon our ability to inform potential
customers that the distinctive characteristics of our products make them
superior to competitive products and justify their pricing. Our current and
proposed products may not be accepted by consumers or able to compete
effectively against other premium or non-premium dairy products. Lack of market
acceptance would limit our revenues and profitability.
In
addition, we market our product, in part, as a healthy and good source of
nutrition, however, periodically, medical and other studies are released and
announcements by medical and other groups are made which raise concerns over the
healthfulness of cow’s milk in the human diet. An unfavorable study or medical
finding could erode the popularity of milk in the Chinese diet and negatively
affect the marketing of our product causing sales, and cause our revenues, to
decline.
Contamination
of milk powder products produced in the PRC could result in negative publicity
and have a material adverse effect on our business.
In
mid-2008, a number of milk powder products produced within the PRC were found to
contain unsafe levels of tripolycyanamide, also known as melamine, sickening
thousands of infants. This prompted the Chinese government to conduct a
nationwide investigation into how the milk powder was contaminated, and caused a
worldwide recall of certain milk powder products produced within the PRC. On September 16,
2008, the PRC’s Administration of Quality Supervision, Inspection and Quarantine
(“AQSIQ”) revealed that it had tested samples from 175 dairy manufacturers, and
published a list of 22 companies whose products contained melamine. We passed
the emergency inspection and were not included on AQSIQ’s list. Although we
believe that the inevitable contraction in the Chinese milk powder industry
caused by this crisis will lead to increased demand for our products, we can not
be certain that the illnesses caused by contamination in the milk powder
industry, whether or not related to our products, won’t lead to a sustained
decrease in demand for milk powder products produced within the PRC, thereby
having a material adverse effect on our business.
- 14
-
As
we increase the scale of our operations, we may be unable to maintain the level
of quality we currently attain by producing our products in small batches. If
quality of our product declines, our sales may decline.
Our
products are manufactured in small batches. If we are able to increase our
sales, we will be required to increase our production. Increased production
levels may force us to modify our current manufacturing methods in order to meet
demand. We may be unable to maintain the quality of our dairy products at
increased levels of production. If quality declines, consumers may not wish to
purchase our products and a decline in the quality of our products could damage
our reputation, business, operations and finances.
We
depend on supplies of raw milk and other raw materials, a shortage of which
could result in reduced production and sales revenues and/or increased
production costs.
Raw milk
is the primary raw material we use to produce our products. As we pursue our
growth strategy, we expect raw milk demands to continue to grow. Because we own
only a small number of dairy cows, we depend on dairy farms and dairy farmers
for our supply of fresh milk. We expect that we will need to continue to
increase the number of dairy farmers from which we source raw milk. If we are
not able to renew our contracts with suppliers or find new suppliers to provide
raw milk we will not be able to meet our production goals and our sales revenues
will fall. If we are forced to expand our sources for raw milk, it may be more
and more difficult for us to maintain our quality control over the handling of
the product in our supply and manufacturing chain. A decrease in the quality of
our raw materials would cause a decrease in the quality of our product and could
damage our reputation and cause sales to decrease.
Raw milk
production is, in turn, influenced by a number of factors that are beyond our
control including, but not limited to, the following:
|
·
|
seasonal factors: dairy
cows generally produce more milk in temperate weather than in cold or hot
weather and extended unseasonably cold or hot weather could lead to lower
than expected production;
|
|
·
|
environmental factors:
the volume and quality of milk produced by dairy cows is closely linked to
the quality of the nourishment provided by the environment around them,
and, therefore, if environmental factors cause the quality of nourishment
to decline, milk production could decline and we may have difficulty
finding sufficient raw milk; and
|
|
·
|
governmental agricultural and
environmental policy: declines in government grants, subsidies,
provision of land, technical assistance and other changes in agricultural
and environmental policies may have a negative effect on the viability of
individual dairy farms, and the numbers of dairy cows and quantities of
milk they are able to produce.
|
We also
source large volumes of soy beans, rice, and other raw materials from suppliers.
Interruption of or a shortage in the supply of raw milk or any of our other raw
materials could result in our being unable to operate our production facilities
at full capacity or, if the shortage is severe, at any production level at all,
thereby leading to reduced production output and sales and reduced revenues. In
2009, Yu Ya We Trading Company, which supplies us with whey used in production
of our products, supplied us with approximately 11% of our raw materials. In
2008, no single supplier accounted for more than 10% of our raw
materials.
Even if
we are able to source sufficient quantities of raw milk or our other raw
materials to meet our needs, downturns in the supply of such raw materials
caused by one or more of these factors could lead to increased raw material
costs which we may not be able to pass on to the consumers of our products,
causing our profit margins to decrease.
- 15
-
Volatility
of raw milk costs makes our operating results difficult to predict, and a steep
cost increase could cause our profits to diminish significantly.
The
policy of the PRC since the mid-1990s has focused on moving the Chinese dairy
industry in a more market-oriented direction. These reforms have resulted in the
potential for greater price volatility relative to past periods, as prices are
more responsive to the fundamental supply and demand aspects of the market.
These changes in the PRC’s dairy policy could increase the risk of price
volatility in the dairy industry, making our net income difficult to predict.
Also, if prices are allowed to escalate sharply, our costs will rise and we may
not be able to pass them on to consumers of our products, which will lead to a
decrease in our profits.
The
milk business is highly competitive and, therefore, we face substantial
competition in connection with the marketing and sale of our
products.
We face
competition from non-premium milk producers distributing milk in our marketing
area and other milk producers packaging their milk in glass bottles, and other
special packaging, which serve portions of our marketing area. Most of our
competitors are well established, have greater financial, marketing, personnel
and other resources, have been in business for longer periods of time than we
have, and have products that have gained wide customer acceptance in the
marketplace. Our largest competitors are state-owned dairies owned by the
government of the PRC. Large foreign milk companies have also entered the milk
industry in the PRC. The greater financial resources of such competitors will
permit them to procure retail store shelf space and to implement extensive
marketing and promotional programs, both generally and in direct response to our
advertising claims. The milk industry is also characterized by the frequent
introduction of new products, accompanied by substantial promotional campaigns.
We may be unable to compete successfully or our competitors may develop products
which have superior qualities or gain wider market acceptance than
ours.
We
face the potential risk of product liability associated with food products; Lack
of general liability insurance exposes us to liability risks in the event of
litigation against us.
We sell
products for human consumption, which involves risks such as product
contamination or spoilage, product tampering and other adulteration of our
products. We may be subject to liability if the consumption of any of our
products causes injury, illness or death. In addition, we may recall products in
the event of contamination or damage. A significant product liability judgment
or a widespread product recall may negatively impact our profitability for a
period of time depending on product availability, competitive reaction and
consumer attitudes. Even if a product liability claim is unsuccessful or is not
fully pursued, the negative publicity surrounding any assertion that our
products caused illness or injury could adversely affect our reputation with
existing and potential customers and our corporate and brand image. We would
also have to incur defense costs, including attorneys’ fees, even if a claim is
unsuccessful. We do not have liability insurance with respect to product
liability claims. Any product liabilities claims could have a material adverse
effect on its business, operating results and financial condition.
The
loss of any of our key executives could cause an interruption of our business
and an increase in our expenses if we are forced to recruit a replacement; We
have no key-man life insurance covering these executives.
We are
highly dependent on the services of Yang Yong Shan, our Chairman, Chief
Executive Officer and President. He has been primarily responsible for the
development and marketing of our products and the loss of his services would
have a material adverse impact on our operations. We have not applied for
key-man life insurance on his life and have no current plans to do
so.
We
do not have any independent directors serving on our board of directors, which
could present the potential for conflicts of interest and prevent our common
stock from being listed on a national securities exchange.
We
currently do not have any independent directors serving on our board of
directors and we cannot guarantee that our board of directors will have any
independent directors in the future. In the absence of a majority of independent
directors, our executive officers could establish policies and enter into
transactions without independent review and approval thereof. This could present
the potential for a conflict of interest between us and our stockholders,
generally, and the controlling officers, stockholders or
directors.
- 16
-
In
addition, since none of the directors currently on our board of would qualify as
an independent director under the rules of the New York Stock Exchange, NYSE
Amex Equities or The Nasdaq Stock Market, we would fail to satisfy at least one
of the necessary initial listing requirements for any of these national
securities exchanges. Therefore, until we appoint a majority of independent
directors to our board we expect that our common stock will continue to be
listed on Over-the-Counter Bulletin Board (“OTCBB”) maintained by the Financial
Industry Regulatory Authority (“FINRA”), which might make our common stock less
attractive to potential investors than if it had been listed on a national
securities exchange.
Our
management has identified certain material weaknesses in our internal control
over financial reporting, which if not properly remediated could result in
material misstatements in our future interim and annual financial statements and
have a material adverse effect on our business, financial condition and results
of operations and the price of our common stock.
Our
management is responsible for establishing and maintaining adequate internal
control over financial reporting. Internal control over financial reporting is a
process designed to provide reasonable assurance regarding the reliability of
financial reporting and the preparation of financial statements in accordance
with U.S. generally accepted accounting principles.
As
further described in “Item 9A. Controls and Procedures,” our management has
identified certain material weaknesses in our internal control over financial
reporting. A material weakness, as defined in the standards established by the
Public Company Accounting Oversight Board (“PCAOB”), is a deficiency, or a
combination of deficiencies, in internal control over financial reporting, such
that there is a reasonable possibility that a material misstatement of our
annual or interim financial statements will not be prevented or detected on a
timely basis.
Although
we are in the process of implementing initiatives aimed at addressing these
material weaknesses, these initiatives may not remediate the identified material
weakness. Failure to achieve and maintain an effective internal control
environment could result in us not being able to accurately report our financial
results, prevent or detect fraud or provide timely and reliable financial
information pursuant to the reporting obligations we will have as a public
company, which could have a material adverse effect on our business, financial
condition and results of operations. Further, it could cause our investors to
lose confidence in the financial information we report, which could adversely
affect the price of our common stock.
Ensuring
that we have adequate internal financial and accounting controls and procedures
in place might entail substantial costs, may take a significant period of time,
and may distract our officers and employees from the operation of our business,
which could adversely affect our operating results and our ability to operate
our business.
Ensuring
that we have adequate internal financial and accounting controls and procedures
in place to help ensure that we can produce accurate financial statements on a
timely basis is a costly and time-consuming effort that needs to be re-evaluated
frequently. We became a public company on October 2007, by virtue of the Reverse
Merger. As a public company, we need to document, review, and test
and, if appropriate, improve our internal controls and procedures in connection
with Section 404 of the Sarbanes-Oxley Act, which requires annual management
assessments of the effectiveness of our internal control over financial
reporting and, in the future, will also require a report by our independent
auditors on our assessment. Both the Company and its independent
auditors will be testing our internal controls in connection with the Section
404 requirements and, as part of that documentation and testing, will identify
areas for further attention and improvement.
Implementing
any appropriate changes to our internal controls might entail substantial costs
in order to add personnel and modify our existing accounting systems, take a
significant period of time to complete, and distract our officers and employees
from the operation of our business. These changes might not, however,
be effective in maintaining the adequacy of our internal controls, and could
adversely affect our operating results and our ability to operate our
business.
- 17
-
Risks
Related to Doing Business in the PRC
Changes
in the PRC’s political or economic situation could harm us and our operational
results.
Economic
reforms which have been adopted by the Chinese government could change at any
time. Because many reforms are unprecedented or experimental, they
are expected to be refined and adjusted. Other political, economic and social
factors, such as political changes, changes in the rates of economic growth,
unemployment or inflation, or in the disparities in per capita wealth between
regions within the PRC, could lead to further readjustment of the reform
measures. This refining and readjustment process may negatively affect our
operations This could damage our operations and profitability. Some
of the things that could have this effect are:
|
·
|
level
of government involvement in the
economy;
|
|
·
|
control
of foreign exchange;
|
|
·
|
methods
of allocating resources;
|
|
·
|
balance
of payments position;
|
|
·
|
international
trade restrictions; or
|
|
·
|
international
conflict.
|
The
Chinese economy differs from the economies of most countries belonging to the
Organization for Economic Cooperation and Development, or OECD, in many ways. As
a result of these differences, we may not develop in the same way or at the same
rate as might be expected if the Chinese economy were similar to those of the
OECD member countries. It is possible that the Chinese government may
abandon its reforms all together and return to a more nationalized economy.
Negative impact upon economic reform policies or nationalization could result in
a total investment loss in our common stock.
Changes
in the interpretations of existing laws and the enactment of new laws may
negatively impact our business and results of operation.
There are
substantial uncertainties regarding the application of Chinese laws, especially
with respect to existing and future foreign investments in the PRC. The Chinese
legal system is a civil law system based on written statutes. Unlike common law
systems, it is a system in which precedents set in earlier legal cases are not
generally used. Laws and regulations effecting foreign invested enterprises in
the PRC have only recently been enacted and are evolving rapidly, and their
interpretation and enforcement involve uncertainties. Changes in existing laws
or new interpretations of such laws may have a significant impact on our methods
and costs of doing business. For example, new legislative proposals for product
pricing, approval criteria and manufacturing requirements may be proposed and
adopted. Such new legislation or regulatory requirements may have a material
adverse effect on our financial condition, results of operations or cash flows.
In addition, we will be subject to varying degrees of regulation and licensing
by governmental agencies in the PRC. Future regulatory, judicial and legislative
changes could have a material adverse effect on our Chinese operating
subsidiaries. Regulators or third parties may raise material issues
with regard to our Chinese subsidiaries or our compliance or non-compliance with
applicable laws or regulations or changes in applicable laws or regulations may
have a material adverse effect on our operations. Because of the evolving nature
in the law, it will be difficult for us to manage and plan for changes that may
arise.
- 18
-
It
will be difficult for any shareholder of ours to commence a legal action against
our executives. Enforcing judgments won against them or the Company
will be difficult.
Most of
our officers and directors reside outside of the United States. As a result, it
will be difficult, if not impossible, to acquire jurisdiction over those persons
in a lawsuit against any of them, including with respect to matters arising
under U.S. federal securities laws or applicable state securities
laws. Because the majority of our assets are located in the PRC, it
would also be extremely difficult to access those assets to satisfy an award
entered against us in United States court. Moreover, we have been advised that
the PRC does not have treaties with the United States providing for the
reciprocal recognition and enforcement of judgments of courts.
Recent
PRC regulations relating to mergers and acquisitions of domestic enterprises by
foreign investors may increase the administrative burden we face and create
regulatory uncertainties.
On August
8, 2006, six PRC regulatory agencies, namely, the PRC Ministry of Commerce
(“MOFCOM”), the State Assets Supervision and Administration Commission
(“SASAC”), the State Administration for Taxation, the State Administration for
Industry and Commerce, the China Securities Regulatory Commission (“CSRC”), and
the State Administration of Foreign Exchange (“SAFE”), jointly adopted the
Regulations on Mergers and Acquisitions of Domestic Enterprises by Foreign
Investors (the “New M&A Rule”), which became effective on September 8, 2006.
The New M&A Rule purports, among other things, to require offshore special
purpose vehicles (“SPVs”), formed for overseas listing purposes through
acquisitions of PRC domestic companies and controlled by PRC companies or
individuals, to obtain the approval of the CSRC prior to publicly listing their
securities on an overseas stock exchange.
On
September 21, 2006, pursuant to the New M&A Rule and other laws and
regulations of the PRC (“PRC Laws”), the CSRC, on its official website,
promulgated relevant guidance with respect to the issues of listing and trading
of domestic enterprises’ securities on overseas stock exchanges (the
“Administrative Permits”), including a list of application materials with
respect to the listing on overseas stock exchanges by SPVs.
On
October 9, 2007, AIDH, parent company of the Chinese corporations through which
we do all of our business, became a subsidiary through a Reverse Merger, as
further described in “Management’s Discussion and Analysis of Financial
Condition and Results of Operations — Recent Developments — Reverse Merger,
Private Placements and Related Transactions.”
Based on
our understanding of current PRC Laws, we believe that the New M&A Rule does
not require us or our Chinese shareholders or our entities in China to obtain
the CSRC approval in connection with the Reverse Merger because AIDH completed
the approval procedures of the acquisition of a majority equity interest in its
PRC subsidiary before September 8, 2006 when the New M&A Rule became
effective.
There
are, however, substantial uncertainties regarding the interpretation and
application of current or future PRC Laws, including the New M&A Rule. PRC
government authorities may take a view contrary to our understanding that we do
not need the CSRC approval, and Chinese government authorities may impose
additional approvals and requirements.
Further,
if the PRC government finds that we or our Chinese shareholders did not obtain
the CSRC approval, which should have been obtained before consummating the
Reverse Merger, we could be subject to severe penalties. The New M&A Rule
does not specify penalty terms, so we are not able to predict what penalties we
may face, but they could be materially adverse to our business and
operations.
Future
inflation in the PRC may inhibit our ability to conduct business in the
PRC.
In recent
years, the Chinese economy has experienced periods of rapid expansion and high
rates of inflation. During the past ten years, the annual rate of inflation in
the PRC has been as high as 20.7% and as low as 2.2%. These factors have led to
the adoption by the Chinese government, from time to time, of various corrective
measures designed to restrict the availability of credit or regulate growth and
contain inflation. High inflation may in the future cause the Chinese government
to impose controls on credit and/or prices, or to take other action, which could
inhibit economic activity in the PRC, which could harm the market for our
products and adversely effect our operations and business.
- 19
-
We
may have difficulty establishing adequate management, legal and financial
controls in the PRC.
The PRC
historically has been deficient in western-style management and financial
reporting concepts and practices, as well as in modern banking, computer and
other control systems. We may have difficulty in hiring and retaining a
sufficient number of qualified employees to work in the PRC. As a result of
these factors, we may experience difficulty in establishing management, legal
and financial controls, collecting financial data and preparing financial
statements, books of account and corporate records and instituting business
practices that meet western standards. If we are not able to maintain
adequate controls our financial statements may not properly represent our
financial condition, results of operation or cash flows. Weakness in
our controls could also delay disclosure of information to the public which is
material to an investment decision with respect to our stock.
Fluctuations
in the exchange rate between the Chinese currency and the United States dollar
could adversely affect our operating results.
The
functional currency of our operations in China is “Renminbi,” or “RMB.” However,
results of our operations are translated at average exchange rates into United
States dollars for purposes of reporting results. As a result, fluctuations in
exchange rates may adversely affect our expenses and results of operations as
well as the value of our assets and liabilities. Fluctuations may adversely
affect the comparability of period-to-period results. We currently do
not use hedging techniques, and even if in the future we do, we may not be able
to eliminate the effects of currency fluctuations. Thus, exchange rate
fluctuations could cause our profits to decline, which, in turn, may cause our
stock prices, to decline.
Changes
in foreign exchange regulations in the PRC may affect our ability to pay
dividends in foreign currency or conduct other foreign exchange
business.
The
Renminbi is currently not a freely convertible currency, and the restrictions on
currency exchange may limit our ability to use revenues generated in RMB to fund
our business activities outside the PRC, or to make dividends or other payments
in United States dollars. The PRC government strictly regulates conversion of
RMB into foreign currencies. Over the years, foreign exchange regulations in the
PRC have significantly reduced the government’s control over routine foreign
exchange transactions under current accounts. In the PRC, SAFE regulates the
conversion of the RMB into foreign currencies. Pursuant to applicable PRC laws
and regulations, foreign invested enterprises incorporated in the PRC are
required to apply for “Foreign Exchange Registration Certificates.” Currently,
conversion within the scope of the “current account” (e.g. remittance of foreign
currencies for payment of dividends, etc.) can be effected without requiring the
approval of SAFE. However, conversion of currency in the “capital account”
(e.g. for capital items
such as direct investments, loans, securities, etc.) still requires the approval
of SAFE.
In
addition, on October 21, 2005, SAFE issued the Notice on Issues Relating to the
Administration of Foreign Exchange in Fundraising and Reverse Investment
Activities of Domestic Residents Conducted via Offshore Special Purpose
Companies (“Notice 75”), which became effective as of November 1, 2005. Notice
75 replaced the two rules issued by SAFE in January and April 2005.
According
to Notice 75:
|
·
|
prior
to establishing or assuming control of an offshore company for the purpose
of obtaining overseas equity financing with assets or equity interests in
an onshore enterprise in the PRC, each PRC resident, whether a natural or
legal person, must complete the overseas investment foreign exchange
registration procedures with the relevant local SAFE
branch;
|
|
·
|
an
amendment to the registration with the local SAFE branch is required to be
filed by any PRC resident that directly or indirectly holds interests in
that offshore company upon either (1) the injection of equity interests or
assets of an onshore enterprise to the offshore company, or (2) the
completion of any overseas fund raising by such offshore company;
and
|
- 20
-
|
·
|
an
amendment to the registration with the local SAFE branch is also required
to be filed by such PRC resident when there is any material change in the
capital of the offshore company that does not involve any return
investment, such as (1) an increase or decrease in its capital, (2) a
transfer or swap of shares, (3) a merger or division, (4) a long term
equity or debt investment, or (5) the creation of any security
interests.
|
Moreover,
Notice 75 applies retroactively. As a result, PRC residents who have established
or acquired control of offshore companies that have made onshore investments in
the PRC in the past are required to complete the relevant overseas investment
foreign exchange registration procedures by March 31, 2006. Under the relevant
rules, failure to comply with the registration procedures set forth in Notice 75
may result in restrictions being imposed on the foreign exchange activities of
the relevant onshore company, including the payment of dividends and other
distributions to its offshore parent or affiliate and the capital inflow from
the offshore entity, and may also subject relevant PRC residents to penalties
under PRC foreign exchange administration regulations.
In
addition, SAFE issued updated internal implementing rules (“Implementing Rules”)
in relation to Notice 75. The Implementing Rules were promulgated and became
effective on May 29, 2007. Such Implementing Rules provide more detailed
provisions and requirements regarding the overseas investment foreign exchange
registration procedures. However, even after the promulgation of Implementing
Rules there still exist uncertainties regarding the SAFE registration for PRC
residents’ interests in overseas companies. It remains uncertain whether PRC
residents shall go through the overseas investment foreign exchange registration
procedures under Notice 75 or Implementing Rules.
Penalties
for non-compliance which may be issued by SAFE can impact the PRC resident
investors as well as the onshore subsidiary. However, certain matters related to
implementation of Circular No. 75 remain unclear or untested. As a result, we
may be impacted by potential penalties which may be issued by SAFE. For
instance, remedial action for violation of the SAFE requirements may be to
restrict the ability of our Chinese subsidiaries to repatriate and distribute
its profits to us in the United States. The results of non-compliance are
uncertain, and penalties and other remedial measures may have a material adverse
impact upon our financial condition and results of operations.
Extensive
regulation of the food processing and distribution industry in the PRC could
increase our expenses resulting in reduced profits.
We are
subject to extensive regulation by the PRC's Agricultural Ministry, and by other
county and local authorities in jurisdictions in which our products are
processed or sold, regarding the processing, packaging, storage, distribution
and labeling of our products. Applicable laws and regulations governing our
products may include nutritional labeling and serving size requirements. Our
processing facilities and products are subject to periodic inspection by
national, county and local authorities. To the extent that new regulations are
adopted, we will be required to conform our activities in order to comply with
such regulations. Our failure to comply with applicable laws and regulations
could subject us to civil remedies, including fines, injunctions, recalls or
seizures, as well as potential criminal sanctions, which could have a material
adverse effect on our business, operations and finances.
Limited
and uncertain trademark protection in the PRC makes the ownership and use of our
trademarks uncertain.
We have
obtained trademark registrations for the use of our tradenames “Xing An Ling”
and “Yi Bai”, which have been registered with the PRC’s Trademark Bureau of the
State Administration for Industry and Commerce with respect to our milk
products. We believe our trademarks are important to the establishment of
consumer recognition of our products. However, due to uncertainties in Chinese
trademark law, the protection afforded by our trademarks may be less than we
currently expect and may, in fact, be inadequate. Moreover, in the event our
trademarks or trade names are challenged or infringed, we may not have the
financial resources to defend against any challenge or infringement and such
defense could in any event be unsuccessful. Moreover, any events or conditions
that negatively impact our trademarks could have a material adverse effect on
our business, operations and finances.
- 21
-
Risks
Relating to the Market for Our Common Stock
Because
we became public by means of a reverse merger, we may not be able to attract the
attention of major brokerage firms.
There may
be risks associated with our becoming public through a the Reverse
Merger. Because of our Reverse Merger, we could be exposed to
undisclosed liabilities resulting from our operations prior to the merger and we
could incur losses, damages or other costs as a result. In addition,
securities analysts of major brokerage firms may not provide coverage of us
since there is no incentive to brokerage firms to recommend the purchase of our
common stock. Further, brokerage firms may not want to conduct any secondary
offerings on our behalf in the future. These factors may negatively
effect the market price and liquidity of our common stock.
There
is currently a limited trading market for our common stock and a more liquid
trading market may never develop or be sustained and stockholders may not be
able to liquidate their investment at all, or may only be able to liquidate the
investment at a price less than the Company’s value.
There is
currently a limited trading market for our common stock and a more liquid
trading market may never develop. As a result, the price if traded
may not reflect the value of the Company. Consequently, investors may
not be able to liquidate their investment at all, or if they are able to
liquidate it may only be at a price that does not reflect the value of our
business. Because the price for our stock is low, many brokerage
firms may not be willing to effect transactions in the securities. Even if an
investor finds a broker willing to effect a transaction in our stock, the
combination of brokerage commissions, transfer fees, taxes, if any, and any
other selling costs may exceed the selling price. Further, many lending
institutions will not permit the use of common stock like ours as collateral for
any loans. Even if a more active market should develop, the price may
be highly volatile.
Our
common stock is currently approved for quotation on the OTCBB. We do
not satisfy the initial listing standards of the New York Stock Exchange, NYSE
Amex Equities or The Nasdaq Stock Market. If we never are able to
satisfy any of those listing standards our common stock will never be listed on
an exchange, or we may choose not to apply for any such listing. As a
result, the trading price of our stock may be lower than if we were listed on an
exchange. Our stock may be subject to increased volatility. When a
stock is thinly traded, a trade of a large block of shares can lead to a
dramatic fluctuation in the share price. These factor may make it
more difficult for our shareholders to sell their shares.
Our
stock price may be volatile in response to market and other
factors.
The
market price for our stock may be volatile and subject to price and volume
fluctuations in response to market and other factors, including the following,
some of which are beyond our control:
|
·
|
the
increased concentration of the ownership of our shares by a limited number
of affiliated stockholders following the Reverse Merger may limit interest
in our securities;
|
|
·
|
variations
in quarterly operating results from the expectations of securities
analysts or investors;
|
|
·
|
announcements
of technological innovations or new products or services by us or our
competitors;
|
|
·
|
reductions
in the market share of our
products;
|
|
·
|
announcements
by us or our competitors of significant acquisitions, strategic
partnerships, joint ventures or capital
commitments;
|
|
·
|
general
technological, market or economic
trends;
|
|
·
|
volatility
in our results of operations;
|
- 22
-
|
·
|
investor
perception of our industry or
prospects;
|
|
·
|
insider
selling or buying;
|
|
·
|
investors
entering into short sale contracts;
|
|
·
|
regulatory
developments affecting our industry;
and
|
|
·
|
additions
or departures of key personnel.
|
These
factors may negatively effect the market price and liquidity of our common
stock.
“Penny
Stock” rules may make buying or selling our common stock difficult.
Trading
in our common stock is subject to the “penny stock” rules. The SEC has adopted
regulations that generally define a penny stock to be any equity security that
has a market price of less than $5.00 per share, subject to certain exceptions.
These rules require that any broker-dealer that recommends our common stock to
persons other than prior customers and accredited investors, must, prior to the
sale, make a special written suitability determination for the purchaser and
receive the purchaser’s written agreement to execute the transaction. Unless an
exception is available, the regulations require the delivery, prior to any
transaction involving a penny stock, of a disclosure schedule explaining the
penny stock market and the risks associated with trading in the penny stock
market. In addition, broker-dealers must disclose commissions payable to both
the broker-dealer and the registered representative and current quotations for
the securities they offer. The additional burdens imposed upon broker-dealers by
such requirements may discourage broker-dealers from effecting transactions in
our common stock, which could severely limit the market price and liquidity of
our common stock.
We
have a concentration of stock ownership and control, which may have the effect
of delaying, preventing, or deterring certain corporate actions and may lead to
a sudden change in our stock price.
Our
common stock ownership is highly concentrated. As of the date hereof, our
Chairman, Chief Executive Officer and President, Yang Yong Shan, beneficially
owns 13,978,329 shares, or approximately 42.1% of our total outstanding common
stock. His interests may differ significantly from your
interests. As a result of the concentrated ownership of our stock, a
relatively small number of stockholders, acting together, will be able to
control all matters requiring stockholder approval, including the election of
directors and approval of mergers and other significant corporate
transactions. In addition, because our stock is so thinly traded, the
sale by any of our large stockholders of a significant portion of that
stockholder’s holdings could cause a sharp decline in the market price of our
common stock.
We
have the right to issue up to 10,000,000 shares of "blank check" preferred
stock, which may adversely affect the voting power of the holders of other of
our securities and may deter hostile takeovers or delay changes in management
control.
Our
certificate of incorporation provides that we may issue up to 10,000,000 shares
of preferred stock from time to time in one or more series, and with such
rights, preferences and designations as our board of directors may determinate
from time to time. While none of our preferred stock has yet been issued, our
board of directors, without further approval of our common stockholders, is
authorized to fix the dividend rights and terms, conversion rights, voting
rights, redemption rights, liquidation preferences and other rights and
restrictions relating to any series of our preferred stock. Issuances of shares
of preferred stock could, among other things, adversely affect the voting power
of the holders of other of our securities and may, under certain circumstances,
have the effect of deterring hostile takeovers or delaying changes in management
control. Such an issuance would dilute existing stockholders, and the
securities issued could have rights, preferences and designations superior to
our common stock.
- 23
-
A
substantial number of shares of our common stock are issuable upon exercise of
outstanding warrants, the exercise of which will substantially reduce the
percentage ownership of holders of our currently outstanding shares of common
stock, and the sale of which may cause a decline in the price at which shares of
our common stock can be sold.
As of the
date hereof, we have outstanding exercisable warrants to purchase an aggregate
of 7,395,598 shares of our common stock, of which:
|
·
|
373,334
are exercisable at a price of $0.75 per share (all of which will expire if
not exercised on or prior to April 6,
2010);
|
|
·
|
499,522
are exercisable at a price of $1.20 per share (all of which will expire if
not exercised on or prior to April 6,
2010);
|
|
·
|
833,811
are exercisable at a price of $1.50 per
share;
|
|
·
|
2,333,297
are exercisable at a price of $1.63 per share (184,049 of which will
expire if not exercised on or prior to April 6,
2010);
|
|
·
|
875,515
are exercisable at a price of $2.04 per
share;
|
|
·
|
75,000
are exercisable at a price of $2.61 per share;
and
|
|
·
|
2,405,119
are exercisable at a price of $3.26 per
share.
|
We also
have an additional 758,929 warrants, which may become exercisable at a price of
$1.68 per share if certain conditions are met by June 30, 2010.
The
issuance of all or substantially all additional shares of common stock that are
issuable upon exercise of our outstanding warrants will substantially reduce the
percentage equity ownership of holders of shares of our common
stock. In addition, the exercise of a significant number of warrants,
and subsequent sale of shares of common stock received upon such exercise, could
cause a sharp decline in the market price of our common stock.
We
have not paid, and do not intend to pay, cash dividends in the foreseeable
future.
We have
not paid any cash dividends on our common stock and do not intend to pay cash
dividends in the foreseeable future. We intend to retain future earnings, if
any, for reinvestment in the development and expansion of our business. Dividend
payments in the future may also be limited by other loan agreements or covenants
contained in other securities which we may issue. Any future determination to
pay cash dividends will be at the discretion of our board of directors and
depend on our financial condition, results of operations, capital and legal
requirements and such other factors as our board of directors deems
relevant. In addition, the promissory notes we issued in the June
2008 Note Offering, as amended, and November 2008 Note Offering, further
described in “Management’s Discussion and Analysis of Financial Condition and
Results of Operations – Liquidity and Capital Resources — Promissory
Notes.”
FORWARD-LOOKING
STATEMENTS
This
Annual Report on Form 10-K, contains certain “forward-looking statements” within
the meaning of Section 27A of the Securities Act, and Section 21E of the
Exchange Act. We intend such forward-looking statements to be covered
by the safe harbor provisions for forward-looking statements contained in the
Private Securities Litigation Reform Act of 1995, and include this statement for
purposes of complying with these safe harbor provisions.
These
forward-looking statements are based on our current
expectations. They include statements relating to:
- 24
-
|
·
|
future
sales and financings;
|
|
·
|
the
future development of our business;
|
|
·
|
our
ability to execute our business
strategy;
|
|
·
|
projected
expenditures; and
|
|
·
|
the
market for our products.
|
You can
identify forward-looking statements by terminology such as “may,” “will,”
“should,” ‘could,’ “expects,” ‘intends,” “plans,” “anticipates,” “believes,”
“estimates,” “predicts,” “potential” or “continue” or the negative of these
terms or other comparable terminology. You should not rely on
forward-looking statements since they involve known and unknown risks,
uncertainties and other factors that are, in some cases, beyond our control and
which could materially affect actual results, performances or achievements and
such statements speak only as of the date they were made. Actual
events or results may differ materially from those suggested by these
forward-looking statements. All forward-looking statements
attributable to us or persons acting on our behalf are expressly qualified in
their entirety by these cautionary factors and to others contained throughout
this report. We are under no duty to update any of the
forward-looking statements after the date of this prospectus or to conform these
statements to actual results.
Although
it is not possible to create a comprehensive list of all factors that may cause
actual results to differ from the results expressed or implied by our
forward-looking statements or that may affect our future results, some of these
factors are set forth under “Risk Factors” discussed in Part 1, Item 1A of this
Annual Report on Form 10-K. We do not intend to update publicly any
forward-looking statement contained herein to reflect any change our
expectations with regard thereto, or any change in events, conditions or
circumstances on which any such statement is based.
Unless the context otherwise requires,
the terms “the Company,” “we,” “us” and “our” refer to Emerald Dairy Inc.,
together with our consolidated subsidiaries.
- 25
-
Item.
1B. Unresolved Staff Comments
None.
Item
2. Properties.
Under Chinese law, the government owns
all of the land in the PRC and companies and individuals are authorized to use
the land only through land use rights granted by the PRC
government.
We have one manufacturing facility,
which is located in Be’ian City, Heilongjiang Province, PRC. This
production facility occupies approximately 38,600 square meters of land and has
approximately 4,600 square meters for production. Currently there are
three production lines with daily capacity to process 200 tons of fresh
milk.
We also have sales offices in each of
the 20 provinces in the PRC in which our products are sold. All
leases are on an annual basis and commence on January 1, of each
year. For the years ended December 31, 2009 and 2008, we incurred
aggregate rental expenses of $76,098 and $17,255, respectively. As of
December 31, 2009, we had outstanding lease commitments totaling $276,256, of
which $157,328 is due in 2010 and $118,928 is due in 2011.
In the opinion of our management, each
of our properties is adequately covered by insurance.
In July 2008, we commenced construction
of a new facility in Hailun City, Heilongjiang Province, PRC, as discussed
elsewhere in this report. We anticipate that production at this new
facility will commence in the second quarter of fiscal 2010. We plan
to raise the funds needed for the completion of the first production line, and
subsequent expansion of this new facility, from the capital market through
private or public equity and/or debt offerings, although there can be no
assurance that any additional financing will be available to us on acceptable
terms, if at all (see “Management’s Discussion and Analysis of Financial
Condition and Results of Operations — Liquidity and Capital Resources —
General.”).
In addition, in fiscal 2008 we
purchased and paid for an office building, located in Heilongjiang Province,
PRC, for approximately $1.8 million. This office building, which
contains approximately 6,900 square feet of space, serves as our corporate
headquarters.
Item
3. Legal Proceedings.
There are no legal proceedings pending
or threatened against us, and we are not aware of any proceedings that a
governmental authority is contemplating against us.
Item
4. (Removed and Reserved).
- 26
-
PART II
Item 5.
|
Market
for Registrant's Common Equity, Related Stockholder Matters and Issuer
Purchases of Equity
Securities.
|
Market
Information
Our
common stock was approved for quotation on the OTCBB in the first quarter of
2007. Through October 9, 2007, our trading symbol was “MCTC.OB.” As
of October 9, 2007, we changed our name to Amnutria Dairy Inc. and were assigned
a new trading symbol of “AUDY.OB.” On January 25, 2008, we changed
our name to Emerald Dairy Inc. and received a new trading symbol of
“EMDY.OB”
On
October 20, 2008, shares of common stock purchased in two private offerings we
conducted in fiscal 2007 became eligible for sale pursuant to Rule 144 under the
Securities Act. Prior to that date, there had been no established
public trading market for shares of our common stock for over five years. There
is currently only a limited trading market for our common stock and no assurance
can be given that a more liquid trading market for our common stock will develop
or be maintained.
The high
and low sales prices for our common stock for the fiscal years ended
December 31, 2008 and 2009, and the subsequent interim period, were as
follows:
Quarter Ended
|
High
|
Low
|
||||||
2008
|
||||||||
March
31, 2008
|
$ | 0 | $ | 0 | ||||
June
30, 2008
|
$ | 0 | $ | 0 | ||||
September
30, 2008
|
$ | 0 | $ | 0 | ||||
December
31, 2008 (commencing October 17, 2008)
|
$ | 2.50 | $ | 0.70 | ||||
2009
|
||||||||
March
31, 2009
|
$ | 1.00 | $ | 0.26 | ||||
June
30, 2009
|
$ | 2.11 | $ | 0.60 | ||||
September
30, 2009
|
$ | 1.90 | $ | 1.30 | ||||
December
31, 2009
|
$ | 2.00 | $ | 1.50 |
Trading
in our common stock has been sporadic and the quotations set forth above are not
necessarily indicative of actual market conditions. All prices
reflect inter-dealer prices without retail mark-up, mark-down, or commission and
may not necessarily reflect actual transactions.
Holders
As of the
date hereof, there were 196 holders of record of our common
stock. Such number of record owners was determined from our
shareholder records and does not include beneficial owners whose shares are held
in nominee accounts with brokers, dealers, banks and clearing
agencies.
Dividends
We have
not paid any dividends since inception and do not anticipate paying any
dividends in the foreseeable future. We currently intend to retain
all available funds and any future earnings of our business for use in the
operation of our business. The declaration, payment and amount of
future dividends, if any, will depend upon our future earnings, results of
operations, financial position and capital requirements, among other factors,
and will be at the sole discretion of our Board of Directors. Certain
promissory notes we’ve issued, as further described in “Management’s Discussion
and Analysis of Financial Condition and Results of Operations – Liquidity and
Capital Resources – Promissory Notes,” contain restrictive covenants on our
payment of dividends.
- 27
-
Securities
Authorized For Issuance Under Equity Compensation Plan
See “Item 12. Security Ownership
of Certain Beneficial Owners and Management and Related Stockholder Matters” for
certain information with respect to our equity compensation plans as of December
31, 2009.
Recent
Sales of Unregistered Securities
The
following is a list of certain securities we sold or issued during fiscal
2008. There were no underwriting discounts or commissions paid in
connection with the sale of these securities, except as otherwise
noted. Certain information previously included in prior Exchange Act
reports we filed has not been furnished in this report.
As of
November 10, 2009, we amended a purchase agreement we originally entered into in
connection with our November 2008 Offering, as further described in
“Management’s Discussion and Analysis of Financial Condition and Results of
Operation – Recent Developments - Amendment to November 2008 Promissory
Note.” In consideration for its services in connection with this
amendment, among other services, we issued warrants to purchase 120,000 shares
of our common stock to the entity that had acted as placement agent for the
November 2008 Offering. These warrants will expire on November 10,
2012, and are exercisable either for cash, at an exercise price of $1.63 per
share, or on a cashless basis.
As of
November 23, 2009, we amended our letter agreement with a financial advisor,
pursuant to which the advisor is providing us with certain financial advisory
services. In connection with this amendment, we issued the financial
advisor an additional 44,643 warrants, which will be exercisable at a price of
$1.68 per share, or on a cashless basis, provided, certain conditions are met by
June 30, 2010.
We
believe that the issuance of the warrants in connection with these transactions
was exempt from registration under the Securities Act pursuant to Section 4(2)
and/or Regulation D promulgated thereunder, as transactions by an issuer not
involving a public offering.
Item
6. Selected Financial Data.
We are a smaller reporting company as
defined by Rule 12b-2 of the Exchange Act and are not required to provide the
information under this item.
- 28
-
Item
7. Management’s Discussion and Analysis of Financial Condition and
Results of Operation.
The financial and business analysis in
this Annual Report on Form 10-K (the “Report”) provides information we believe
is relevant to an assessment and understanding of our financial condition and
results of operations. The following discussion should be read in conjunction
with our consolidated financial statements and related notes included in Part
II, Item 8 of this Report.
Overview
We are a
producer of milk powder, rice powder and soybean milk powder, which currently
comprise approximately 94.4%, 3.0% and 2.6% of our sales,
respectively. Through our network of over 1,100 salespeople, our
products are distributed throughout 20 provinces in the PRC, and sold in over
6,000 retail outlets.
Our
products are marketed under two brand names:
|
·
|
“Xing
An Ling,” which is designed for high-end customers;
and
|
|
·
|
“Yi
Bai,” which is designed for middle and low-end
customers.
|
The
Chinese government has initiated programs to promote milk consumption and is
providing incentives to increase dairy production. The dairy market
is one of the fastest growing markets in the PRC. It has been growing
at a rate of 16% per year over the past six years, according to the National
Bureau of Statistics of China, and is expected to grow at a rate of 15% per year
for the foreseeable future. We focus on the infant formula segment of
the market, which, according to the Dairy Association of China, has grown even
faster in recent years, at a rate of 20%-30% per year. Currently, it is
estimated that demand for infant formula in the PRC outstrips supply by at least
2-to-1.
We have
received an Infant & Baby Formula Milk Powder Production Permit from the
State General Administration of Quality Supervision and Inspection and
Quarantine of the PRC. Only current license holders are permitted to
produce formula milk powder in the PRC.
Because
of our close proximity to our sources of fresh milk, we are able to complete the
production process in approximately 30-35 hours, which is faster than
competitors of ours that are not similarly situated. We produced
approximately 7,000 tons of milk powder at our facility in Be’ian City,
Heilongjiang Province, PRC in fiscal 2007, up from approximately 5,000 tons in
fiscal 2006. By adding a third shift to the existing two shifts
working schedule, we produced approximately 9,000 tons of milk powder in each of
fiscal 2008 and 2009.
We
believe that a lack of adequate production capacity has been a significant
impediment to our ability to increase our revenue in recent years. In
July 2008, through our wholly-owned subsidiary, HXD, we commenced construction
of a new production facility in Hailun City, Heilongjiang Province,
PRC. Between our existing production facility in Be’ian City and our
new production facility in Hailun City, we believe we will have the capacity to
produce approximately 27,000 tons of milk powder per year by the end of fiscal
2011. It is expected that our production of rice powder and soymilk
powder will also increase in volume over the same period, while continuing to
comprise an aggregate of approximately 5% of our overall sales.
Initially,
this new facility will have one production line, with the capacity to produce
9,000 tons of milk power annually. A second production line can be
added at this new facility, which, when completed, would enable us to produce an
additional 9,000 tons of milk powder per year, giving us a total annual
production capacity of 27,000 tons of milk powder. We anticipate that production
at this new facility will commence in the second quarter of fiscal 2010,
provided we are able to raise the additional $2.0 million we believe will be
required to complete the equipping of the first production line in satisfaction
with proposed more stringent government manufacturing standards expected to be
adopted in the near future. The cost to add a second production line,
would be an additional $15.0 million. We plan to raise the funds
needed for the new facility from the capital market through private or public
equity and/or debt offerings. There can be no assurance that that any
additional financing will become available to us, and if available, on terms
acceptable to us.
- 29
-
All of
our business is conducted through our wholly-owned Chinese
subsidiaries:
|
·
|
XAL,
which handles our promotion, sales and administrative
functions;
|
|
·
|
Lvbao,
which handles production of our products in Be’ian City, Heilongjiang
Province, PRC; and
|
|
·
|
HXD,
which, upon completion of the first production line of our new facility,
will handle additional production of our products in Hailun City,
Heilongjiang Province, PRC.
|
Our
products have become increasing popular in mainland China due to our continued
sales and marketing efforts. As a result, we have experienced
tremendous growth well above the industry average during recent
years. Sales increased from approximately $7.9 million in 2005 to
approximately $44.7 million in 2009, a 466% increase over four
years. Net income increased from approximately $0.7 million in 2005
to approximately $4.2 million in 2009, a 500% increase over four
years.
Recent
Developments
Third Warrant Tender Offer
On March
17, 2010, we closed our third offer (the “Third Warrant Tender Offer”) to
holders of an aggregate of 5,374,648 warrants to purchase shares of our common
stock (the “October 2007 Warrants”) we originally issued in connection with
private placements we consummated in October 2007 (the “October 2007 Private
Placements”), to exchange their October 2007 Warrants for warrants exercisable
at reduced exercise prices (“Amended Warrants”). In connection with
the Third Warrant Tender Offer we issued a total of 1,056,905 Amended Warrants
with reduced exercise prices.
Any
warrant holder that exchanged October 2007 Warrants for Amended Warrants in the
Third Warrant Tender Offer that wishes to exercise the Amended Warrants received
in connection therewith must do so on or before April 6, 2010. If all
of the Amended Warrants are exercised at their reduced exercise prices, we will
receive gross proceeds of approximately $1,179,427, although there can be no
assurance that any of these Amended Warrants will be exercised.
See Note
23 of the Notes to our consolidated financial statements for additional
information concerning the Third Warrant Tender Offer.
Extension
of Expiration Dates of Warrants
Pursuant
to the provisions of the October 2007 Warrants, the original expiration dates
were to be extended beyond their initial stated termination dates for certain
specified periods until we satisfied certain registration rights provisions
relating to the shares of our common stock underlying the October 2007
Warrants. As a result of our satisfaction of the registration rights
provisions on January 28, 2010, the expiration dates of the October 2007
Warrants were extended. We expect to record a non-cash charge against
earnings of approximately $5.0 million in the first quarter of 2010 resulting
from the extension of the expiration dates of the October 2007
Warrants.
See
Note 23 of the Notes to our consolidated financial statements for additional
information concerning the extension of the expiration dates of the October 2007
Warrants.
- 30
-
Second
Amendment to June 2008 Promissory Notes
As of
December 31, 2009, we entered into a second amendment (the “Second Amendment”)
to purchase agreements we originally entered into in connection with our June
2008 private placement (“June 2008 Offering”) of an aggregate principal amount
of $2,250,000 promissory notes (the “June 2008 Notes”) and 225,000 warrants (the
“June 2008 Investor Warrants”). Pursuant to the Second
Amendment:
|
·
|
the
Maturity Date of the indebtedness represented by the June 2008 Notes was
extended from December 31, 2009 to December 31,
2010;
|
|
·
|
accrued
and unpaid interest on the June 2008 Notes, in the aggregate amount of
$323,301, was added to the principal amount outstanding (resulting in an
aggregate principal balance of $2,573,301 immediately after the Second
Amendment reflected in the Amended June 2008 Notes defined
below);
|
|
·
|
amended
and restated notes (the “Amended June 2008 Notes”) incorporating the
changes set forth above were issued to the investors in the June 2008
Offering (the “June 2008 Investors”) in exchange for the cancellation of
the June 2008 Notes;
|
|
·
|
the
June 2008 Investors received additional three-year warrants to purchase an
aggregate of 789,356 shares of our common stock, at an exercise price of
$1.63 per share (the “Additional June 2008 Investor Warrants”);
and
|
|
·
|
Our
repayment of amounts due under the Amended June 2008 Notes is secured by a
pledge of an aggregate of 3,157,425 shares of our common stock
beneficially owned by Yang Yong Shan, our Chairman, Chief Executive
Officer and President.
|
In
consideration for its services in connection with the Second Amendment, we
issued 200,000 shares of our common stock to the entity that had acted as
placement agent for the June 2008 Offering.
The
rights and obligations under the Amended June 2008 Notes are further described
in “— Liquidity and Capital Resources — Promissory Notes” below.
December
2009 Note Offering
On December 24, 2009, we sold to three
“accredited investors” (the “December 2009 Noteholders”) for an aggregate
purchase price of $1,750,000, (i) promissory notes in the aggregate principal
amount of $1,750,000, with an interest rate of 10% per annum (the “December 2009
Notes”) and (ii) three-year warrants to purchase an aggregate of 536,809 shares
of our common stock, at an exercise price of $1.63 per share (the “December 2009
Warrants”) (the “December 2009 Note Offering”).
At the
closing of the December 2009 Note Offering, we paid the December 2009
Noteholders a closing fee in the aggregate amount of $35,000, and prepaid
interest on the December 2009 Notes in the aggregate amount of
$175,000. As a result, we received net proceeds of
$1,540,000. We have applied the net proceeds primarily toward (i) the
cost of equipping the first production line of our newly-constructed milk powder
processing facility located in Hailun City, Heilongjiang Province, PRC, (ii) the
payment of expenses incurred in connection with the December 2009 Note Offering,
and (iii) general working capital purposes.
Our
repayment of amounts due under the December 2009 Notes is secured by a pledge of
5,883,329 shares of our common stock beneficially owned by Yang Yong Shan, our
Chairman, Chief Executive Officer and President.
The
rights and obligations under the December 2009 Notes are further described in “—
Liquidity and Capital Resources — Promissory Notes” below.
- 31
-
November
2009 Term Loan
On November 30, 2009, we entered into a
Loan Agreement with an unrelated third party (the “Lender”), pursuant to which
we borrowed $1,750,000 from the Lender (the “November 2009 Term Loan”), in
consideration for which we issued the Lender a promissory note (the “Term Loan
Note”). We have applied the gross proceeds from the Term Loan primarily toward
(i) the cost of equipping the first production line of our newly-constructed
milk powder processing facility located in Hailun City, Heilongjiang Province,
PRC, (ii) the payment of expenses incurred in connection with the Term Loan, and
(iii) general working capital purposes.
The
rights and obligations under the Term Loan Note are further described in “—
Liquidity and Capital Resources — Promissory Notes” below.
Amendment
to November 2008 Promissory Note
As of
November 10, 2009, we entered into an amendment (the “Amendment”) to a purchase
agreement we originally entered into in connection with our November 2008
private placement (“November 2008 Offering”) of a promissory note in the
principal amount of $500,000 (the “November 2008 Note”) and warrants to purchase
50,000 shares (the “November 2008 Investor Warrants”). Pursuant to
the Amendment:
|
·
|
the
Maturity Date of the indebtedness represented by the November 2008 Note
was extended from November 10, 2009 to May 10,
2010;
|
|
·
|
an
amended and restated note (the “Amended November 2008 Note”) incorporating
the changes set forth above was issued to the investor in the November
2008 Offering (the “November 2008 Investor”) in exchange for the
cancellation of the November 2008 Note;
and
|
|
·
|
the
November 2008 Investor received additional three-year warrants to purchase
100,000 shares of our common stock at an exercise price of $1.63 per share
(the “Additional November 2008 Investor
Warrants”).
|
The
rights and obligations under the Amended November 2008 Note is further described
in “— Liquidity and Capital Resources — Promissory Notes” below.
Payment
of Liquidated Damages
We
entered into registration rights agreements (the “Registration Rights
Agreements”) with the investors in our October 2007 Private Placements (the
“October 2007 Investors”). Pursuant to the Registration Rights
Agreements, we were required to pay liquidated damages to the investors, if we
failed to satisfy certain registration requirements, as further described in “—
Liquidity and Capital Resources — Registration Rights and Liquidated Damages”
below.
As a
result of our failure to satisfy the registration requirements, we accrued a
total of $1,201,998 in liquidated damages through October 19, 2008, the date the
shares purchased in the October 2007 Private Placements became eligible for sale
pursuant to Rule 144 under the Securities Act. Pursuant to the
Registration Rights Agreements, the liquidated damages were payable in cash or
shares of our common stock, at our discretion. As of October 5, 2009,
in full payment of the liquidated damages, we issued an aggregate of
667,777 shares of
our common stock to the October 2007 Investors, valued at $1.80 per share, the
closing price on the OTCBB on October 20, 2008.
- 32
-
In
addition, pursuant to the Registration Rights Agreements, if we failed to pay
any liquidated damages in full within seven days after the date payable, we were
required to pay interest thereon at a rate of 15% per annum until such amounts,
plus all such interest thereon, were paid in full. Therefore, as of
October 5, 2009, we paid interest to the October 2007 Investors in the aggregate
amount of approximately $172,900, by issuing an aggregate of 108,056 additional
shares of our common stock, valued at $1.60 per share, the closing price of our
common stock on the OTCBB on October 2, 2009.
Trends
and Uncertainties
Economic
Downturn
The
worldwide economic downturn and market instability, which began in 2008, have
made the business climate more volatile and more costly. Although all
of our business operations are currently conducted in the PRC, our general
business strategy, as well as our results of operations and financial condition,
may be adversely affected by unpredictable and unstable market
conditions. If the current equity and credit markets deteriorate, or
do not improve from current levels, it may make it difficult, if not impossible,
for us to obtain debt or equity financing on acceptable terms at a time when we
wish to do so. Failure to secure any necessary financing in a timely manner and
on favorable terms could have a material adverse effect on our growth strategy,
financial performance and stock price and could require us to delay or abandon
our expansion plans. We do not expect this economic downturn to have
a significant effect on our business or operations in the near
future.
Narrowing
of Gap in Milk Consumption
The
Chinese government has initiated programs to promote milk consumption and is
providing incentives to increase dairy production. In addition to improving the
overall health of its populous, the government views increased dairy production
as a means of improving employment in rural areas thus improving social
stability. The programs are designed to narrow the significant gap between the
PRC’s per capita milk consumption of 15 kg per person and the global average of
100 kg per person. We believe this initiative will continue to
provide us with growth opportunities.
Industry
Growth
The dairy
market is one of the fastest growing markets in the PRC. It has been
growing at a rate of 16% per year over the past six years, according to the
National Bureau of Statistics of China, and is expected to grow at a rate of 15%
per year for the foreseeable future. On its website, the Dairy
Association of China estimates that the infant formula market segment, which is
the market segment we target, has grown even faster in recent years, at a rate
of 20%-30% per year. We believe the following three factors are the main drivers
of the infant formula market:
|
·
|
Increased
household income made infant formula more affordable in the
PRC;
|
|
·
|
Increased
number of working mothers or busy mothers created more demands for infant
formula products; and
|
|
·
|
Increased
popularity and acceptance of infant formula
products.
|
Based on
these factors, we expect to see significant growth in our business and
operations when we commence production at our new production facility in Hailun
City.
- 33
-
Supply
of Infant Formula
It is
estimated that the demand for infant formula in the PRC outstrips supply by at
least 2-to-1. In recent years, our production capabilities have not been able to
keep up with demand for our products. We have commenced construction of a new
production facility in Hailun City with an initial annual production capacity of
9,000 tons of milk powder, which is expected to start production in the second
quarter of 2010, provided we are able to raise the additional $2.0 million we
believe will be required to complete the equipping of the first production line
in satisfaction with proposed more stringent government manufacturing standards
expected to be adopted in the near future. We expect that this increase in
production capacity of approximately 100% will result in the doubling of our
sales revenues, with a corresponding increase in cost of goods sold and sales
and administrative expenses.
Product
Pricing and Raw Material Supply
Historically
we have been able to obtain sufficient raw milk and other raw materials to meet
our production needs. The price of raw milk is affected by regional market in
Heilongjiang Province, PRC, while other raw materials are affected by global
markets. We expect that the raw materials we require to produce our products
will continue to be available to us for the foreseeable future. In
fiscal 2009, the price of certain raw materials we use
declined. However, we believe that the prices will start to increase
again in fiscal 2010. To some extent, we believe we will be able to increase the
prices for our products to pass on any higher raw material costs to
consumers. However, there is no guarantee that we will be able to
raise prices to the full extent necessary to cover rises in costs for raw
materials, which could have a negative material impact on our financial
condition and results of operations.
Brand
Name and Product Quality
There are
more than 30 brand names of infant formula products sold in the PRC. Most of our
international and larger competitors have been concentrating in the first tier
cities, or well-known urban centers such as Beijing and Shanghai. The
rest of the Chinese domestic companies in the industry, including us, have been
focusing on less developed second and third tier cities where competition is
less severe than the top tier cities. As consumers have many options for infant
formula products, infant formula producers with better quality and safety images
have the advantages to sell their product at higher price. Brand
image and recognition are increasingly important in gaining customer
loyalty. We plan to continue to focus on penetrating less-competitive
second and third tier cities.
Label
Milk Products
Currently,
there are no organic label milk powder products in the mainland China market. In
February 2008, we obtained organic label certification from Guangdong Zhongjian
Certification Co., Ltd. We plan to create an organic label product line by the
end of fiscal 2010. We will need to test the market to determine demand for
organic milk products. Initially, we expect sales of organic milk powder to be
insignificant. However, over the long term, we believe that, similar to the
growth of the organic milk market in the U.S., organic milk products will become
increasingly popular in the PRC. Over time, this will help increase our
revenues.
Factors
Affecting Raw Milk Production
Raw milk
production is influenced by a number of factors that are beyond our control
including, but not limited to, the following:
|
·
|
Seasonal factors: dairy
cows generally produce more milk in temperate weather than in cold or hot
weather and extended unseasonably cold or hot weather could lead to lower
than expected production;
|
|
·
|
Environmental factors:
the volume and quality of milk produced by dairy cows is closely linked to
the quality of the nourishment provided by the environment around them, if
environmental factors cause the quality of nourishment to decline, milk
production could decline and we may have difficulty finding sufficient raw
milk; and
|
|
·
|
Governmental agricultural and
environmental policy: declines in government grants, subsidies,
provision of land, technical assistance and other changes in agricultural
and environmental policies may have a negative effect on the viability of
individual dairy farms, and the numbers of dairy cows and quantities of
milk they are able to produce.
|
- 34
-
Contamination
of Milk Powder Products Produced in the PRC
In
mid-2008, a number of milk powder products produced within the PRC were found to
contain unsafe levels of tripolycyanamide, also known as melamine, sickening
thousands of infants. This prompted the Chinese government to conduct a
nationwide investigation into how the milk powder was contaminated, and caused a
worldwide recall of certain milk powder products produced within the
PRC. On September 16, 2008, China’s Administration of Quality
Supervision, Inspection and Quarantine (AQSIQ) revealed that it had tested
samples from 175 dairy manufacturers, and published a list of 22 companies whose
products contained melamine. We passed the emergency inspection and were not
included on AQSIQ’s list. The contraction in the Chinese milk powder industry
caused by this crisis has lead to increased demand for our
products. However, we can not be certain that the illnesses caused by
contamination in the milk powder industry, whether or not related to our
products, will not lead to decreased demand for milk powder products produced
within the PRC, thereby having a material adverse effect on our
business.
Results
of Operations
Fiscal
Year Ended December 31, 2009 Compared to Fiscal Year Ended December 31,
2008
The
following summarizes changes in our operations for the fiscal years ended
December 31, 2009 and 2008. Net income increased by $1,897,516, or
82.0%, from $2,314,507 in the fiscal year ended December 31, 2008 to $4,212,023
for the fiscal year ended December 31, 2009. The increase in net
income during the year ended December 31, 2009, as compared to the same time
period in the prior year, was primarily due to an increase in our gross profit
and a decrease in our operating expenses as further described
below.
Sales
and Cost of Goods Sold
|
For the Fiscal Years
Ended December 31,
|
|||||||
|
2009
|
2008
|
||||||
|
||||||||
Sales
|
$
|
44,729,276
|
$
|
44,325,179
|
||||
Cost of Goods
Sold
|
24,056,601
|
26,546,291
|
||||||
Gross
Profit
|
$
|
20,672,675
|
$
|
17,778,888
|
Sales. Sales volume decreased
by 500 metric tons, or 5.6%, period on period to 8,476 metric tons for the
fiscal year ended December 31, 2009, from 8,976 metric tons for the fiscal year
ended December 31, 2008, due to our shift in sales mix from subcontracting to
our production of more of our higher end products. These higher end
products are sold in smaller containers, requiring more time to be devoted to
packaging. Sales revenues increased by $404,097, or 0.9%, from $44,325,179
in the fiscal year ended December 31, 2008 to $44,729,276 for the fiscal year
ended December 31, 2009, primarily due to an increase in the average selling
price of our products, of $339 per metric ton, as compared to the fiscal year
ended December 31, 2008, occurring because we produced more of our high end
product line in fiscal 2009.
- 35
-
Sales by product
line. A break-down of our sales by product line for the years
ended December 31, 2009 and 2008 is as follows:
|
Fiscal Year Ended December 31,
|
|||||||||||||||||||||||||||
|
2009
|
2008
|
Period-on-period
|
|||||||||||||||||||||||||
Product category
|
Quantity
(tons)
|
$ Amount
|
% of sales
|
Quantity
(tons)
|
$ Amount
|
% of
sales
|
Qty.
Variance
|
|||||||||||||||||||||
|
||||||||||||||||||||||||||||
Milk
powder
|
6,217 | 38,590,606 | 86.3 | 6,175 | 36,245,495 | 81.8 | 42 | |||||||||||||||||||||
Rice
powder
|
239 | 1,358,127 | 3.0 | 198 | 1,105,837 | 2.5 | 41 | |||||||||||||||||||||
Soybean
powder
|
681 | 1,164,347 | 2.6 | 477 | 882,185 | 2.0 | 204 | |||||||||||||||||||||
Subcontracting
|
1,339 | 3,616,196 | 8.1 | 2,126 | 6,091,662 | 13.7 | (787 | ) | ||||||||||||||||||||
Total
|
8,476 | 44,729,276 | 100.0 | 8,976 | 44,325,179 | 100.0 | (500 | ) |
There
were various changes to the break-down of sales among our product lines over the
fiscal year ended December 31, 2009, as we increased production in most of our
product lines, but attempted to adjust our sales mix to higher margin
products. Milk powder accounted for 86.3% of the fiscal year 2009
sales mix, at an average selling price of $6,207 per metric ton, as compared to
81.8% of the fiscal year 2008 sales mix, at an average selling price of $5,869
per metric ton. Rice powder accounted for 3.0% of the fiscal year 2009 sales
mix, at an average selling price of $5,683 per metric ton, as compared to 2.5%
of the fiscal year 2008 sales mix, at an average selling price of $5,585 per
metric ton. Soybean powder accounted for 2.6% of our sales mix for
the fiscal year 2009, at an average selling price of $1,710 per metric ton, as
compared to 2.0% of our sales mix in fiscal year 2008, at an average selling
price of $1,849 per metric ton. We decreased our subcontract
production during fiscal year 2009 to 8.1% of the sales mix, at an average
selling price of $2,701 per metric ton, as compared to 13.7% of the sales mix in
fiscal year 2008, at an average sales price of $2,865 per metric
ton.
A
breakdown of our average selling price by product line for the years ended
December 31, 2009 and 2008 is as follows:
Fiscal Year Ended
December 31,
|
||||||||||||||||
Average selling prices
|
2009
|
2008
|
Variance
|
|||||||||||||
|
$
|
$
|
$
|
%
|
||||||||||||
Milk
powder
|
6,207 | 5,869 | 338 | 5.8 | ||||||||||||
Rice
powder
|
5,683 | 5,575 | 108 | 1.9 | ||||||||||||
Soybean
powder
|
1,710 | 1,849 | (139 | ) | (7.5 | ) | ||||||||||
Subcontracting
|
2,701 | 2,865 | (164 | ) | (5.7 | ) | ||||||||||
Total
|
5,277 | 4,938 | 339 | 6.9 |
Cost of Goods
Sold. Cost of goods sold decreased by $2,489,690, or 9.4%,
from $26,546,291 in the fiscal year ended December 31, 2008, to $24,056,601 for
the fiscal year ended December 31, 2009. This decrease was directly
related to a change in our sales mix during fiscal year 2009 to a mix with a
lower cost per metric ton. Overall our cost per metric ton decreased
by $119, or 4.0%, to $2,838 per metric ton in the fiscal year ended December 31,
2009, as compared to $2,957 per metric ton in fiscal year ended December 31,
2008, due to a decrease in the cost of our raw materials during the
year.
- 36
-
A
breakdown of cost of sales by product line for the years ended December 31, 2009
and 2008 is as follows:
Fiscal Year Ended December 31,
|
||||||||||||||||
2009
|
2008
|
Variance
|
||||||||||||||
$
|
$
|
$
|
%
|
|||||||||||||
Cost of sales
|
||||||||||||||||
Milk
powder
|
19,348,556 | 20,185,806 | (837,250 | ) | (4.1 | ) | ||||||||||
Rice
powder
|
532,599 | 433,662 | 98,937 | 22.8 | ||||||||||||
Soybean
powder
|
853,857 | 580,684 | 273,173 | 47.0 | ||||||||||||
Subcontracting
|
3,321,589 | 5,346,139 | (2,024,550 | ) | (37.9 | ) | ||||||||||
|
24,056,601 | 26,546,291 | (2,489,690 | ) | (9.4 | ) | ||||||||||
|
||||||||||||||||
Cost per units sold(per
ton)
|
||||||||||||||||
Milk
powder
|
3,112 | 3,269 | (157 | ) | (4.8 | ) | ||||||||||
Rice
powder
|
2,228 | 2,186 | 42 | 1.9 | ||||||||||||
Soybean
powder
|
1,254 | 1,217 | 37 | 3.0 | ||||||||||||
Subcontracting
|
2,481 | 2,515 | (34 | ) | 1.4 | |||||||||||
Average
cost per unit sold
|
2,838 | 2,957 | (119 | ) | 4.0 |
Gross Profit. Gross profit was
$20,672,675, or 46.2% of our sales for the fiscal year ended December 31, 2009,
as compared to gross profit of $17,778,888, or 40.1% for the fiscal year ended
December 31, 2008. During the fiscal year ended December 31, 2009 our gross
margin on milk powder increased to 49.9% from 44.3% in the prior year, due to an
increase in the average sales price of 5.8%, while there was a 4.8% decrease in
the cost per metric ton from the fiscal year ended December 31, 2008. The
gross margin for rice powder stayed consistent at 60.8%. The gross
margin for soybean powder declined 7.5% to 26.7% in fiscal year 2009 as compared
to 34.2% in fiscal year 2008 due to increase in the average cost per ton of 3.0%
in fiscal year 2009 as compared to fiscal year 2008.
A
breakdown of gross margin by product line for the years December 31, 2009 and
2008 is as follows:
Fiscal Year Ended December 31,
|
||||||||||||||||||||
2009
|
2008
|
Period-on-period
|
||||||||||||||||||
Product category
|
$ Amount
|
Gross
Margin %
|
$ Amount
|
Gross
Margin %
|
Margin
Variance
|
|||||||||||||||
Milk
powder
|
19,242,050 | 49.9 | 16,059,689 | 44.3 | 5.6 | |||||||||||||||
Rice
powder
|
825,528 | 60.8 | 672,175 | 60.8 | - | |||||||||||||||
Soybean
powder
|
310,490 | 26.7 | 301,501 | 34.2 | (7.5 | ) | ||||||||||||||
Subcontracting
|
294,607 | 8.1 | 745,523 | 12.2 | (4.1 | ) | ||||||||||||||
Total
|
20,672,675 | 46.2 | 17,778,888 | 40.1 | 6.1 |
Operating
Expenses
|
For the Fiscal Years
Ended December 31,
|
|||||||
|
2009
|
2008
|
||||||
Operating Expenses
|
||||||||
Selling
expenses
|
$
|
10,047,861
|
$
|
10,602,185
|
||||
Administrative
expenses
|
3,271,892
|
3,494,733
|
||||||
Depreciation
and amortization
|
178,281
|
113,660
|
||||||
Total
operating expenses
|
$
|
13,498,034
|
$
|
14,210,578
|
Selling Expenses. Selling
expenses overall decreased by $554,324, or 5.2%, from $10,602,185 in fiscal year
ended December 31, 2008, to $10,047,861 for the fiscal year ended December 31,
2009. The major factors in the decrease in selling expenses are as
follows:
- 37
-
|
·
|
Advertising
and promotion decreased by $871,184, or 17.8%, to $4,023,691 in 2009, from
$4,894,875 in 2008, due to our increased advertising in 2008 to offset
negative affects of the Chinese milk powder melamine
scandal.
|
|
·
|
Sales
entertainment expenses decreased by $169,913, or 27.6%, to $445,040 in
2009, from $614,953 in 2008, due to normal fluctuations occurring from
year to year.
|
|
·
|
Transportation
expenses decreased by $77,431, or 7.2%, to $990,828 in 2009, from
$1,068,259 in 2008, as a result of our shipping less product in 2009 as
compared to 2008, in addition to lower shipping
costs.
|
These
decreases were partially offset by an increase in selling salaries by $254,947,
or 12.8%, to $2,243,063 in 2009, from $1,988,116 in 2008, due to our increase in
sales staff to prepare for the beginning of production in our new processing
facility. Rather than using a wholesaler, our sales people deal
directly with the retail outlets. This business model has higher
sales expenses compared to the traditional business model, but creates better
profit margins for us. For a more complete discussion regarding the
costs and profits of our retail sales model, see “Description of Business —
Company Strategy — Market Strategy — Sales Channel.”
Administrative Expenses.
Administrative expenses decreased by $222,841, or approximately 6.4%, from
$3,494,733 in fiscal year ended December 31, 2008, to $3,271,892 for the fiscal
year ended December 31, 2009. The major factor in the decrease in
administrative expenses was that liquidated damages incurred in 2008 of $986,699
were not similarly incurred in 2009.
This decrease was partially offset
by:
|
·
|
Stock
option expenses of $265,825 incurred in 2009 from employee
awards.
|
|
·
|
Increase
in consulting expenses of $227,638, or 245.6%, to $320,323 in 2009, from
$92,685 in 2008, due to increased assistance capital planning with
consultants.
|
Provision for
Income Taxes
For the Fiscal Years
Ended December 31,
|
||||||||
2009
|
2008
|
|||||||
Provision
for Income Taxes
|
||||||||
Current
|
$
|
1,327,527
|
$
|
840,198
|
||||
Deferred
|
—
|
—
|
||||||
$
|
1,327,527
|
$
|
840,198
|
Provision for Income Taxes.
Income taxes increased by $487,329, or 58.0%, from $840,198 in fiscal year ended
December 31, 2008, to $1,327,527 for the fiscal year ended December 31,
2009. This increase was due to the increase in our taxable income
resulting from an increase of gross profit of approximately $2.9 million in our
operating subsidiaries. The increase in our gross profit was related
to a reduction in the price of our raw materials combined with our production of
more of our higher end products.
- 38
-
Liquidity
and Capital Resources
Uses
of Capital
For the Fiscal
Years Ended
December 31,
|
||||||||
2009
|
2008
|
|||||||
Net
cash provided by operating activities
|
$
|
4,480,927
|
$
|
6,326,610
|
||||
Net
cash used in investing activities
|
(6,088,608
|
)
|
(8,517,186
|
)
|
||||
Net
cash provided by financing activities
|
$
|
7,758,590
|
$
|
2,458,126
|
Net Cash Provided By Operating
Activities. For the fiscal year ended December 31, 2009,
$4,480,927 was provided by operating activities, compared with $6,326,610
provided by operating activities for the fiscal year ended December 31,
2008. Our net cash flows provided from operating activities decreased
during 2009 due primarily to the following factors:
|
·
|
Trade
accounts receivable increased by $1,080,391, due to the increased level of
sales during the year.
|
|
·
|
Advances
to suppliers and other receivables increased by $311,638, due the increase
in our level of production during
2009.
|
|
·
|
Inventory
increased at December 31, 2009 by $415,773, due to an increase in the
amount of work-in-process at year
end.
|
|
·
|
Accounts
payable and accrued expenses decreased by $33,232 at December 31, 2009, as
compared to 2008, as we paid down our accounts payable at year
end.
|
Net Cash Used In Investing
Activities. For the fiscal year ended December 31, 2009, we
used $6,088,608 in investing activities, compared with $8,517,186 used in
investing activities for the fiscal year ended December 31, 2008. The
decrease in net cash flows used in investing activities during 2009 was due to a
deposit on equipment for the new production facility of $3,712,883 in 2008 that
we did not similarly make in 2009.
Net Cash Provided By Financing
Activities. For the fiscal year ended December 31, 2009,
$7,758,590 was provided by financing activities, compared with $2,458,126
provided by financing activities for the fiscal year ended December 31,
2008. We raised $3,325,000 through the sale of promissory notes
payable and warrants during 2009. We also received $4,433,590 from the exercise
of warrants in the year ended December 31, 2009.
General
Cash and
cash equivalents at December 31, 2009 increased by approximately 83.6% to
$13,486,429, from $7,343,588 at December 31, 2008. Working capital increased
from approximately $10.5 million at December 31, 2008, to approximately $17.3
million at December 31, 2009, including cash generated from operations, as well
as funds raised from private offerings of promissory notes and warrants we
consummated in fiscal 2009. Based upon our short term liabilities, we believe
our cash and cash equivalents are adequate to satisfy our working capital needs
and sustain our ongoing operations for the next twelve months.
We
believe that a lack of adequate production capacity has been a significant
impediment to our ability to increase our revenue in recent
years. Our growth strategy for the next three years will be primarily
focused on expanding production capacity and strengthening sales efforts.
Management plans to achieve this strategy by increasing our production capacity
with introduction of our new production facility, sales staff, and advertising
expenditures.
- 39
-
In July
2008, we commenced construction of a new production facility in Hailun City,
Heilongjiang Province, PRC. The first phase of this project has cost an
aggregate of approximately $20.0 million, including land use rights,
construction expenses and equipment costs. Upon completion of the first phase,
the new facility will have one production line, which will have the capacity to
produce 9,000 tons of milk power annually. We anticipate that production at this
new facility will commence in the second quarter of fiscal 2010, provided we are
able to raise the additional $2.0 million we believe will be required to
complete the equipping of the first production line in satisfaction with
proposed more stringent government manufacturing standards expected to be
adopted in the near future. In the second phase, a second production
line may be added at this new facility, which, when completed, would enable us
to produce an additional 9,000 tons of milk powder per year, giving us a total
annual production capacity of 27,000 tons of milk powder. We believe the cost to
add a second production line would be an additional $15.0 million.
Historically
we relied on investments by our Chief Executive Officer and shareholders, and
bank loans, to meet our cash and capital expenditures. However, as the amount of
our capital expenditures increases, we will depend more on the capital markets
to raise funds through private and public offerings of equity and/or debt. There
can be no assurance that any future financing will be available to us when
needed, and on commercially reasonable terms.
In fiscal
2009, we raised approximately $3.3 million through the sale of promissory notes
payable and warrants, and approximately $4.4 million from the exercise of
warrants, as follows.
|
·
|
On
March 2, 2009, we closed our offer, pursuant to which the holders of the
October 2007 Warrants had the opportunity to tender their October 2007
Warrants for shares of our common stock at a reduced exercise prices (the
“First Warrant Tender Offer”). In connection with the First Warrant Tender
Offer, we received gross proceeds of approximately
$758,000.
|
|
·
|
On
August 13, 2009, we closed our second offer, pursuant to which the holders
of the October 2007 Warrants had the opportunity to tender their October
2007 Warrants for shares of our common stock at a reduced exercise prices
(the “Second Warrant Tender Offer”). On August 14, 2009, the
warrant holders that participated in the Second Warrant Tender Offer
exercised all of the amended warrants they received in connection
therewith, at an exercise price of $1.63 per share. As a result, we
received gross proceeds of
$3,675,000.
|
|
·
|
On
November 30, 2009, we borrowed $1,750,000 through the November 2009 Term
Loan from the Lender.
|
|
·
|
On
December 24, 2009, we consummated the December 2009 Note Offering pursuant
to which we received net proceeds of
$1,540,000.
|
We used
the proceeds we received from the First Warrant Tender Offer, Second Warrant
Tender Offer, November 2009 Term Loan and December 2009 Note Offering for the
construction and equipping of our new production facility, to pay expenses
related to these transactions, and for general working capital purposes. We
anticipate that production at this new facility will commence in the second
quarter of fiscal 2010, provided we are able to raise the additional $2.0
million we believe will be required to complete the equipping of the first
production line in satisfaction with proposed more stringent government
manufacturing standards expected to be adopted in the near
future. There can be no assurance that that any additional financing
will become available to us, and if available, on terms acceptable to
us.
Following
the completion of the first production line of our new facility, we plan to add
a second production line, which, when completed, would enable us to produce an
additional 9,000 tons of milk powder per year, giving us a total annual
production capacity of 27,000 tons of milk powder. We believe it will cost
approximately $15.0 million to add a second production line. We
currently have no sources for the additional financing we may need to add a
second production line at our new processing facility. There can be no assurance
that that any additional financing will become available to us, and if
available, on terms acceptable to us.
- 40
-
In
addition to constructing our new production facility, we have purchased an
office building located in Heilongjiang Province, PRC, for approximately $1.8
million, serves as our corporate headquarters. The purchase price of this
building was paid out of our retained earnings.
Currently,
we spend approximately 8%-12% of total revenues on advertising and promotional
efforts through out the year. We spent approximately $4.5 million, $5.4 million
and $3.0 million on advertising and promotion in fiscal 2009, 2008 and 2007,
respectively. We currently expect to spend an aggregate of approximately $6.0
million on advertising and promotion in fiscal 2010. This will still fall within
our standard budget for advertising and promotion of 8%-12% of total
revenues. The funds for advertising and promotion will generally come
out of our earnings.
Management
will also consider making strategic acquisitions if there are good opportunities
in the marketplace. However, revenue from acquisitions has not been included in
our planned growth.
Registration
Rights and Liquidated Damages
In
connection with the October 2007 Private Placements, we entered into
Registration Rights Agreements with the October 2007 Investors, pursuant to
which we agreed that within thirty (30) business days of the respective closing
date (the “Filing Date”), we would file a registration statement with the SEC
(the “Registration Statement”) covering the resale of (i) the shares of common
stock purchased in the October 2007 Private Placements (the “Purchased Shares”),
and (ii) the common stock issuable upon exercise of the October 2007 Warrants
(collectively (i) and (ii), the “Registrable Securities”). Further, we agreed to
use our best efforts to (i) cause the Registration Statement to be declared
effective within ninety (90) calendar days from the Filing Date, or, if reviewed
by the SEC, within one hundred eighty (180) calendar days after the Filing Date,
and (ii) keep the Registration Statement continuously effective until all of the
Registrable Securities have been sold, or may be sold without volume
restrictions pursuant to Rule 144.
Pursuant
to the Registration Rights Agreements, we were required to pay liquidated
damages to the holders of the Purchased Shares if (i) we failed to file the
Registration Statement on or before the Filing Date, (ii) the SEC did not
declare the Registration Statement effective within ninety (90) days of the
Filing Date (or one hundred eighty (180) days in the event of a review by the
SEC) (the “Effectiveness Date”), (iii) we failed to request acceleration of
effectiveness within five (5) business days of a notice of no further review
from the SEC, (iv) we failed to respond to the SEC within ten (10) business days
of receipt by us of any comments on the Registration Statement, or (v) after it
has been declared effective, the Registration Statement ceases to be effective
or available or if we suspend the use of the prospectus forming a part of the
Registration Statement (A) for more than thirty (30) days in any period of 365
consecutive days if we suspend in reliance on its ability to do so due to the
existence of a development that, in the good faith discretion of its board of
directors, makes it appropriate to so suspend or which renders us unable to
comply with SEC requirements, or (B) for more than ninety (60) days in any
period of 365 consecutive days for any reason. The liquidated damages accumulate
at the rate of one and one-half percent (1.5%) of the purchase price paid by the
October 2007 Investors for units of our securities purchase in the October 2007
Private Placements for each thirty (30) day period during which a registration
default is continuing; provided, however, that (i) we would not be liable for
liquidated damages with respect to any warrants or shares of common stock
underlying the warrants, and (ii) in no event would we be liable for liquidated
damages in excess of 1.5% of the aggregate purchase price of the securities
purchased in the October Offerings in any 30 day period, and (iii) the maximum
aggregate liquidated damages payable to any of the October 2007 Investors shall
be 20% of the aggregate purchase price paid by such purchaser. The
Registration Rights Agreements further required that if we failed to pay any
partial liquidated damages in full within seven days after the date payable, we
will pay interest thereon at a rate of 15% per annum, until such amounts, plus
all such interest thereon, are paid in full.
We did
not satisfy these registration requirements and, as a result, accrued a total of
$1,201,998 in liquidated damages and $172,900 in interest. As of
October 5, 2009, we issued an aggregate of 775,833 shares in full payment of the
liquidated damages and interest, as further described in “— Recent Developments
— Payment of Liquidated Damages” above.
- 41
-
On
January 28, 2010, a Registration Statement we filed to register the Registrable
Securities for resale was declared effective by the SEC.
Put/Call
Agreements
In
October 2007, we entered into agreements (the “Put/Call Agreements”) with
certain shareholders of ours (the “Put/Call Shareholders”). Pursuant to the
Put/Call Agreements, we had an option to repurchase an aggregate of 1,944,444
shares of our common stock (the “Put/Call Shares”) from the Put/Call
Shareholders (the “Call Option”), for an exercise price of $1.63 per share (the
“Call Option Price”), if the following conditions were met (the “Call Option
Conditions”):
|
·
|
either
(a) a registration statement (“Registration Statement”) covering the
resale of the Put/Call Shares had been declared effective by the SEC, and
had been kept continuously effective by us, or (b) all of the Put/Call
Shares were available for sale without registration pursuant to Rule 144;
and
|
|
·
|
the
closing price of a share of our common stock as traded on the OTCBB (or
such other exchange or stock market on which the common stock may be
listed or quoted) equaled or exceeded $4.08 (appropriately adjusted for
any stock split, reverse stock split, stock dividend or other
reclassification or combination of the common stock occurring after the
date hereof) for at least ten (10) consecutive trading days immediately
preceding the date notice of exercise of a Call Option was given by
us.
|
In
addition, pursuant to the Put/Call Agreements, the Put/Call Shareholders had the
right to cause us to repurchase the Put/Call Shares (the “Put Right”), for a
price of $1.63 per share (the “Put Purchase Price”), if:
|
·
|
we
failed to exercise our Call Option within ten (10) days of a date on which
all of the Call Option Conditions had been met;
or
|
|
·
|
we
consummated a private offering of our securities of $5,000,000 or greater
(a “Qualified Offering”); or
|
|
·
|
we
failed to consummate a Qualified Offering on or prior to October 9, 2009
(each of the aforementioned conditions, a “Put Right
Trigger”).
|
Initially,
our failure to (i) file the Registration Statement within thirty (30) business
days of October 9, 2007 (the “Filing Date”), (ii) have the Registration
Statement declared effective within ninety (90) calendar days from the Filing
Date, or, if reviewed by the SEC, within one hundred eighty (180) calendar days
after the Filing Date, or (iii) keep the Registration Statement continuously
effective until all of the “Registrable Securities” were available for sale
without registration pursuant to Rule 144, would also have served as a Put Right
Trigger. However, as of April 9, 2008, the Put/Call Shareholders agreed to amend
the Put/Call Agreements to delete this provision. We did not pay any
consideration to the Put/Call Shareholders in connection with their waiver of
this provision.
We had
recorded the value of the Put/Call Agreements as a liability in the aggregate
amount of $3,169,444 as of October 9, 2007, based on the fair market value of
the underlying common stock of $1.63 as of such date. The parties mutually
agreed that it was in the best interests of the Company and its stockholders for
the Put/Call Agreements to be terminated. Therefore, as of March 3, 2009, the
Put/Call Agreements were terminated.
- 42
-
Changes
in foreign exchange regulations in the PRC and ability to pay dividends in
foreign currency or conduct other foreign exchange business
The
Renminbi is currently not a freely convertible currency, and the restrictions on
currency exchange may limit our ability to use revenues generated in RMB to fund
our business activities outside the PRC, or to make dividends or other payments
in United States dollars. The PRC government strictly regulates conversion of
RMB into foreign currencies. Over the years, foreign exchange regulations in the
PRC have significantly reduced the government’s control over routine foreign
exchange transactions under current accounts. In the PRC, SAFE, regulates the
conversion of the RMB into foreign currencies. Pursuant to applicable PRC laws
and regulations, foreign invested enterprises incorporated in the PRC are
required to apply for “Foreign Exchange Registration Certificates.” Currently,
conversion within the scope of the “current account” (e.g. remittance of foreign
currencies for payment of dividends, etc.) can be effected without requiring the
approval of SAFE. However, conversion of currency in the “capital account” (e.g.
for capital items such as direct investments, loans, securities, etc.) still
requires the approval of SAFE. See the discussion in Risk Factors on
page 5 for more information.
Warrants
As of the
date hereof, we have outstanding exercisable warrants to purchase an aggregate
of 7,395,598 shares of our common stock, of which:
|
·
|
373,334
are exercisable at a price of $0.75 per share (all of which will expire if
not exercised on or prior to April 6,
2010);
|
|
·
|
499,522
are exercisable at a price of $1.20 per share (all of which will expire if
not exercised on or prior to April 6,
2010);
|
|
·
|
833,811
are exercisable at a price of $1.50 per
share;
|
|
·
|
2,333,297
are exercisable at a price of $1.63 per share (184,049 of which will
expire if not exercised on or prior to April 6,
2010);
|
|
·
|
875,515
are exercisable at a price of $2.04 per
share;
|
|
·
|
75,000
are exercisable at a price of $2.61 per share;
and
|
|
·
|
2,405,119
are exercisable at a price of $3.26 per
share.
|
If all of
the warrants are exercised at their reduced exercise prices, we will receive
gross proceeds of approximately $15.8 million, although there can be no
assurance that any of these warrants will be exercised.
We also
have an additional 758,929 warrants, which may become exercisable at a price of
$1.68 per share if certain conditions are met by June 30, 2010.
- 43
-
Promissory
Notes
The Amended June 2008
Notes
The
Amended June 2008 Notes have an aggregate principal balance of $2,573,301, which
bears interest at a rate of 10% until Amended June 2008 Notes become due and
payable on December 31, 2010. Any amount of principal or interest which is not
paid when due will bear interest at a rate of 12%. We may prepay the entire
amount due under the Amended June 2008 Notes at any time without penalty, upon
15 days prior written notice. Each holder of the Amended June 2008 Notes has the
right to be prepaid any amounts due under his, her or its Amended June 2008
Notes from the proceeds of any future offering we consummate resulting in gross
proceeds of $4,500,000 or more. So long as we have any obligation
under the Amended June 2008 Notes, there are limitations on our ability to: (a)
pay dividends or make other distributions on our capital stock; (b) redeem,
repurchase or otherwise acquire any of our securities; (c) create, incur or
assume any liability for borrowed money (except as is related to the completion
of the construction of our new production facility); (d) sell, lease or
otherwise dispose of any significant portion of its assets; (e) lend money, give
credit or make advances; or (f) assume, guarantee, endorse, contingently agree
to purchase or otherwise become liable upon the obligation of any other person
or entity. It shall be deemed an “Event of Default” under each Amended June 2008
Note if: (a) we fail to pay principal or interest when due on the Amended June
2008 Note; (b) we breach any material covenant or other material term or
condition contained in the Amended June 2008 Note or securities purchase
agreement entered into in connection with the June 2008 Offering, as amended
(the “June Purchase Agreement”), and such breach continues for a period of
thirty (30) days after written notice thereof; (c) any representation or
warranty we made under the Amended June 2008 Notes or the June Purchase
Agreement shall be false or misleading in any material respect; (d) we, or any
subsidiary of ours, shall make an assignment for the benefit of creditors, or
apply for or consent to the appointment of a receiver or trustee, or such a
receiver or trustee shall otherwise be appointed; (e) a money judgment shall be
entered against us, or any subsidiary of ours, for more than $250,000, that
remains in effect for a period of twenty (20) days; (f) bankruptcy, insolvency,
reorganization or liquidation proceedings or other similar proceedings shall be
instituted by or against us, or any subsidiary of ours, which are not dismissed
within sixty (60) days; or (g) we fail to maintain the listing of our common
stock on at least one of the OTCBB, the Nasdaq National Market, the Nasdaq
SmallCap Market, the New York Stock Exchange, or the NYSE Amex Equities. Upon
the occurrence of any Event of Default under a Amended June 2008 Note, unless
such Event of Default shall have been waived in writing by the holder, the
holder may consider the Amended June 2008 Note immediately due and payable,
without presentment, demand, protest or notice of any kind, and the holder may
immediately enforce any and all of its rights and remedies provided in the June
2008 Note or any other right or remedy afforded by law. Our repayment
of amounts due under the Amended June 2008 Notes is secured by a pledge of an
aggregate of 3,157,425 shares of our common stock of the Company beneficially
owned by Yang Yong Shan, our Chairman, Chief Executive Officer and
President.
The Amended November 2008
Note
The
Amended November 2008 Note has a principal balance of $500,000, and bears
interest at a rate of 10% until it becomes due and payable on May 10,
2010. The holder of the Amended November 2008 Note has the right to
be prepaid any amounts due under his Amended November 2008 Note from the
proceeds of any future offering we consummate resulting in gross proceeds of
$6,500,000 or more. Otherwise, the terms and conditions of the
Amended November 2008 Note are substantially similar to those of the Amended
June 2008 Notes.
The Term Loan
Note
The Term Loan Note has a principal
balance of $1,750,000. The interest rate on the Term Loan Note is 10%
per annum and is payable on maturity. The Term Loan Note has a stated maturity
date of November 30, 2010. Upon the maturity of the Term Loan Note,
by acceleration or otherwise, interest on unpaid amounts shall thereafter be
payable at the rate of 12% per annum (“Default Interest”), until the obligation
is paid in full. Any regular interest or Default Interest not paid
when due under the Term Loan Note shall be added to the principal of the Term
Loan Note. We may from time-to-time prepay any amount due under the
Term Loan Note, in whole or in part, without penalty. The entire
unpaid principal balance, together with accrued interest, shall become due and
payable, without presentment, demand, protest, notice of protest or other notice
of dishonor of any kind upon the occurrence of an “Event of Default,” as defined
in our Loan Agreement with the Lender.
The December 2009
Notes
The December 2009 Notes have an
aggregate principal balance of $1,750,000. The December 2009 Notes
bear interest at a rate of 10% until due and payable on December 24,
2010. Any amount of principal or interest which is not paid when due
will bear interest at a rate of 15% per annum. We may prepay the
entire amount due under the December 2009 Notes at any time without penalty,
upon 15 days prior written notice; provided, however, in such event the December
2009 Noteholders will be entitled to retain an amount of prepaid interest equal
to the greater of (i) the amount accrued as of the prepayment date, and (ii) an
aggregate of $105,000. The December 2009 Noteholders have the right
to be prepaid any amounts due under the December 2009 Notes should we consummate
certain additional offerings of equity or debt securities. So long as
we have any obligation under the December 2009 Notes, there are limitations on
our ability to: (a) pay dividends or make other distributions on our capital
stock; (b) redeem, repurchase or otherwise acquire any of our securities; (c)
create, incur or assume any liability for borrowed money; (d) sell, lease or
otherwise dispose of any significant portion of our assets; (e) lend money, give
credit or make advances; or (f) assume, guarantee, endorse, contingently agree
to purchase or otherwise become liable upon the obligation of any other person
or entity. The entire unpaid principal balance, together with accrued interest,
shall become due and payable, without presentment, demand, protest, notice of
protest or other notice of dishonor of any kind upon the occurrence of an “Event
of Default,” as defined in the December 2009 Notes. Our repayment of
amounts due under the December 2009 Notes is secured by a pledge of an aggregate
of 5,883,329 shares of our common stock beneficially owned by Yang Yong Shan,
our Chairman, Chief Executive Officer and President.
- 44
-
Dividends
We have
not paid any dividends. In all likelihood, we will use our earnings to develop
our business and do not intend to declare dividends for the foreseeable future.
Any decision to pay dividends on our common stock in the future will be made by
our board of directors on the basis of earnings, financial requirements and
other such conditions that may exist at that time. In addition, the
Notes we issued in the Note Offering, further described in “— Recent
Developments — Sale of Notes and Warrants” above, contain restrictive covenants
on our payment of dividends, as further described in “Description of Securities
— Promissory Notes” above.
Contractual
Obligations and Commercial Commitments
Our contractual obligations, as of
December 31, 2009, were as follows:
Payments Due By Period
|
||||||||||||||||||||
Contractual obligations
|
Total
|
Less than
1 year
|
1-3 years
|
3-5 years
|
More than
5 years
|
|||||||||||||||
Equipment
purchase
|
$
|
1,590,304
|
$
|
1,590,304
|
—
|
—
|
—
|
|||||||||||||
Debt
Obligations
|
7,258,451
|
7,258,451
|
—
|
—
|
—
|
|||||||||||||||
Operating
leases
|
276,256
|
157,328
|
118,928
|
—
|
—
|
|||||||||||||||
Total:
|
$
|
9,125,011
|
$
|
9,006,083
|
118,928
|
—
|
—
|
Critical
Accounting Policies and Estimates
We have
established various accounting policies that govern the application of
accounting principles generally accepted in the U.S., which were utilized in the
preparation of our financial statements. Certain accounting policies
involve significant judgments and assumptions by management that have a material
impact on the carrying value of certain assets and
liabilities. Management considers such accounting policies to be
critical accounting policies. The judgments and assumptions used by
management are based on historical experience and other factors, which are
believed to be reasonable under the circumstances. Because of the
nature of the judgments and assumptions made by management, actual results could
differ from these judgments and estimates, which could have a material impact on
the carrying values of assets and liabilities and the results of
operations.
While our
significant accounting policies are more fully described in Note 3 to our
financial statements included in this Annual Report on Form 10-K for the year
ended December 31, 2009, we believe that the following accounting policies are
the most critical to aid you in fully understanding and evaluating our reported
financial results and affect the more significant judgments and estimates that
we use in the preparation of our financial statements.
Long
Lived Assets
Our
long-lived assets and other assets (consisting of property and equipment and
purchased intangible assets) are reviewed for impairment in accordance with the
guidance of the FASB Topic ASC 360, “Property, Plant, and
Equipment”, and FASB ASC Topic 205 “ Presentation of Financial
Statements ”. We test for impairment losses on long-lived
assets used in operations whenever events or changes in circumstances indicate
that the carrying amount of the asset may not be recoverable.
Recoverability of an asset to be held and used is measured by a comparison
of the carrying amount of an asset to the future undiscounted cash flows
expected to be generated by the asset. If such asset is considered to be
impaired, the impairment to be recognized is measured by the amount by which the
carrying amount of the asset exceeds its fair value. Impairment
evaluations involve management’s estimates on asset useful lives and future cash
flows. Actual useful lives and cash flows could be different from
those estimated by management which could have a material effect on our
reporting results and financial positions. Fair value is determined
through various valuation techniques including discounted cash flow models,
quoted market values and third-party independent appraisals, as considered
necessary. Through December 31, 2009, we had not experienced impairment
losses on our long-lived assets. However, there can be no assurances that demand
for our products or services will continue, which could result in an impairment
of long-lived assets in the future.
- 45
-
Revenue
Recognition
Revenue
is recognized in when the following criteria are met: (1) persuasive
evidence of an arrangement exists; (2) the service has been rendered;
(3) the selling price is fixed or determinable; and (4) collection of
the resulting receivable is reasonably assured.
Interest
income is recognized when earned, taking into account the average principal
amounts outstanding and the interest rates applicable.
As of
December 31, 2009, we had no sales or contracts that included multiple
deliverables that would fall under accounting guidance.
Freestanding
Financial Instruments with Characteristics of Both Liabilities and
Equity
In
accordance with accounting guidance FASB Topic ASC 825, we account for financial
instruments as a liability if it embodies an obligation to repurchase the
issuer’s equity shares, or is indexed to such an obligation, and that requires
or may require the issuer to settle the obligation by transferring
assets. Freestanding financial instruments are financial instruments
that are entered into separately and apart from any of the entity's other
financial instruments or equity transactions, or that is entered into in
conjunction with some other transaction and is legally detachable and separately
exercisable. As of December 31, 2009 and 2008, there were no
financial instruments recorded as liability.
Share-based
compensation
For
purposes of determining the variables used in the calculation of stock
compensation expense under the provisions of FASB ASC Topic 505, “Equity ” and
FASB ASC Topic 718, “Compensation — Stock Compensation,” we perform an analysis
of current market data and historical company data to calculate an estimate of
implied volatility, the expected term of the option and the expected forfeiture
rate. With the exception of the expected forfeiture rate, which is not an input,
we use these estimates as variables in the Black-Scholes option pricing model.
Depending upon the number of stock options granted, any fluctuations in these
calculations could have a material effect on the results presented in our
consolidated statement of income and other comprehensive income. In addition,
any differences between estimated forfeitures and actual forfeitures could also
have a material impact on our financial statements.
There was
$265,825 and $0 share-based compensation in the years ended December 31, 2009
and 2008.
Recent accounting
pronouncements
Refer to
Note 3 to the Financial Statements included in Item 8 of this Annual Report on
Form 10-K, which discusses new accounting pronouncements we adopted during 2009,
as well as accounting pronouncements recently issued or proposed but not yet
required to be adopted.
Off-Balance
Sheet Arrangements
We are
not a party to any off-balance sheet arrangements.
- 46
-
Item
7A. Quantitative and Qualitative Disclosures About Market
Risk
We are a smaller reporting company as
defined by Rule 12b-2 of the Exchange Act and are not required to provide the
information under this item.
Item
8. Financial Statements and Supplementary Data.
Financial Statements for the years
ended December 31, 2009 and 2008 (see pages F-1 through F-43
hereof).
- 47
-
EMERALD
DAIRY INC.
CONSOLIDATED
FINANCIAL STATEMENTS
December
31, 2009
CONTENTS
Independent
Auditors’ Report of Windes & McClaughry Accountancy
Corporation
|
F-2
|
|
Consolidated
Balance Sheet
|
F-3
|
|
Consolidated
Statements of Operations
|
F-4
|
|
Consolidated
Statements of Changes in Stockholders’ Equity and Accumulated Other
Comprehensive Income
|
F-5
|
|
Consolidated
Statements of Cash Flows
|
F-6
|
|
Footnotes
to Consolidated Financial Statements
|
F-7
- F-43
|
F-1
REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the
Board of Directors and
Stockholders
of Emerald Dairy, Inc.:
We have
audited the accompanying consolidated balance sheets of Emerald Dairy, Inc. and
subsidiaries as of December 31, 2009 and 2008, and the related consolidated
statements of income, stockholders’ equity and accumulated other comprehensive
income and cash flows for each of the years in the two-year period ended
December 31, 2009. Emerald Dairy, Inc’s management is responsible for these
consolidated financial statements. Our responsibility is to express an opinion
on these consolidated financial statements based on our audits.
We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. The company is not required to have,
nor were we engaged to perform, an audit of its internal control over financial
reporting. Our audit included consideration of internal control over financial
reporting as a basis for designing audit procedures that are appropriate in the
circumstances, but not for the purpose of expressing an opinion on the
effectiveness of the company’s internal control over financial reporting.
Accordingly, we express no such opinion. An audit also includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements, assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our
opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the financial position of Emerald Dairy, Inc. and
subsidiaries as of December 31, 2009 and 2008, and the results of their
operations and their cash flows the each of the years in the two-year period
ended December 31, 2009, in conformity with accounting principles generally
accepted in the United States of America.
/s/
Windes & McClaughry
Windes
& McClaughry Accountancy Corporation
Long
Beach, California
March 31,
2010
F-2
Emerald
Dairy Inc. and Subsidiaries
Consolidated
Balance Sheet
December
31, 2009
December 31,
|
December 31,
|
|||||||
2009
|
2008
|
|||||||
ASSETS
|
||||||||
Current
Assets
|
||||||||
Cash
and cash equivalents
|
$ | 13,486,429 | $ | 7,343,588 | ||||
Trade
accounts receivable,net
|
7,223,016 | 6,146,228 | ||||||
Inventory,
net
|
1,298,488 | 883,233 | ||||||
Advances
to equipment supplier
|
3,710,707 | 3,712,883 | ||||||
Advances
to suppliers and other receivables
|
1,221,151 | 549,835 | ||||||
Deposits
|
71,598 | 74,614 | ||||||
Total
current assets
|
27,011,389 | 18,710,381 | ||||||
Property,
plant and equipment
|
||||||||
Property,
plant and equipment, net
|
5,946,330 | 6,101,566 | ||||||
Contruction
in progress
|
8,772,931 | 2,482,339 | ||||||
14,719,261 | 8,583,905 | |||||||
Intangible
assets, net
|
1,341,534 | 1,380,089 | ||||||
$ | 43,072,184 | $ | 28,674,375 | |||||
LIABILITIES
AND STOCKHOLDERS' EQUITY
|
||||||||
Current
Liabilities
|
||||||||
Accounts
payable
|
$ | 2,308,866 | $ | 3,264,066 | ||||
Accrued
expenses
|
608,932 | 1,387,881 | ||||||
Notes
payable, net of debt discount of $729,830 and $87,888 at December 31, 2009
and 2008, respectively
|
5,843,472 | 2,662,112 | ||||||
Advances
from employees
|
- | 248,424 | ||||||
Taxes
payable
|
704,056 | 480,435 | ||||||
Loan
from shareholder
|
210,142 | 210,265 | ||||||
Total
current liabilities
|
9,675,468 | 8,253,183 | ||||||
Commitments
and Contingencies (Note 21)
|
||||||||
Stockholders'
Equity
|
||||||||
Preferred
stock ($0.001 par value, 10,000,000 shares authorized, none issued and
outstanding at December 31, 2009 and 2008)
|
- | - | ||||||
Common
stock ($0.001 par value, 100,000,000 shares authorized, 34,890,267 and
31,243,776 issued and outstanding at December 31, 2009 and 2008,
respectively)
|
34,890 | 31,244 | ||||||
Treasury
Stock (1,944,444 shares at December 31, 2009 and 2008,
respectively)
|
(1,944 | ) | (1,944 | ) | ||||
Additional
paid-in capital
|
17,003,093 | 8,225,922 | ||||||
Retained
earnings (of which $1,834,742 and $1,314,861 are restricted at December
31, 2009 and 2008, respectively, for common welfare
reserves)
|
14,318,425 | 10,106,402 | ||||||
Accumulated
other comprehensive income
|
2,042,252 | 2,059,568 | ||||||
Total
stockholders' equity
|
33,396,716 | 20,421,192 | ||||||
$ | 43,072,184 | $ | 28,674,375 |
The
accompanying notes are an integral part of these consolidated financial
statements.
F-3
Emerald
Dairy Inc. and Subsidiaries
Consolidated
Statements of Operations
For
the Years Ended December 31, 2009 and 2008
2009
|
2008
|
|||||||
Sales
|
$ | 44,729,276 | $ | 44,325,179 | ||||
Cost
of Goods Sold
|
24,056,601 | 26,546,291 | ||||||
Gross
Profit
|
20,672,675 | 17,778,888 | ||||||
Operating
Expenses
|
||||||||
Selling
expenses
|
10,047,861 | 10,602,185 | ||||||
Administrative
expenses
|
3,271,892 | 3,494,733 | ||||||
Depreciation
and amortization
|
178,281 | 113,660 | ||||||
Total
operating expenses
|
13,498,034 | 14,210,578 | ||||||
Other
Income (Expense)
|
||||||||
Interest
income
|
6,187 | 13,041 | ||||||
Interest
expense
|
(236,226 | ) | (426,646 | ) | ||||
Loss
on extinguishment of debt
|
(1,405,052 | ) | - | |||||
Total
other income (expense)
|
(1,635,091 | ) | (413,605 | ) | ||||
Net
Income Before Provision for Income Tax
|
5,539,550 | 3,154,705 | ||||||
Provision
for Income Taxes
|
||||||||
Current
|
1,327,527 | 840,198 | ||||||
1,327,527 | 840,198 | |||||||
Net
Income
|
$ | 4,212,023 | $ | 2,314,507 | ||||
Basic
Earnings Per Share
|
$ | 0.14 | $ | 0.08 | ||||
Basic
Weighted Average Shares Outstanding
|
30,661,333 | 29,299,332 | ||||||
Diluted
Earnings Per Share
|
$ | 0.14 | $ | 0.08 | ||||
Diluted
Weighted Average Shares Outstanding
|
31,001,248 | 29,518,067 | ||||||
The
Components of Other Comprehensive Income
|
||||||||
Net
Income
|
$ | 4,212,023 | $ | 2,314,507 | ||||
Foreign
currency translation adjustment
|
(26,236 | ) | 1,767,982 | |||||
Income
tax related to other comprehensive income
|
8,920 | (601,114 | ) | |||||
Comprehensive
Income
|
$ | 4,194,707 | $ | 3,481,375 |
The
accompanying notes are an integral part of these consolidated financial
statements.
F-4
Emerald
Dairy Inc. and Subsidiaries
Consolidated
Statements of Stockholders' Equity and Accumulated Other Comprehensive
Income
For
the Years Ended December 31, 2009 and 2008
Common
Stock
|
Accumulated
|
|||||||||||||||||||||||||||
Number
|
Additional
|
Other
|
Total
|
|||||||||||||||||||||||||
of
|
Par
|
Treasury
|
Paid-In
|
Retained
|
Comprehensive
|
Stockholders'
|
||||||||||||||||||||||
Shares
|
Value
|
Stock
|
Capital
|
Earnings
|
Income
|
Equity
|
||||||||||||||||||||||
Balance
at December 31, 2007
|
31,241,276 | $ | 31,241 | $ | (1,944 | ) | $ | 4,666,244 | $ | 7,791,895 | $ | 892,700 | $ | 13,380,136 | ||||||||||||||
Transfer
agent correction of shares
|
2,500 | 3 | - | (3 | ) | - | - | - | ||||||||||||||||||||
Warrants
issued as loan discount
|
- | - | - | 305,163 | - | - | 305,163 | |||||||||||||||||||||
Warrants
issued for issuance costs
|
- | - | - | 85,074 | - | - | 85,074 | |||||||||||||||||||||
Termination
of Put/Call agreement
|
3,169,444 | 3,169,444 | ||||||||||||||||||||||||||
Foreign
currency translation adjustment, net of tax
|
- | - | - | - | - | 1,166,868 | 1,166,868 | |||||||||||||||||||||
Net
income for the year ended December 31, 2008
|
- | - | - | - | 2,314,507 | - | 2,314,507 | |||||||||||||||||||||
Balance
at December 31, 2008
|
31,243,776 | 31,244 | (1,944 | ) | 8,225,922 | 10,106,402 | 2,059,568 | 20,421,192 | ||||||||||||||||||||
Warrants
exercised
|
2,614,222 | 2,614 | - | 4,430,977 | - | - | 4,433,591 | |||||||||||||||||||||
Stock
option expense
|
- | - | - | 265,825 | - | - | 265,825 | |||||||||||||||||||||
Stock
issued for services
|
256,436 | 256 | - | 426,048 | - | - | 426,304 | |||||||||||||||||||||
Stock
issued for liquidated damages
|
775,833 | 776 | - | 1,374,111 | - | - | 1,374,887 | |||||||||||||||||||||
Warrants
issued for services
|
- | - | - | 302,083 | - | - | 302,083 | |||||||||||||||||||||
Warrants
issued as loan discount
|
- | - | - | 1,974,152 | - | - | 1,974,152 | |||||||||||||||||||||
Modifcation
of warrants
|
- | - | - | 3,975 | - | - | 3,975 | |||||||||||||||||||||
Foreign
currency translation adjustment, net of tax
|
- | - | - | - | - | (17,316 | ) | (17,316 | ) | |||||||||||||||||||
Net
income for the Year ended
|
- | - | ||||||||||||||||||||||||||
December
31, 2009
|
- | - | - | - | 4,212,023 | - | 4,212,023 | |||||||||||||||||||||
Balance
at December 31, 2009
|
34,890,267 | $ | 34,890 | $ | (1,944 | ) | $ | 17,003,093 | $ | 14,318,425 | $ | 2,042,252 | $ | 33,396,716 |
The
accompanying notes are an integral part of these consolidated financial
statements.
F-5
Emerald
Dairy Inc. and Subsidiaries
Consolidated
Statements of Cash Flows
For
the Years Ended December 31, 2009 and 2008
2009
|
2008
|
|||||||
Cash
flows from operating activities
|
||||||||
Net
Income
|
$ | 4,212,023 | $ | 2,314,507 | ||||
Adjustments
to reconcile net cash provided by operating activities
|
||||||||
Depreciation
and amortization
|
538,626 | 438,521 | ||||||
Amortization
of loan discount
|
102,159 | 217,275 | ||||||
Loss
on extinquishment of debt
|
1,405,052 | - | ||||||
Capitalized
interest
|
(552,683 | ) | (89,868 | ) | ||||
Stock
issued for services
|
66,304 | - | ||||||
Warrants
modified for services
|
3,975 | - | ||||||
Warrants
issued for loan costs
|
302,083 | - | ||||||
Incentive
stock options
|
265,825 | - | ||||||
Net
change in assets and liabilities
|
||||||||
Trade
accounts receivable
|
(1,080,391 | ) | (716,373 | ) | ||||
Inventory
|
(415,773 | ) | 182,562 | |||||
Advances
to suppliers and other receivables
|
(311,638 | ) | 346,398 | |||||
Deposits
|
2,972 | 1,459,633 | ||||||
Accounts
payable
|
(953,286 | ) | 998,946 | |||||
Accrued
expenses
|
920,053 | 1,101,309 | ||||||
Advances
from employees
|
(248,278 | ) | (72,929 | ) | ||||
Taxes
payable
|
223,903 | 146,629 | ||||||
Net
cash provided by operating activities
|
4,480,926 | 6,326,610 | ||||||
Cash
flows from investing activities
|
||||||||
Deposit
on equipment purchase
|
- | (3,712,883 | ) | |||||
Construction
in progress
|
(5,739,364 | ) | (2,392,471 | ) | ||||
Purchases
of fixed assets and intangibles
|
(349,244 | ) | (2,411,832 | ) | ||||
Net
cash used in investing activities
|
(6,088,608 | ) | (8,517,186 | ) | ||||
Cash
flows from financing activities
|
||||||||
- | - | |||||||
Exercise
of warrants
|
4,433,591 | - | ||||||
Repayments
of notes payable
|
- | (291,874 | ) | |||||
Advances
on notes payable
|
3,325,000 | 2,750,000 | ||||||
Net
cash provided by (used in) financing activities
|
7,758,591 | 2,458,126 | ||||||
Effect
of exchange rate
|
(8,068 | ) | 515,107 | |||||
Net
increase in cash
|
6,142,841 | 782,657 | ||||||
Cash
and cash equivalents at beginning of period
|
7,343,588 | 6,560,931 | ||||||
Cash
and cash equivalents at end of period
|
$ | 13,486,429 | $ | 7,343,588 | ||||
Supplemental
disclosure of cash flow information
|
||||||||
Interest
paid
|
$ | - | $ | 1,295 | ||||
Enterprise
incomes taxes paid
|
$ | - | $ | 629,515 | ||||
Supplemental
disclosure of noncash investing and financing activities
|
||||||||
Warrants
issued as loan discount
|
$ | 569,100 | $ | 305,163 | ||||
Warrants
issued as loan issuance costs
|
$ | 302,083 | $ | 85,074 | ||||
Warrants
issued on extinguishment of debt
|
$ | 1,405,052 | $ | - | ||||
Stock
issued for services
|
$ | 426,304 | $ | - |
The
accompanying notes are an integral part of these consolidated financial
statements.
F-6
Emerald
Dairy Inc. and Subsidiaries
Footnotes
to Consolidated Financial Statements
December
31, 2009 and 2008
1. Description of
Business
Emerald
Dairy, Inc. (the “Company”), a Nevada corporation, is a producer of milk powder,
rice powder and soybean milk powder in the People’s Republic of China (“PRC”)
through its wholly owned subsidiaries.
American
International Dairy Holdings, Inc. (“AIDH”), a Nevada corporation, was formed in
2005 for the purpose of acquiring the stock in Heilongjiang Xing An Ling Dairy,
Co. On May 30, 2005, AIDH, pursuant to the Share Transfer Agreement acquired
Heilongjiang Xing An Ling Dairy Co. Limited, (“XAL”) a corporation formed on
September 8, 2003 in Heilongjiang Providence, PRC. This transaction was treated
as a recapitalization of XAL for financial reporting purposes. The effect of
this recapitalization was rolled back to the inception of XAL for financial
reporting purposes.
XAL is a
dairy company engaged in manufacturing of milk, soybean and rice powder. Through
the Company’s network of over 800 salespeople, the Company’s products are
distributed throughout 20 provinces in the People’s Republic of China, and sold
in over 5,800 retail outlets.
Prior to
September 23, 2006, XAL owned 57.7% of Heilongjiang Be’ian Nongken Changxing
LvBao Dairy Limited Liability Company (“LvBao”) with the remaining balance being
held by the Company’s sole shareholder. On September 23, 2006, the remaining
42.3% ownership in LvBao was transferred to XAL and was treated as an additional
capital contribution. The effect of this contribution by the sole shareholder
was rolled back to September 8, 2003 for financial reporting purposes. LvBao was
formed on January 20, 2000 and is engaged in manufacturing and sales of
dairy products.
On
May 22, 2008, the Company formed a new wholly-owned subsidiary,
Hailun Xinganling Dairy Co., Ltd. (“HXD”), under the laws of the
PRC. In July 2008, HXD commenced construction of a production
facility in Hailun City, Heilongjiang Province, PRC. It is
anticipated that HXD will engage in the manufacture of the Company's milk,
soybean and rice powder products at this new facility.
2. Basis of Preparation of Financial
Statements
XAL,
LvBao and HXD maintain their books and accounting records in Renminbi
(“RMB”).
In June
2009, the Financial Accounting Standards Board (“FASB”) issued Statement of
Financial Accounting Standard (“SFAS”) No. 168, The FASB Accounting Standards
Codification and the Hierarchy of Generally Accepted Accounting Principles, a
replacement of FASB Statement No. 162 . This statement modifies the
Generally Accepted Accounting Principles (“GAAP”) hierarchy by establishing only
two levels of GAAP, authoritative and nonauthoritative accounting literature.
Effective July 2009, the FASB Accounting Standards Codification (“ASC”), also
known collectively as the “Codification,” is considered the single source of
authoritative U.S. accounting and reporting standards, except for additional
authoritative rules and interpretive releases issued by the SEC.
Nonauthoritative guidance and literature would include, among other things, FASB
Concepts Statements, American Institute of Certified Public Accountants Issue
Papers and Technical Practice Aids and accounting textbooks. The Codification
was developed to organize GAAP pronouncements by topic so that users can more
easily access authoritative accounting guidance. It is organized by topic,
subtopic, section, and paragraph, each of which is identified by a numerical
designation. This statement applies beginning in third quarter
2009. All accounting references have been updated, and therefore SFAS
references have been replaced with ASC references.
The
Company operates in one operating segment in accordance with accounting guidance
FASB ASC Topic 280, “Segment
Reporting.” Our CEO has been identified as the chief operating
decision maker as defined by FASB ASC Topic 280.
The
financial statements have been prepared in order to present the consolidated
financial position and consolidated results of operations in accordance with
accounting principles generally accepted in the United States of America (“US
GAAP”) and are expressed in terms of US dollars (see paragraph “Foreign
Currency” below).
F-7
Emerald
Dairy Inc. and Subsidiaries
Footnotes
to Consolidated Financial Statements
December
31, 2009 and 2008
2. Basis of Preparation of Financial
Statements (Continued)
The
consolidated financial statements include the accounts of the Company and its
wholly owned subsidiaries, AIDH, XAL, LvBao and HXD. All inter-company
transactions and balances have been eliminated in consolidation.
Effective
beginning second quarter 2009, the FASB Topic 810, “Consolidation Topic”, revised
the accounting treatment for noncontrolling minority interests of
partially-owned subsidiaries. Noncontrolling minority interests
represent the portion of earnings that is not within the parent company’s
control. These amounts are now required to be reported as equity instead of as a
liability on the balance sheet. In addition this statement requires net
income from noncontrolling minority interest to be shown separately on the
consolidated statements of operations and comprehensive income. As
the Company has no noncontrolling interest at December 31, 2009, this change did
not have an impact on the Company’s consolidated financial
statements.
3. Summary of Significant Accounting
Policies
Use of Estimates - The
preparation of these consolidated financial statements in conformity with
accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the dates of the consolidated financial statements and the
reported amounts of net sales and expenses during the reported
periods.
Significant
estimates and assumptions by management include, among others, values and lives
assigned to acquired intangible assets, reserves for customer returns and
allowances, uncollectible accounts receivable, slow moving, obsolete and/or
damaged inventory, deferred tax assets, property, plant and equipment, reserve
for employee benefit obligations, stock warrant valuation, income tax
uncertainties and other uncertainties. Actual results may differ from these
estimates. The current economic environment has increased the degree
of uncertainty inherent in these estimates and assumptions.
Cash and Cash Equivalents -
Cash and cash equivalents represent cash on hand, demand deposits and all
highly liquid investments placed with banks or other financial institutions with
original maturities of three months or less. Substantially all of the Company’s
cash is held in bank accounts in the PRC and is not protected by FDIC insurance
or any other similar insurance. Accounts held at United States financial
institutions are insured by the Federal Deposit Insurance Corporation (“FDIC”)
up to $250,000. As of December 31, 2009, $161,628 in U.S. balances are in excess
of insured amounts. Given the current economic environment and risks in the
banking industry, there is a risk that the deposits may not be readily available
or covered by such insurance.
Inventory - Inventory is
stated at the lower of cost or market. Cost is determined using the weighted
average method. Market value represents the estimated selling price in the
ordinary course of business less the estimated costs necessary to complete the
sale.
Raw
materials consist of raw milk, soybeans, rice and rice powder. Work in process
consists of materials and products in process of conversion to powder but not
yet packaged.
The cost
of inventory comprises all costs of purchases, costs of conversion and other
costs incurred in bringing the inventory to its present location and condition.
The costs of conversion of inventory include fixed and variable production
overheads, taking into account the stage of completion.
F-8
Emerald
Dairy Inc. and Subsidiaries
Footnotes
to Consolidated Financial Statements
December
31, 2009 and 2008
3. Summary of Significant Accounting
Policies (Continued)
Trade Accounts Receivable -
Trade accounts receivable are recorded at the invoiced amount and do not
bear interest. Amounts collected on trade accounts receivable are included in
net cash provided by operating activities in the consolidated statements of cash
flows. The Company maintains an allowance for doubtful accounts for estimated
losses inherent in its accounts receivable portfolio. In establishing the
required allowance, management considers historical losses, current receivables
aging, and existing industry and PRC economic data. The Company reviews its
allowance for doubtful accounts monthly. Past due balances over 90 days and over
a specified amount are reviewed individually for collectibility. Account
balances are charged off against the allowance after all means of collection
have been exhausted and the potential for recovery is considered remote. At
December 31, 2009 and 2008 there was no allowance for doubtful accounts based on
the review of the above factors. There were no write-off’s for 2009 and 2008,
respectively. The Company does not have any off-balance-sheet credit exposure
related to its customers.
Advances to Suppliers - In
order to insure a steady supply of raw materials, the Company is required from
time to time to make cash advances when placing its purchase
orders.
Property and Equipment -
Property and equipment is stated at the historical cost, less accumulated
depreciation. Depreciation on property, plant, and equipment is provided using
the straight-line method over the estimated useful lives of the assets after
taking into account any salvage value as follows:
Buildings
|
30
years
|
|
Communication
equipment, plant and machinery
|
10
- 30 years
|
|
Motor
vehicles
|
10
years
|
|
Dairy
cows
|
5
years
|
|
Furniture,
Fixtures, and Equipment
|
5 -
10 years
|
Expenditures
for renewals and betterments are capitalized, while repairs and maintenance
costs are normally charged to the statement of operations in the year in which
they are incurred. In situations where it can be clearly demonstrated that the
expenditure has resulted in an increase in the future economic benefits expected
to be obtained from the use of the asset, the expenditure is capitalized as an
additional cost of the asset.
Upon sale
or disposal of an asset, the historical cost and related accumulated
depreciation or amortization of such asset were removed from their respective
accounts and any gain or loss is recorded in the statements of
operations.
Intangible Assets - Intangible
assets consist of land use rights acquired by the Company and are amortized on a
straight line basis over the lives of the rights agreements, which is fifty
years and purchased patents which are amortized on a straight line basis over
the remaining life of the patents which is five years.
Long Lived Assets - The
Company’s long-lived assets and other assets (consisting of property and
equipment and purchased intangible assets) are reviewed for impairment in
accordance with the guidance of the FASB Topic ASC 360, “Property, Plant, and
Equipment”, and FASB ASC Topic 205 “ Presentation of Financial
Statements ”. The Company tests for impairment losses on
long-lived assets used in operations whenever events or changes in circumstances
indicate that the carrying amount of the asset may not be recoverable.
Recoverability of an asset to be held and used is measured by a comparison of
the carrying amount of an asset to the future undiscounted cash flows expected
to be generated by the asset. If such asset is considered to be impaired, the
impairment to be recognized is measured by the amount by which the carrying
amount of the asset exceeds its fair value. Impairment evaluations involve
management’s estimates on asset useful lives and future cash
flows. Actual useful lives and cash flows could be different from
those estimated by management which could have a material effect on our
reporting results and financial positions. Fair value is determined
through various valuation techniques including discounted cash flow models,
quoted market values and third-party independent appraisals, as considered
necessary. Through December 31, 2009, the Company had not experienced impairment
losses on its long-lived assets. However, there can be no assurances that demand
for the Company’s products or services will continue, which could result in an
impairment of Long-Lived assets in the future.
F-9
Emerald
Dairy Inc. and Subsidiaries
Footnotes
to Consolidated Financial Statements
December
31, 2009 and 2008
3. Summary of Significant Accounting
Policies (Continued)
Construction-in-Progress -
Plant and production lines currently under development are accounted for as
construction-in-progress. Construction-in-progress is recorded at acquisition
cost, including land rights cost, development expenditure, professional fees and
the interest expenses capitalized during the course of construction for the
purpose of financing the project. Upon completion and readiness for use of the
project, the cost of construction-in-progress is to be transferred to fixed
assets, at which time depreciation will commence. As of December 31, 2009, the
Company has incurred and capitalized into construction-in-progress $8,130,380 of
construction costs and $642,551 of capitalized interest. The
estimated cost to be incurred in 2010 to complete the project is approximately
$7,228,000.
Capitalized Interest – The
Company’s policy is to capitalize interest costs on debt during the construction
of major projects exceeding one year. A reconciliation of total
interest cost to interest expense as reported in the consolidated statements of
income for 2009 and 2008 is as follows:
2009
|
2008
|
|||||||
Interest
cost capitalized
|
$
|
552,683
|
$
|
89,868
|
||||
Interest
cost charged to income
|
236,226
|
426,646
|
||||||
$
|
788,909
|
$
|
516,514
|
Foreign Currency - The
Company’s principal country of operations is The People’s Republic of China. The
financial position and results of operations of the Company are determined using
the local currency (“Renminbi” or “Yuan”) as the functional currency. The
results of operations denominated in foreign currency are translated at the
average rate of exchange during the reporting period.
Assets
and liabilities denominated in foreign currencies at the balance sheet date are
translated at the exchange rates prevailing at the balance sheet date. The
registered equity capital denominated in the functional currency is translated
at the historical rate of exchange at the time of capital contribution. All
translation adjustments resulting from the translation of the financial
statements into the reporting currency (“US Dollars”) are dealt with as a
separate component within stockholders’ equity. Translation adjustments net of
tax totaled $(17,316) and $1,166,868, for the years ended December 31, 2009 and
2008, respectively.
As of
December 31, 2009 and 2008, the exchange rate was 6.827 Yuan and 6.823 Yuan per
U.S. Dollar, respectively.
Revenue Recognition - Revenue
is recognized in when the following criteria are met: (1) persuasive
evidence of an arrangement exists; (2) the service has been rendered;
(3) the selling price is fixed or determinable; and (4) collection of
the resulting receivable is reasonably assured.
Interest
income is recognized when earned, taking into account the average principal
amounts outstanding and the interest rates applicable.
As of
December 31, 2009, the Company has no sales or contracts that included multiple
deliverables that would fall under accounting guidance.
Sales Returns - The Company
does not allow return of products except for unsold products after expiration
date and for products that were damaged during shipment. The total amount of
returned product is less than 0.05% of total sales. The cost of unsold products
and damaged products are netted against sales and cost of goods sold,
respectively.
Research and Development Costs
– Research and development costs are expenses as
incurred.
F-10
Emerald
Dairy Inc. and Subsidiaries
Footnotes
to Consolidated Financial Statements
December
31, 2009 and 2008
3. Summary of Significant Accounting
Policies (Continued)
Advertising - The Company
expenses advertising costs the first time the respective advertising takes
place. These costs were included in selling expenses. The total advertising
expenses incurred for the years ended December 31, 2009 and 2008 were $984,907
and $3,438,187, respectively.
Product Display Fees -
The Company has entered into a number of agreements with the resellers of its
products, whereby the Company pays the reseller an agreed upon amount to display
its products. The Company has reduced sales by the amounts paid under these
agreements. For the years ended December 31, 2009 and 2008, these totaled
$1,566,726 and $1,339,735, respectively.
Shipping and Handling Costs -
The Company's shipping and handling costs are included in cost of sales for all
periods presented.
Earnings Per Share - Basic net
earnings per common stock is computed by dividing net earnings applicable to
common shareholders by the weighted-average number of common stock outstanding
during the period. Diluted net earnings per common stock is determined using the
weighted-average number of common stock outstanding during the period, adjusted
for the dilutive effect of common stock equivalents, using the treasury stock
method, consisting of shares that might be issued upon exercise of common stock
warrants. In periods where losses are reported, the weighted-average number of
common stock outstanding excludes common stock equivalents, because their
inclusion would be anti-dilutive.
Basic
earnings per share is based on the weighted-average number of shares of common
stock outstanding. Earnings per share, assuming dilution, is based on the
weighted-average number of shares of common stock outstanding adjusted for the
effects of common stock that may be issued as a result of the following types of
potentially dilutive instruments:
|
·
|
warrants.,
|
|
·
|
employee
stock options, and
|
|
·
|
other
equity awards, which include long-term incentive
awards.
|
The FASB
Topic ASC 260, “Earnings Per
Share”, requires the Company to include additional shares in the
computation of earnings per share, assuming dilution. The additional
shares included in diluted earnings per share represents the number of shares
that would be issued if all of the Company’s outstanding dilutive instruments
were converted into common stock.
Diluted
earnings per share are based on the assumption that all dilutive options were
converted or exercised. Dilution is computed by applying the treasury stock
method. Under this method, options are assumed to be exercised at the time of
issuance, and as if funds obtained thereby were used to purchase common stock at
the average market price during the period.
Taxation - Taxation on
profits earned in the PRC has been calculated on the estimated assessable
profits for the year at the rates of taxation prevailing in the PRC in which the
Company operates after taking into effect the benefits from any special tax
credits or “tax holidays” allowed in the country of operations.
F-11
Emerald
Dairy Inc. and Subsidiaries
Footnotes
to Consolidated Financial Statements
December
31, 2009 and 2008
3. Summary of Significant Accounting
Policies (Continued)
The
Company accounts for income tax under the provisions of FASB ASC Topic 740, “Income Taxes”, which
requires recognition of deferred tax assets and liabilities for the expected
future tax consequences of the events that have been included in the financial
statements or tax returns. Deferred income taxes are recognized for all
significant temporary differences between tax and financial statements bases of
assets and liabilities. Valuation allowances are established against net
deferred tax assets when it is more likely than not that some portion or all of
the deferred tax asset will not be realized.
The
Company does not have any long-term deferred tax assets or liabilities in China
that will exist once the tax holiday (See Note 12) expires. The Company
does not have any significant deferred tax asset or liabilities that relate to
tax jurisdictions not covered by the tax holiday.
The
Company does not accrue United States income tax on unremitted earnings from
foreign operations, as it is the Company’s intention to invest these earnings in
the foreign operations indefinitely.
Enterprise income
tax
Under the
Provisional Regulations of The People’s Republic of China Concerning Income Tax
on Enterprises promulgated by the State Council which came into effect on
January 1, 1994, income tax is payable by a Wholly Foreign Owned Enterprise at a
rate of 15% of their taxable income. Preferential tax treatment may, however, be
granted pursuant to any law or regulations from time to time promulgated by the
State Council. XAL enjoyed a 100% exemption from enterprise income taxes
starting on January 10, 2006 due to its classification as a “Wholly Foreign
Owned Enterprise. On March 16, 2007, the PRC enacted a new Enterprise Income Tax
Law for the purpose of unifying the tax treatment of domestic and foreign
enterprises. This new law eliminates the preferential tax treatment for new
Wholly Foreign Owned Enterprises but allows previously granted exemptions to
stay in place through 2012, with the exception that the statutory tax rate will
increase by 2% per year from 15% in 2006 to 25% by 2012. This exemption ended on
January 10, 2008, at which time XAL qualified under the current tax structure
for a 50% reduction in the statutory enterprise income tax rates for an
additional three years.
Deferred
tax assets and liabilities are recognized for the future tax consequences
attributable to differences between the financial statement carrying amounts of
existing assets and liabilities and their respective tax basis. Deferred tax
assets, including tax loss and credit carryforwards, and liabilities are
measured using enacted tax rates expected to apply to taxable income in the
years in which those temporary differences are expected to be recovered or
settled. The effect of deferred tax assets and liabilities of a change in tax
rates is recognized in income in the period that includes the enactment date.
Deferred income tax expense represents the change during the period in the
deferred tax assets and deferred tax liabilities. The components of the deferred
tax assets and liabilities are individually classified as current and noncurrent
based on their characteristics. Deferred tax assets are reduced by a valuation
allowance when, in the opinion of management, it is more likely than not that
some portion or all of the deferred tax assets will not be
realized.
A
provision has not been made at December 31, 2009 for U.S. or additional foreign
withholding taxes on approximately $22,212,000 of undistributed earnings of
foreign subsidiaries because it is the present intention of management to
reinvest the undistributed earnings indefinitely in foreign operations.
Generally, such earnings become subject to U.S. tax upon the remittance of
dividends and under certain other circumstances. It is not practicable to
estimate the amount of deferred tax liability on such undistributed
earnings.
F-12
Emerald
Dairy Inc. and Subsidiaries
Footnotes
to Consolidated Financial Statements
December
31, 2009 and 2008
3. Summary of Significant Accounting
Policies (Continued)
In 2006,
the Financial Accounting Standards Board (FASB) issued accounting guidance which
clarified prior accounting guidance by defining a criterion that an individual
income tax position must meet for any part of the benefit of that position to be
recognized in an enterprise’s financial statements and provides guidance on
measurement, derecognition, classification, accounting for interest and
penalties, accounting in interim periods, disclosure and transition. In
accordance with the transition provisions, the Company adopted this accounting
guidance effective January 1, 2007.
The
Company recognizes that virtually all tax positions in the PRC are not free of
some degree of uncertainty due to tax law and policy changes by the PRC.
However, the Company cannot reasonably quantify political risk factors and thus
must depend on guidance issued by current PRC officials.
Based on
all known facts and circumstances and current tax law, the Company believes that
the total amount of unrecognized tax benefits as of December 31, 2009, is not
material to its results of operations, financial condition or cash flows. The
Company also believes that the total amount of unrecognized tax benefits as of
December 31, 2009, if recognized, would not have a material effect on its
effective tax rate. The Company further believes that there are no tax positions
for which it is reasonably possible, based on current Chinese tax law and
policy, that the unrecognized tax benefits will significantly increase or
decrease over the next 12 months producing, individually or in the aggregate, a
material effect on the Company’s results of operations, financial condition or
cash flows. Generally, years beginning after fiscal 2006, the Company is open to
examination by PRC and U.S. taxing authorities.
Value added
tax
The
Provisional Regulations of The People’s Republic of China Concerning Value Added
Tax promulgated by the State Council came into effect on January 1, 1994. Under
these regulations and the Implementing Rules of the Provisional Regulations of
the PRC Concerning Value Added Tax, value added tax is imposed on goods sold in
or imported into the PRC and on processing, repair and replacement services
provided within the PRC.
Value
added tax payable in The People’s Republic of China is charged on an aggregated
basis at a rate of 13% or 17% (depending on the type of goods involved) on the
full price collected for the goods sold or, in the case of taxable services
provided, at a rate of 17% on the charges for the taxable services provided, but
excluding, in respect of both goods and services, any amount paid in respect of
value added tax included in the price or charges, and less any deductible value
added tax already paid by the taxpayer on purchases of goods and services in the
same financial year.
Warrants - The Company
evaluates its warrants on an ongoing basis considering the accounting guidance
of FASB Topic ASC 825, which establishes standards for issuers of financial
instruments with characteristics of both liabilities and equity related to the
classification and measurement of those instruments. The warrants are evaluated
considering the accounting guidance of FASB Topic ASC 815, which establishes
accounting and reporting standards for derivative instruments, including certain
derivative instruments embedded in other contracts, and for hedging
activities.
F-13
Emerald
Dairy Inc. and Subsidiaries
Footnotes
to Consolidated Financial Statements
December
31, 2009 and 2008
3. Summary of Significant Accounting
Policies (Continued)
Freestanding Financial Instruments
with Characteristics of Both Liabilities and Equity - In accordance with
accounting guidance FASB Topic ASC 825, the Company accounts for financial
instruments as a liability if it embodies an obligation to repurchase the
issuer’s equity shares, or is indexed to such an obligation, and that requires
or may require the issuer to settle the obligation by transferring assets.
Freestanding financial instruments are financial instruments that are entered
into separately and apart from any of the entity's other financial instruments
or equity transactions, or that is entered into in conjunction with some other
transaction and is legally detachable and separately exercisable. As of December
31, 2009 and 2008, there were no financial instruments recorded as
liability.
Retirement Benefit Costs -
According to the PRC regulations on pensions, the Company contributes to a
defined contribution retirement program organized by the municipal government in
the province in which the Company was registered and all qualified employees are
eligible to participate in the program. Contributions to the program are
calculated at 23.5% of the employees’ salaries above a fixed threshold amount
and the employees contribute 2% to 8% while the Company contributes the balance
contribution of 21.5% to 15.5%. The Company has no other material obligation for
the payment of retirement benefits beyond the annual contributions under this
program.
Comprehensive Income - Total
comprehensive income is defined as all changes in shareholders' equity during a
period, other than those resulting from investments by and distributions to
shareholders (i.e., issuance of equity securities and dividends).
Generally, for the Company, total comprehensive income equals net income plus or
minus adjustments for currency translation. Total comprehensive income
represent the activity for a period net of related tax and were $(17,316) and
$1,166,868 for the year ended December 31, 2009 and 2008,
respectively.
While
total comprehensive income is the activity in a period and is largely driven by
net earnings in that period, accumulated other comprehensive income or loss
(“AOCI”) represents the cumulative balance of other comprehensive income as of
the balance sheet date. For the Company, AOCI is primarily the cumulative
balance related to the currency adjustments and increased overall equity by
$2,042,252 and $2,059,568 as of December 31, 2009 and 2008,
respectively.
Share-based Compensation - For purposes of
determining the variables used in the calculation of stock compensation expense
under the provisions of FASB ASC Topic 505, “Equity ” and FASB ASC Topic
718, “Compensation — Stock
Compensation,” the Company performs an analysis of current market data
and historical Company data to calculate an estimate of implied volatility, the
expected term of the option and the expected forfeiture rate. With the exception
of the expected forfeiture rate, which is not an input, the Company uses these
estimates as variables in the Black-Scholes option pricing model. Depending upon
the number of stock options granted, any fluctuations in these calculations
could have a material effect on the results presented in the Company’s
consolidated statement of income and other comprehensive income. In addition,
any differences between estimated forfeitures and actual forfeitures could also
have a material impact on our financial statements.
There was
$265,825 and $0 share-based compensation in the years ended December 31, 2009
and 2008.
F-14
Emerald
Dairy Inc. and Subsidiaries
Footnotes
to Consolidated Financial Statements
December
31, 2009 and 2008
3. Summary of Significant Accounting
Policies (Continued)
Fair Value of Financial Instruments -
The Company applies the provisions of accounting guidance, FASB Topic ASC
825 that requires all entities to disclose the fair value of financial
instruments, both assets and liabilities recognized and not recognized on the
balance sheet, for which it is practicable to estimate fair value, and defines
fair value of a financial instrument as the amount at which the instrument could
be exchanged in a current transaction between willing parties. As of
December 31, 2009 and 2008 the fair value of cash, trade accounts receivable,
other receivables, accounts payable, notes payables, and other payable
approximated carrying value due to the short maturity of the instruments, quoted
market prices, or interest rates, which fluctuate with market
rates.
Fair Value Measurements -
Effective April 1, 2009, the FASB ASC Topic 825, “Financial Instruments,”
requires disclosures about fair value of financial instruments in
quarterly reports as well as in annual reports.
The FASB
ASC Topic 820, “Fair Value
Measurements and Disclosures,” clarifies the definition of fair value for
financial reporting, establishes a framework for measuring fair value and
requires additional disclosures about the use of fair value
measurements.
Various
inputs are considered when determining the fair value of the Company’s financial
instruments. The inputs or methodologies used for valuing securities are
not necessarily an indication of the risk associated with investing in these
securities. These inputs are summarized in the three broad levels
listed below.
|
·
|
Level
1 – observable market inputs that are unadjusted quoted prices for
identical assets or liabilities in active
markets.
|
|
·
|
Level
2 – other significant observable inputs (including quoted prices for
similar securities, interest rates, credit risk,
etc.).
|
|
·
|
Level
3 – significant unobservable inputs (including the Company’s own
assumptions in determining the fair value of financial
instruments).
|
The
Company’s adoption of FASB ASC Topic 825 did not have a material impact on the
Company’s consolidated financial statements.
The
carrying value of financial assets and liabilities recorded at fair value is
measured on a recurring or nonrecurring basis. Financial assets and liabilities
measured on a non-recurring basis are those that are adjusted to fair value when
a significant event occurs. The Company had no financial assets or liabilities
carried and measured on a nonrecurring basis during the reporting periods.
Financial assets and liabilities measured on a recurring basis are those that
are adjusted to fair value each time a financial statement is prepared. The
Company’s had no financial assets and/or liabilities carried at fair value on a
recurring basis at December 31, 2009.
The
availability of inputs observable in the market varies from instrument to
instrument and depends on a variety of factors including the type of instrument,
whether the instrument is actively traded, and other characteristics particular
to the transaction. For many financial instruments, pricing inputs are readily
observable in the market, the valuation methodology used is widely accepted by
market participants, and the valuation does not require significant management
discretion. For other financial instruments, pricing inputs are less observable
in the market and may require management judgment.
F-15
Emerald
Dairy Inc. and Subsidiaries
Footnotes
to Consolidated Financial Statements
December
31, 2009 and 2008
3. Summary of Significant Accounting
Policies (Continued)
Accounting
Pronouncements
Accounting
Standards Update ("ASU") ASU No. 2009-05 (ASC Topic 820), which amends Fair
Value Measurements and Disclosures - Overall, ASU No. 2009-08, Earnings per
Share, ASU No. 2009-12 (ASC Topic 820), Investments in Certain Entities That
Calculate Net Asset Value per Share, and various other ASU's No. 2009-2 through
ASU No. 2009-15 which contain technical corrections to existing guidance or
affect guidance to specialized industries or entities were recently issued.
These updates have no current applicability to the Company, or their effect on
the financial statements would not have been significant.
In
October 2009, the FASB issued Accounting Standards Update, 2009-13, Revenue
Recognition (Topic 605): “Multiple Deliverable Revenue
Arrangements – A Consensus of the FASB Emerging Issues Task
Force.” This update provides application guidance on whether
multiple deliverables exist, how the deliverables should be separated and how
the consideration should be allocated to one or more units of accounting. This
update establishes a selling price hierarchy for determining the selling price
of a deliverable. The selling price used for each deliverable will be based on
vendor-specific objective evidence, if available, third-party evidence if
vendor-specific objective evidence is not available, or estimated selling price
if neither vendor-specific or third-party evidence is available. The Company
will be required to apply this guidance prospectively for revenue arrangements
entered into or materially modified after January 1, 2011; however, earlier
application is permitted. The Company has not determined the impact that this
update may have on its financial statements.
In June
2009, the FASB issued guidance related to accounting for transfers of financial
assets. This guidance improves the information that a reporting entity provides
in its financial reports about a transfer of financial assets; the effects of a
transfer on its financial position, financial performance and cash flows; and a
continuing interest in transferred financial assets. In addition, this guidance
amends various ASC concepts with respect to accounting for transfers and
servicing of financial assets and extinguishments of liabilities, including
removing the concept of qualified special purpose entities. This guidance must be
applied to transfers occurring on or after the effective date. The Company will
adopt this guidance in its first annual and interim reporting periods beginning
after November 15, 2009. The Company has not determined the impact that
this guidance may have on its financial statements.
In June
2009, the FASB issued guidance which amends certain ASC concepts related to
consolidation of variable interest entities. Among other accounting and
disclosure requirements, this guidance replaces the quantitative-based risks and
rewards calculation for determining which enterprise has a controlling financial
interest in a variable interest entity with an approach focused on identifying
which enterprise has the power to direct the activities of a variable interest
entity and the obligation to absorb losses of the entity or the right to receive
benefits from the entity. The Company will adopt this guidance in its first
annual and interim reporting periods beginning after November 15, 2009. The
Company has not determined the impact that this guidance may have on its
financial statements.
F-16
Emerald
Dairy Inc. and Subsidiaries
Footnotes
to Consolidated Financial Statements
December
31, 2009 and 2008
4. Concentrations of Business and Credit
Risk
The
Company conducts all of its primary trade in the PRC. There can be no
assurance that the Company will be able to successfully conduct its trade, and
failure to do so would have a material adverse effect on the Company’s financial
position, results of operations and cash flows. Also, the success of the
Company’s operations is subject to numerous contingencies, some of which are
beyond management’s control. These contingencies include general economic
conditions, price of raw material, competition, governmental and political
conditions, and changes in regulations. Because the Company is dependent on
foreign trade in PRC, the Company is subject to various additional political,
economic and other uncertainties. Among other risks, the Company’s operations
will be subject to risk of restrictions on transfer of funds, domestic and
international customs, changing taxation policies, foreign exchange
restrictions, and political and governmental regulations.
Substantially
all of the Company’s bank accounts are in banks located in the PRC and are not
covered by any type of protection similar to that provided by the FDIC on funds
held in U.S banks. Accounts held at U.S. financial institutions are insured by
the FDIC up to $250,000. As of December 31, 2009 $161,628 of the U.S. cash
balances are in excess of insured amounts.
Milk
powder is historically 75% to 80% of the Company’s total sales. Dairy product
consumption in China has historically been lower than in many other countries in
the world. Growing interest in milk products in China is a relatively
recent phenomenon which makes the market for the Company’s products less
predictable. Consumers may lose interest in the
products. As a result, achieving and maintaining market acceptance
for our products will require substantial marketing efforts and the expenditure
of significant funds to encourage dairy consumption in general, and the purchase
of the Company’s products in particular. There is substantial risk
that the market may not accept or be receptive to the Company’s
products. Market acceptance of the Company’s current and proposed
products will depend, in large part, upon its ability to inform potential
customers that the distinctive characteristics of the Company’s products make
them superior to competitive products and justify their pricing. The
Company’s current and proposed products may not be accepted by consumers or able
to compete effectively against other premium or non-premium dairy
products. Lack of market acceptance would limit our revenues and
profitability.
The
Company operates in China, which may give rise to significant foreign currency
risks from fluctuations and the degree of volatility of foreign exchange rates
between the U.S. dollar and the Chinese RMB.
Recently,
a number of milk powder products produced within China were found to contain
unsafe levels of tripolycyanamide, also known as melamine, sickening thousands
of infants. This prompted the Chinese government to conduct a nationwide
investigation into how the milk powder was contaminated, and caused a worldwide
recall of certain milk powder products produced within China. On September 16,
2008, China’s Administration of Quality Supervision, Inspection and Quarantine
(“AQSIQ”) revealed that it had tested samples from 175 dairy manufacturers, and
published a list of 22 companies whose products contained melamine. The Company
passed the emergency inspection and was not included on AQSIQ’s list. Although
the Company believes that the inevitable contraction in the Chinese milk powder
industry caused by this crisis will lead to increased demand for its products,
the Company can not be certain that the illnesses caused by contamination in the
milk powder industry, whether or not related to its products, will not lead to
decreased demand for milk powder products produced within China, thereby having
a material adverse effect on the Company’s business.
Financial
instruments that potentially subject the Company to concentration of credit risk
consist principally of cash and trade receivables, the balances of which are
stated on the balance sheet. Concentration of credit risk with respect to trade
receivables is limited due to the Company's large number of diverse customers in
different locations in China. The Company does not require collateral or other
security to support financial instruments subject to credit risk.
For the
years ended December 31, 2009 and 2008, no single customer accounted for 10% or
more of sales revenues.
F-17
Emerald
Dairy Inc. and Subsidiaries
Footnotes
to Consolidated Financial Statements
December
31, 2009 and 2008
4. Concentrations of Business and Credit
Risk (Continued)
As of
December 31, 2009, the Company had no insurance coverage of any kind. Accrual
for losses is not recognized until such time as an uninsured loss has
occurred.
Payments
of dividends may be subject to some restrictions due to the fact that the
operating activities are conducted in subsidiaries residing in the PRC;
therefore in accordance with Rule 504/4.08 (e) (3) of Regulation S-X, the
following are condensed parent company only financial statements for the two
years ended December 31, 2009 and 2008.
EMERALD DAIRY,
INC.
CONDENSED
PARENT COMPANY ONLY BALANCE SHEETS
AS OF
DECEMBER 31, 2009 and 2008
2009
|
2008
|
|||||||
Current
assets:
|
||||||||
Cash
|
$ | 661,628 | $ | 169,324 | ||||
Prepaid
loan costs
|
828,725 | 69,919 | ||||||
Prepaid
expenses
|
- | 10,750 | ||||||
Total
current assets
|
1,490,353 | 249,993 | ||||||
Property
and equipment, net
|
11,785 | 2,834 | ||||||
Investment
in subsidiaries, reported on equity method
|
38,238,709 | 24,376,090 | ||||||
Total
assets
|
$ | 39,740,847 | $ | 24,628,917 | ||||
Current
liabilities:
|
||||||||
Accounts
payable and accrued expenses
|
$ | 500,659 | $ | 1,545,613 | ||||
Notes
payable, net of debt discount of $729,830 and $87,888 at December
31, 2009 and 2008, respectively
|
5,843,472 | 2,662,112 | ||||||
Total
current liabilities
|
6,344,131 | 4,207,725 | ||||||
Stockholders'
equity:
|
||||||||
Preferred
Stock ($0.001 par value, 10,000,000 shares authorized, none issued and
outstanding at December 31, 2009
|
- | - | ||||||
Common
stock, $.001 par value; 100,000,000 shares authorized; 34,890,267 and
31,243,776 shares issued and outstanding December 31, 2009 and
2008
|
34,890 | 31,244 | ||||||
Treasury
stock (1,944,444 shares at December 31, 2009 and 2008)
|
(1,944 | ) | (1,944 | ) | ||||
Additional
paid-in capital
|
17,003,093 | 8,225,922 | ||||||
Accumulated
other comprehensive income
|
2,042,252 | 2,059,568 | ||||||
Retained
earnings
|
14,318,425 | 10,106,402 | ||||||
Total
stockholders' equity
|
33,396,716 | 20,421,192 | ||||||
Total
liabilities and stockholders' equity
|
$ | 39,740,847 | $ | 24,628,917 |
F-18
Emerald
Dairy Inc. and Subsidiaries
Footnotes
to Consolidated Financial Statements
December
31, 2009 and 2008
4. Concentrations of Business and Credit
Risk (Continued)
EMERALD
DAIRY, INC.
CONDENSED
PARENT COMPANY ONLY INCOME STATEMENTS
FOR THE
YEARS ENDED DECEMBER 31, 2009 AND 2008
SALES
|
$ | — | $ | — | ||||
OPERATING
AND ADMINISTRATIVE
|
||||||||
EXPENSES:
|
||||||||
General
and administrative expenses
|
2,475,944 | 2,529,024 | ||||||
Loss
from operations
|
(2,475,944 | ) | (2,529,024 | ) | ||||
OTHER
INCOME (EXPENSE):
|
||||||||
Interest
income
|
1,993 | 8,596 | ||||||
Interest
expense
|
(236,226 | ) | (425,351 | ) | ||||
Loss
on extinguishment of debt
|
(1,405,052 | ) | — | |||||
Equity
in earnings of unconsolidated subsidiaries
|
8,327,252 | 5,260,286 | ||||||
INCOME
BEFORE INCOME TAXES
|
4,212,023 | 2,314,507 | ||||||
(PROVISION
FOR) BENEFIT FROM
|
||||||||
INCOME
TAXES
|
— | — | ||||||
NET
INCOME
|
$ | 4,212,023 | $ | 2,314,507 |
F-19
Emerald
Dairy Inc. and Subsidiaries
Footnotes
to Consolidated Financial Statements
December
31, 2009 and 2008
4. Concentrations of Business and Credit
Risk (Continued)
EMERALD
DAIRY, INC.
CONDENSED
PARENT COMPANY ONLY STATEMENTS OF CASH FLOWS
FOR THE
YEARS ENDED DECEMBER 31, 2009 AND 2008
CASH
FLOWS FROM OPERATING ACTIVITIES:
|
||||||||
Net
loss
|
$ | 4,212,023 | $ | 2,314,507 | ||||
Adjustments
to reconcile net income to operating activities -
|
||||||||
Less
: Equity in earnings of unconsolidated subsidiaries
|
(8,327,252 | ) | (5,260,286 | ) | ||||
Depreciation
|
1,148 | 443 | ||||||
Amortization
of loan discount
|
102,159 | 217,275 | ||||||
Loss
on extinguishment of debt
|
1,405,052 | - | ||||||
Capitalized
interest
|
(552,683 | ) | - | |||||
Stock
issued for services
|
66,304 | - | ||||||
Warrants
modified for services
|
302,083 | - | ||||||
Warrants
issued for loan costs
|
3,975 | - | ||||||
Incentive
stock option expense
|
265,825 | - | ||||||
Net
change in assets and liabilities
|
||||||||
Prepaid
expenses
|
(388,056 | ) | 4,405 | |||||
Accounts
payable and accrued expenses
|
653,234 | 1,330,314 | ||||||
Net
cash used in operating activities
|
(2,256,188 | ) | (1,393,342 | ) | ||||
CASH
FLOWS FROM INVESTING ACTIVITIES:
|
||||||||
Purchase
of fixed assets
|
(10,099 | ) | (1,160 | ) | ||||
Investments
in subsidiaries
|
(5,000,000 | ) | (2,012,365 | ) | ||||
Net
cash used in investing activities
|
(5,010,099 | ) | (2,013,525 | ) | ||||
CASH
FLOWS FROM FINANCING ACTIVITIES:
|
||||||||
Exercise
of warrants
|
4,433,591 | - | ||||||
Advances
on notes payable
|
3,325,000 | 2,750,000 | ||||||
Net
cash provided by financing activities
|
7,758,591 | 2,750,000 | ||||||
Effect
of exchange rate change on cash and cash equivalents
|
— | — | ||||||
NET
DECREASE IN CASH AND EQUIVALENTS
|
(492,304 | ) | (656,867 | ) | ||||
CASH
AND CASH EQUIVALENTS, BEGINNING OF PERIOD
|
169,324 | 826,191 | ||||||
CASH
AND CASH EQUIVALENTS, END OF PERIOD
|
$ | 661,628 | 169,324 | |||||
SUPPLEMENTAL
DISCLOSURES OF CASH FLOW INFORMATION:
|
||||||||
Interest
paid
|
$ | — | $ | — | ||||
Income
taxes paid
|
$ | — | $ | — |
F-20
Emerald
Dairy Inc. and Subsidiaries
Footnotes
to Consolidated Financial Statements
December
31, 2009 and 2008
4. Concentrations of Business and Credit
Risk (Continued)
Emerald
Dairy, Inc.
Notes to
Condensed Parent Company Only Financial Statements
Note 1 -
These condensed parent company only financial statements should be read in
connection with the consolidated financial statements and notes
thereto.
The
operations of the Company are located in the PRC. Accordingly, the Company’s
business, financial condition, and results of operations may be influenced by
the political, economic, and legal environments in the PRC, as well as by the
general state of the PRC economy.
5. Inventory
As of
December 31, 2009 and 2008 inventory consists of the following:
2009
|
2008
|
|||||||
Raw
materials
|
$
|
689,984
|
$
|
557,128
|
||||
Work-in-process
|
579,806
|
299,931
|
||||||
Finished
goods
|
20,365
|
17,305
|
||||||
Repair
parts
|
8,333
|
8,869
|
||||||
$
|
1,298,488
|
$
|
883,233
|
6. Advances to equipment
supplier
As of
December 31, 2009 and 2008 advances to equipment supplier consisted of
$3,710,707 and $3,712,883, respectively, in advances on a contract to purchase
equipment from a supplier for the second processing facility under
construction. The $1,590,303 remaining on the contract will be due
when the equipment is installed during 2010.
7. Advances to suppliers and other
receivables
As of
December 31, 2009 and 2008, advances to suppliers and other receivables consist
of the following:
2009
|
2008
|
|||||||
Advances
to milk suppliers
|
$
|
368,566
|
$
|
388,406
|
||||
Other
Receivables
|
-
|
-
|
||||||
Advances
to staff
|
15,496
|
76,712
|
||||||
Prepaid
loan costs
|
828,725
|
69,919
|
||||||
Prepaid
expenses
|
8,364
|
14,798
|
||||||
$
|
1,221,151
|
$
|
549,835
|
F-21
Emerald
Dairy Inc. and Subsidiaries
Footnotes
to Consolidated Financial Statements
December
31, 2009 and 2008
8. Deposits
As of
December 31, 2009 and 2008, deposits consist of the following:
2009
|
2008
|
|||||||
Deposit
on contract
|
71,598
|
74,614
|
||||||
$
|
71,598
|
$
|
74,614
|
During
the year ended December 31, 2008 the $1,101,370 deposit on the building the
Company purchased to serve as its corporate headquarters was transferred to
property, plant and equipment upon completion of the purchase of the building
and the $539,725 deposit on the new facility site was transferred to intangible
assets when the land use right agreement was completed. During the
year ended December 31, 2009 and 2008, $74,614 and $1,459,633, respectively, of
the advertising contract was completed and was recorded as advertising
expense.
9. Property, Plant, and
Equipment
As of
December 31, 2009 and 2008, Property, Plant, and Equipment consist of the
following:
2009
|
2008
|
|||||||
Building
|
$
|
3,767,984
|
$
|
3,704,971
|
||||
Plant
and Machinery
|
3,227,110
|
2,972,883
|
||||||
Motor
vehicles
|
526,597
|
526,906
|
||||||
Dairy
cows
|
253,439
|
242,102
|
||||||
Office
equipment
|
76,616
|
59,739
|
||||||
7,851,746
|
7,506,601
|
|||||||
Less:
Accumulated depreciation
|
(1,905,416
|
)
|
(1,405,035
|
)
|
||||
$
|
5,946,330
|
$
|
6,101,566
|
Depreciation
expenses totaled $500,903 and $409,563 for the years ended December 31, 2009 and
2008, respectively, of which $322,718 and $323,457 were included as a component
of cost of goods sold for the years ended December 31, 2009 and 2008,
respectively.
During
the year ended December 31, 2008 a deposit on the new building of $1,101,370 was
transferred to property, plant and equipment upon completion of the purchase of
the office building and the Company commenced depreciation at such
time.
10. Construction in
progress
December 31,
2009
|
December 31,
2008
|
|||||||
Construction
in progress
|
$
|
8,772,931
|
$
|
2,482,339
|
Construction-in-progress
represents construction and installations of the new plant and machinery for the
production facility in Hailun City.
F-22
Emerald
Dairy Inc. and Subsidiaries
Footnotes
to Consolidated Financial Statements
December
31, 2009 and 2008
11. Intangible Assets
December 31,
2009
|
December 31,
2008
|
|||||||
Land
use rights
|
$
|
1,355,589
|
$
|
1,356,384
|
||||
Patents
|
53,171
|
53,202
|
||||||
1,408,760
|
1,409,586
|
|||||||
Less:
Accumulated amortization
|
(67,226
|
)
|
(29,497
|
)
|
||||
$
|
1,341,534
|
$
|
1,380,089
|
For the
years ended December 31, 2009 and 2008, amortization expenses totaled $37,723
and $28,958, respectively. Amortization
expense is estimated to be $37,723 for each of the next five years.
12. Income Taxes
On May
30, 2005, AIDH executed a Share Transfer Agreement with XAL, a corporation
organized and existing under the laws of the PRC. XAL applied to be as a foreign
invested company right after the share transfer, which business license has been
approved as a foreign invested company on January 10, 2006. According to Chinese
taxation policy, there is a total income tax exemption for 2 years followed by a
50% reduction for 3 years applicable to foreign invested companies, Advanced
Technology Companies or Software Development Companies. XAL is considered an
Advanced Technology Company. Therefore the Company receives this income tax
exemption policy from January 10, 2006 the date approval as a foreign invested
company. The Company received a 100% tax holiday as of January 10, 2006. On
January 10, 2008 the Company’s tax exemption was reduced to 50% of the
prevailing tax rate and will continue at this reduced rate for three additional
years.
LvBao is
currently subject to the Enterprise income tax of 33%.
A
reconciliation of the provision for income taxes with amounts determined by the
U.S. federal income tax rate to income before income taxes is as
follows.
The
components of net income (loss) before provision for income tax consist of
following:
Year Ended December 31,
|
||||||||
2009
|
2008
|
|||||||
U.S.
Operations
|
$
|
(4,115,258
|
)
|
$
|
(2,945,700
|
)
|
||
Chinese
Operations
|
9,654,808
|
6,100,000
|
||||||
$
|
5,539,550
|
$
|
3,154,700
|
The
components of the provision for income taxes are approximately as
follows:
Year Ended December 31,
|
||||||||
2009
|
2008
|
|||||||
Federal,
State and Local
|
$
|
-
|
$
|
-
|
||||
People’s
Republic of China -Federal and Local
|
1,327,500
|
840,200
|
||||||
$
|
1,327,500
|
$
|
840,200
|
F-23
Emerald
Dairy Inc. and Subsidiaries
Footnotes
to Consolidated Financial Statements
December
31, 2009 and 2008
12. Income Taxes
(Continued)
The table
below approximately summarizes the reconciliation of the Company’s income tax
provision computed at the statutory U.S. Federal rate and the actual tax
provision:
Year Ended December 31,
|
||||||||
2009
|
2008
|
|||||||
Income
tax provision at Federal statutory rate
|
$
|
1,883,400
|
1,072,600
|
|||||
State
income taxes, net of Federal benefit
|
-
|
189,300
|
||||||
U.S.
tax rate in excess of foreign tax rate
|
(868,900
|
)
|
(427,000
|
)
|
||||
Abatement
of foreign income taxes
|
(1,086,200
|
)
|
(1,161,200
|
)
|
||||
Increase
in valuation allowance
|
1,399,200
|
1,166,500
|
||||||
Tax
provision
|
$
|
1,327,500
|
$
|
840,200
|
The
Company had a U.S. net operating loss carryforward of approximately $6,285,000
as of December 31, 2009 which expires in 2029. The deferred tax asset associated
with these net operating loss carryforwards was fully reserved as of December
31, 2009.
The
change in the valuation allowance as of December 31, 2009 and 2008 was
$1,314,100 and $1,166,500, respectively.
The
effects of the tax exemption per share were as follows:
Year Ended December 31,
|
||||||||
2009
|
2008
|
|||||||
Tax
savings
|
$
|
1,086,200
|
$
|
1,161,200
|
||||
Benefit
per share:
|
||||||||
Basic
|
$
|
0.04
|
$
|
0.04
|
||||
Diluted
|
$
|
0.04
|
$
|
0.04
|
Had the
tax exemption not been in place for the years ended December 31, 2009 and 2008,
the Company estimates the following proforma financial statement
impact:
Year Ended December 31,
|
||||||||
2009
|
2008
|
|||||||
Net
income before tax provision, as reported
|
$
|
5,539,550
|
$
|
3,154,700
|
||||
Less
Tax provision not exempted
|
1,327,500
|
840,200
|
||||||
Less
Tax provision exempted
|
1,086,200
|
1,161,200
|
||||||
Proforma
Net income
|
$
|
3,125,850
|
$
|
1,153,300
|
||||
Proforma
Net income per share
|
||||||||
Basic
|
$
|
0.10
|
$
|
0.04
|
||||
Diluted
|
$
|
0.10
|
$
|
0.04
|
F-24
Emerald
Dairy Inc. and Subsidiaries
Footnotes
to Consolidated Financial Statements
December
31, 2009 and 2008
13. Employee Retirement Benefits and Post
Retirement Benefits
According
to the Heilongjiang Provincial regulations on state pension program, both
employees and employers have to contribute toward pensions. The pension
contributions range from 2% to 8% that was contributed by individuals
(employees), and the Company is required to make contributions to the state
retirement plan based on 20% of the employees’ monthly basic salaries. Employees
in the PRC are entitled to retirement benefits calculated with reference to
their basic salaries on retirement and their length of service in accordance
with a government managed benefits plan. The PRC government is responsible for
the benefit liability to these retired employees. During the years ended
December 31, 2009 and 2008, respectively, the Company contributed $151,051 and
$172,622 in pension contributions.
14. Accrued Expenses
At
December 31, 2009 and 2008 accrued expenses consisted of:
2009
|
2008
|
|||||||
Liquidated
damages
|
$
|
-
|
$
|
1,201,998
|
||||
Accrued
payroll
|
306,011
|
56,404
|
||||||
Accrued
interest
|
71,570
|
105,287
|
||||||
Economic
development advance
|
43,943
|
-
|
||||||
Accrued
insurance
|
187,408
|
24,192
|
||||||
$
|
608,932
|
$
|
1,387,881
|
15.
Notes
Payable
June
2008 Notes Payable
In June
2008 the Company sold 8% promissory notes maturing December 31, 2008 and
three-year warrants to purchase 225,000 shares of common stock at an exercise
price of $2.61 for $2,250,000. Any amount of principal or interest
outstanding after December 31, 2008 will bear interest at a rate of 12%. In
accordance with accounting guidance the proceeds from issuance of the notes were
allocated to the notes and warrants based upon their relative fair values. This
allocation resulted in allocating $210,600 to the warrants to be treated as loan
discount to be amortized over the life of the notes. During the year ended
December 31, 2008, $210,600 of the loan discount was amortized to interest
expense. The following assumptions were used to calculate the fair value of the
warrants using the Black - Scholes Model
Dividend
yield
|
0
|
%
|
||
Expected
volatility
|
118.01
|
%
|
||
Risk-free
interest rate
|
3.35 – 3.17
|
%
|
||
Expected
life
|
3
years
|
|||
Stock
price
|
$
|
1.63
|
||
Exercise
price
|
$
|
2.61
|
The notes
may be prepaid in their entirety without penalty upon 15 day notice. So long as
the Company has any obligation under the notes, there are limitations on its
ability to: (a) pay dividends or make other distributions on its capital stock;
(b) redeem, repurchase or otherwise acquire any of its securities; (c) create,
incur or assume any liability for borrowed money; (d) sell, lease or otherwise
dispose of any significant portion of its assets; (e) lend money, give credit or
make advances; or (f) assume, guarantee, endorse, contingently agree to purchase
or otherwise become liable upon the obligation of any other person or
entity.
F-25
Emerald
Dairy Inc. and Subsidiaries
Footnotes
to Consolidated Financial Statements
December
31, 2009 and 2008
15. Notes Payable
(Continued)
In
connection with the sale of the notes the Company paid a placement agent
$122,500 in fees and delivered 45,000 three-year warrants to purchase 45,000
shares of common stock at an exercise price of $2.61. The warrants were valued
at $46,507 using a Black-Scholes Model and together with the fee were treated as
deferred issuance costs to be amortized over the life of the notes. Amortization
of the deferred issuance costs for the year ended December 31, 2008 was
$169,007. The following assumptions were used to calculate the fair
value of the warrants:
Dividend
yield
|
0
|
%
|
||
Expected
volatility
|
118.01
|
%
|
||
Risk-free
interest rate
|
3.35
|
%
|
||
Expected
life
|
3 years
|
|||
Stock
price
|
$
|
1.63
|
||
Exercise
price
|
$
|
2.61
|
In
connection with the sale of the June 20, 2008 notes the Company paid legal fees
of $15,000 that were treated as deferred issuance costs and are being amortized
to interest expense over the life of the notes.
On
December 31, 2008 the Company and the note holders entered into an agreement,
pursuant to which:
|
·
|
the
maturity date of each note was extended from December 31, 2008 to December
31, 2009;
|
|
·
|
as
of December 31, 2008, the initial interest rate of the notes of 8% per
annum was increased to 10% per
annum;
|
|
·
|
activities
related to the completion of the construction of the Company’s new
production facility were carved out of the noteholders’ “Prepayment
Option” and requirement for the Company to obtain the noteholders’ written
consent for certain additional
borrowings;
|
|
·
|
The
expiration date of the warrants was extended from the third anniversary of
their original issue date to the fifth anniversary of their original issue
date; and
|
|
·
|
The
exercise price of the warrants was reduced from $2.61 to
$1.63.
|
In
accordance with accounting guidance the Company evaluated
the present value of the cash flows under the terms of the amended debt
instrument to determine if they were at least 10 percent different from the
present value of the remaining cash flows under the terms of the original
instrument. It was determined that the terms were substantially different and
therefore should be accounted for as a debt extinguishment and the amended debt
instrument should be initially recorded at fair value which was determined to be
$2,209,887 with the discount to be amortized over the remaining life of the
note. No debt extinguishment gain was recorded as the gain was offset by the
value of the change in the warrants as computed.
As per
accounting guidance the difference in the value of the warrants before and after
the change in terms should be recorded as costs provided to the
creditor. The difference in the value was calculated to be $40,113,
which was recorded as a loan discount and was amortized over during the year
ended December 31, 2009 to interest expense.
F-26
Emerald
Dairy Inc. and Subsidiaries
Footnotes
to Consolidated Financial Statements
December
31, 2009 and 2008
15. Notes Payable
(Continued)
The fair
value of the warrants as of December 31, 2008 before modification of the terms
was calculated to be $91,191. The following assumptions were used to
calculate the fair value of the warrants:
Dividend
yield
|
0
|
%
|
||
Expected
volatility
|
149.89
|
%
|
||
Risk-free
interest rate
|
1.0
|
%
|
||
Expected
life
|
2.45 years
|
|||
Stock
price
|
$
|
0.70
|
||
Exercise
price
|
$
|
2.61
|
The fair
value of the warrants as of December 31, 2008 after modification of the terms
was calculated to be $131,304. The following assumptions were used to
calculate the fair value of the warrants:
Dividend
yield
|
0
|
%
|
||
Expected
volatility
|
149.89
|
%
|
||
Risk-free
interest rate
|
1.0
|
%
|
||
Expected
life
|
4.45 years
|
|||
Stock
price
|
$
|
0.70
|
||
Exercise
price
|
$
|
1.63
|
On
December 31, 2009 the Company and the note holders entered into an agreement,
pursuant to which:
|
·
|
the
Maturity Date of each note was extended from December 31, 2009 to December
31, 2010;
|
|
·
|
Accrued
interest of $323,301.39 was added to the outstanding principal
amount;
|
|
·
|
Three
year warrants to purchase 789,356 shares of the Company’s common stock at
an exercise price of $1.63 per share were issued for extension of the
notes;
|
|
·
|
The
Company’s Chief Executive Officer pledged 3,157,425 shares of common stock
as security for the Company’s payment obligations under the notes;
and
|
|
·
|
200,000
shares of restricted common stock were issued to a placement agent for
assistance in the extension of the
notes.
|
In
accordance with accounting guidance the Company evaluated
the present value of the cash flows under the terms of the amended debt
instrument to determine if they were at least 10 percent different from the
present value of the remaining cash flows under the terms of the original
instrument. It was determined that the terms were substantially different and
therefore should be accounted for as a debt extinguishment and the amended debt
instrument should be initially recorded at fair value which was determined to be
$2,573,301 with the loss on debt extinguishment being calculated as
follows:
Recorded
value of note and accrued interest
|
$ | 2,573,301 | ||
Less:
|
||||
Fair
value of amended notes
|
(2,573,301 | ) | ||
Fair
value of warrants
|
(1,237,378 | ) | ||
Loss
on extinguishment of debt
|
$ | (1,237,378 | ) |
F-27
Emerald
Dairy Inc. and Subsidiaries
Footnotes
to Consolidated Financial Statements
December
31, 2009 and 2008
15. Notes Payable
(Continued)
The fair
value of the warrants issued on December 31, 2009 was calculated to be
$1,237,378. The following assumptions were used to calculate the fair value
of the warrants:
Dividend
yield
|
0
|
%
|
||
Expected
volatility
|
170.83
|
%
|
||
Risk-free
interest rate
|
1.57
|
%
|
||
Expected
life
|
3 years
|
|||
Stock
price
|
$
|
1.80
|
||
Exercise
price
|
$
|
1.63
|
The fair
value of the common stock issued to the placement agent was based on the quoted
closing price of $1.80 per share as of December 31, 2009 for a fair value of
$360,000. The fair value was recorded as prepaid loan costs to be
amortized over the remaining life of the notes.
November
2008 Notes Payable
In
November 2008 the Company sold 10% promissory notes maturing November 10, 2009
and three-year warrants to purchase 50,000 shares of common stock at an exercise
price of $2.61 for $500,000. Pursuant to the provisions of the notes,
any amount of principal or interest outstanding after November 30, 2008 would
bear interest at a rate of 12%. In accordance with accounting guidance the
proceeds from issuance of the notes were allocated to the notes and warrants
based upon their relative fair values. This allocation resulted in allocating
$54,450 to the warrants to be treated as loan discount to be amortized to
interest expense over the life of the notes. During the year ended December 31,
2009 and 2008, $47,775 and $6,675, respectively, of the loan discount was
amortized to interest expense.
The
following assumptions were used to calculate the fair value of the warrants
using the Black - Scholes Model:
Dividend
yield
|
0
|
%
|
||
Expected
volatility
|
131
|
%
|
||
Risk-free
interest rate
|
1.78
|
%
|
||
Expected
life
|
3
years
|
|||
Stock
price
|
$
|
1.75
|
||
Exercise
price
|
$
|
2.61
|
The notes
may be prepaid in their entirety without penalty upon 15 day notice. So long as
the Company has any obligation under the notes, there are limitations on its
ability to: (a) pay dividends or make other distributions on its capital stock;
(b) redeem, repurchase or otherwise acquire any of its securities; (c) create,
incur or assume any liability for borrowed money; (d) sell, lease or otherwise
dispose of any significant portion of its assets; (e) lend money, give credit or
make advances; or (f) assume, guarantee, endorse, contingently agree to purchase
or otherwise become liable upon the obligation of any other person or
entity.
In
connection with the sale of the notes the Company paid a placement agent $40,000
in fees and delivered 25,000 three-year warrants to purchase 25,000 shares of
common stock at an exercise price of $2.61. The warrants were valued at $30,544
using a Black-Scholes Model and together with the fee were treated as deferred
issuance costs and recorded in prepaid expenses to be amortized to interest
expense over the life of the notes. Amortization of the deferred issuance costs
for year ended December 31, 2009 and 2008 was $61,896 and $8,648,
respectively. The following assumptions were used to calculate the
fair value of the warrants:
F-28
Emerald
Dairy Inc. and Subsidiaries
Footnotes
to Consolidated Financial Statements
December
31, 2009 and 2008
15. Notes payable
(Continued)
Dividend
yield
|
0
|
%
|
||
Expected
volatility
|
131
|
%
|
||
Risk-free
interest rate
|
1.78
|
%
|
||
Expected
life
|
3
years
|
|||
Stock
price
|
$
|
1.75
|
||
Exercise
price
|
$
|
2.61
|
On
November 10, 2009, the Company and the note holders entered into an agreement,
pursuant to which:
|
·
|
the
Maturity Date of each note was extended from November 10, 2009 to May 10,
2010;
|
|
·
|
three
year warrants to purchase 100,000 shares of the Company’s common stock at
an exercise price of $1.63 per share were issued for extension of the
notes; and
|
|
·
|
a
fee was paid to a placement agent for loan costs of
$62,762.
|
In
accordance with accounting guidance the Company evaluated
the present value of the cash flows under the terms of the amended debt
instrument to determine if they were at least 10 percent different from the
present value of the remaining cash flows under the terms of the original
instrument. It was determined that the terms were substantially different and
therefore should be accounted for as a debt extinguishment and the amended debt
instrument should be initially recorded at fair value which was determined to be
$500,000 with the loss on debt extinguishment being calculated as
follows:
Recorded
value of note and accrued interest
|
$ | 500,000 | ||
Less:
|
||||
Fair
value of amended note
|
(500,000 | ) | ||
Fair
value of warrants
|
(167,674 | ) | ||
Loss
on extinguishment of debt
|
$ | (167,674 | ) |
The fair
value of the warrants issued on November 10, 2009 was calculated to be
$167,674. The following assumptions were used to calculate the fair value
of the warrants:
Dividend
yield
|
0
|
%
|
||
Expected
volatility
|
180.22
|
%
|
||
Risk-free
interest rate
|
1.33
|
%
|
||
Expected
life
|
3 years
|
|||
Stock
price
|
$
|
1.88
|
||
Exercise
price
|
$
|
1.63
|
Costs
paid to the placement agent of $62,762 have been recorded in prepaid loan costs
to be amortized over the remaining term of the notes.
11/30/09
Note Payable
On
November 30, 2009 the Company entered into a loan agreement pursuant to which
the Company borrowed $1,750,000 at 10% due November 30, 2010. The
Company had loan costs of $303,166 which have been recorded as prepaid loan
costs to be amortized over the life of the note.
F-29
Emerald
Dairy Inc. and Subsidiaries
Footnotes
to Consolidated Financial Statements
December
31, 2009 and 2008
15. Notes Payable
(Continued)
12/24/09
Notes Payable
On
December 24, 2009 the Company sold 10% promissory notes maturing December 24,
2010 and three-year warrants to purchase 536,809 shares of common stock at an
exercise price of $1.63 for $1,750,000. Any amount of principal or
interest outstanding after December 24, 2010 will bear interest at a rate of
12%. In accordance with accounting guidance the proceeds from issuance of the
notes were allocated to the notes and warrants based upon their relative fair
values. This allocation resulted in allocating $569,100 to the warrants to be
treated as loan discount to be amortized over the life of the notes. During the
year ended December 31, 2009, $14,270 of the loan discount was amortized to
interest expense. The following assumptions were used to calculate the fair
value of the warrants using the Black – Scholes Model:
Dividend
yield
|
0
|
%
|
||
Expected
volatility
|
171.93
|
%
|
||
Risk-free
interest rate
|
1.43
|
%
|
||
Expected
life
|
3
years
|
|||
Stock
price
|
$
|
1.80
|
||
Exercise
price
|
$
|
1.63
|
At the
closing the Company paid the investors a closing fee in the aggregate amount of
$35,000, and prepaid interest on the notes in the aggregate amount of
$175,000. As a result, the Company received net proceeds of
$1,540,000. The prepaid interest has been recorded as loan
discount to be amortized to interest expense over the life of the loan. The
closing fee has been recorded as prepaid loan costs to be amortized over the
life of the loan.
The
Company also paid a placement agent $105,000 in fees related to the
notes. This fee has been record as prepaid loan costs to be amortized
over the life of the loan.
The
Company’s repayment obligations of amounts due under the notes is secured by a
pledge of 5,883,329 shares of common stock of the Company beneficially owned by
Yang Yong Shan, the Company’s Chairman, Chief Executive Officer and
President.
At
December 31, 2009 and 2008 notes payable consisted of the
following:
Year Ended December 31,
|
||||||||
2009
|
2008
|
|||||||
Notes
dated June, 2008, due December 31, 2010 with a interest rate of
10%
|
$
|
2,573,301
|
$
|
2,209,887
|
||||
Notes
dated November 10, 2008 due May 10, 2010 with a interest rate of
10%
|
500,000
|
452,225
|
||||||
Note
dated November 30, 2009 due November 30, 2010 with a interest rate of
10%
|
1,750,000
|
—
|
|
|||||
Notes
dated December 24, 2009 due December 24, 2010 with a interest rate of 10%,
net of debt discount of $729,830
|
1,020,171
|
—
|
||||||
$
|
5,843,472
|
$
|
2,662,112
|
F-30
Emerald
Dairy Inc. and Subsidiaries
Footnotes
to Consolidated Financial Statements
December
31, 2009 and 2008
16. Put/Call Liability
On
October 9, 2007, the Company entered into Put/Call Agreements with two (2) of
its stockholders (the “Put/Call Stockholders”), pursuant to which the Put/Call
Stockholders granted the Company an option to repurchase an aggregate of
1,944,444 shares (the “Put/Call Shares”) from the Put/Call Stockholders (the
“Call Option”), for an exercise price of $1.63 per share (the “Call Option
Price”), if the following conditions have been met (the “Call Option
Conditions”):
|
·
|
Either
(i) a registration statement (“Registration Statement”) covering the
resale of the Put/Call Shares has been declared effective by the
Securities and Exchange Commission (“Commission”), and has been kept
continuously effective by the Company, or (B) all of the Put/Call Shares
are available for sale without registration pursuant to Rule 144(k);
and
|
|
·
|
The
closing price of a share of common stock of the Company as traded on the
Over-the-Counter Bulletin Board (or such other exchange or stock market on
which the Common Stock may then be listed or quoted) equals or exceeds
$4.08 (appropriately adjusted for any stock split, reverse stock split,
stock dividend or other reclassification or combination of the common
stock) for at least ten (10) consecutive trading days immediately
preceding the date that a Call Option exercise notice is given by the
Company.
|
Term of the Call Option - the
Call Option provided that the Company could only exercise the Call Option by
delivering a written notice (a “Call Option Exercise Notice”) to the Put/Call
Stockholders within thirty (30) days of such time as all of the Call Option
Conditions have been met. The Call Option could have been exercised for all, but
not less than all, of the Put/Call Shares. Any repurchase was required to have
been consummated within ninety (90) days following the date of the Call Option
Exercise Notice.
In
addition, the Put/Call Stockholders had the right to cause the Company to
repurchase the Put/Call Shares from the Put/Call Stockholders (the “Put Right”),
for a price of $1.63 per share (the “Put Purchase Price”), if:
|
·
|
the
Company failed to exercise its Call Option within ten (10) days of a date
on which all of the Call Option Conditions have been met;
or
|
|
·
|
the
Company consummated a private offering of not less than $5,000,000 of its
securities (a “Qualified Offering”);
or
|
|
·
|
the
Company failed to (i) file the Registration Statement within thirty (30)
business days of the Closing Date (the “Filing Date”), (B) have the
Registration Statement declared effective within ninety (90) calendar days
from the Filing Date, or, if reviewed by the Commission, within one
hundred eighty (180) calendar days after the Filing Date, or (C) keep the
Registration Statement continuously effective until all of the Shares are
available for sale without registration pursuant to Rule 144(k);
or
|
|
·
|
the
Company fails to consummate a Qualified Offering within two (2) years of
the date hereof (each of the aforementioned conditions, a “Put Right
Trigger”).
|
Term of the Put Right - the
Put Right provided for the Put/Call Stockholders to exercise their Put Right by
giving written notice (“Put Exercise Notice”) of exercise of the Put Right to
the Company within thirty (30) days of a Put Right Trigger. The Put/Call
Stockholders may only exercise their Put Right as to all, but not less than all,
of the Put/Call Shares. Upon exercise of the Put Right by the Shareholder, the
repurchase of the Put/Call Shares by the Company was required to have been
consummated within ninety (90) days following the date of the Put Exercise
Notice.
In
accordance with accounting guidance the Company recorded the value of the
Put/Call agreement of $3,169,444 as a liability as of October 9, 2007. The value
of the Put/Call agreement was based on the fair market value of the underlying
common stock of $1.63 at October 9, 2007.
F-31
Emerald
Dairy Inc. and Subsidiaries
Footnotes
to Consolidated Financial Statements
December
31, 2009 and 2008
16. Put/Call Liability
(Continued)
On April
9, 2008, the Company and the Put/Call Stockholders executed a waiver and
amendment to the Put/Call Agreements reaffirming that the Put/Call Agreements
are still in full force and removing the following provision as a Put Right
Trigger:
|
·
|
The
Company fails to (i) file the Registration Statement within thirty (30)
business days of the Closing Date (the “Filing Date”), (B) have the
Registration Statement declared effective within ninety (90) calendar days
from the Filing Date, or, if reviewed by the Commission, within one
hundred eighty (180) calendar days after the Filing Date, or (C) keep the
Registration Statement continuously effective until all of the Shares are
available for sale without registration pursuant to Rule
144(k).
|
On March
3, 2009 the Company and the Put/Call Stockholders terminated the Put/Call
Agreements.
The
termination of the Put/Call Agreements was considered a type 1 event due to the
culmination of events that started with the waiver executed on April, 9, 2008
and ending with the termination of the Put/Call Agreements on March 3,
2009. As a type 1 event, the termination provided additional evidence
with respect to the valuation of the Put/Call Agreements as of December 31,
2008. As of December 31, 2008, Company reclassified the $3,169,444 value
previous recorded from liabilities to additional paid-in capital.
17. Equity
Registration
Rights Agreement
On
October 9, 2007 and October 19, 2007, the Company entered into Registration
Rights Agreements (each, a “Registration Rights Agreement,” and collectively the
“Registration Rights Agreements”) with certain accredited investors,( the
“Investors”), pursuant to which it agreed that within thirty (30) business days
of the Closing Date (the Filing Date), the Company will file a registration
statement (the Registration Statement) with the Commission covering the resale
of (i) the shares of common stock purchased in the October 2007 private
placements the Company consummated (collectively, the “Offerings”)
(the “Purchased Shares”), and (ii) the common stock issuable upon exercise of
the warrants issued in the Offerings (the “Registrable Securities”). Further,
the Company agreed to use its best efforts to (i) cause the Registration
Statement to be declared effective within ninety (90) calendar days from the
Filing Date, or, if reviewed by the Commission, within one hundred eighty (180)
calendar days after the Filing Date, and (ii) keep the Registration Statement
continuously effective until two (2) years after the Closing Date, subject to
normal and customary blackout periods. After two years the Company’s obligation
to keep the Registration Statement effective ends.
Pursuant
to the Registration Rights Agreements, the Company was required to pay
liquidated damages (payable in cash in arrears at the end of each month during
which a registration default occurs and is continuing) to the holders of the
Registrable Securities if (i) the Company failed to file the Registration
Statement within thirty (30) business days from the Closing Date, (ii) the
Commission did not declare the Registration Statement effective within ninety
(90) days of the Filing Date (or one hundred eighty (180) days in the event of a
review by the Commission) (the “Effectiveness Date”), (iii) the Company failed
to request acceleration of effectiveness within five (5) business days of a
notice of no further review from the Commission, (iv) the Company failed to
respond to the Commission within ten (10) business days of receipt by the
Company of any comments on the Registration Statement, or (v) after it has been
declared effective, the Registration Statement ceases to be effective or
available or if the Company suspends the use of the prospectus forming a part of
the Registration Statement (A) for more than thirty (30) days in any period of
365 consecutive days if the Company suspends in reliance on its ability to do so
due to the existence of a development that, in the good faith discretion of its
board of directors, makes it appropriate to so suspend or which renders the
Company unable to comply with SEC requirements, or (B) for more than sixty (60)
days in any period of 365 consecutive days for any reason. The liquidated
damages will accumulate at the rate of one and one-half percent (1.5%) of the
purchase price paid by the investors for the Registrable Securities offered for
each thirty (30) day period during which a registration default is
continuing.
F-32
Emerald
Dairy Inc. and Subsidiaries
Footnotes
to Consolidated Financial Statements
December
31, 2009 and 2008
17. Equity (Continued)
Notwithstanding
anything to the contrary stated in the Registration Rights Agreements, the
Company shall be entitled to limit the Registrable Securities to the extent
necessary to avoid any issues arising from the recent interpretations by the SEC
of Rule 415 of the Securities Act of 1933, as amended (the “Securities
Act”).
On
January 28, 2010 the registration statement filed with the Commission became
effective.
As of
October 20, 2008 liquidated damages stopped accruing because the shares covered
by the Registration Rights Agreements could be sold under Rule 144 of the
Securities Act. There are accrued liquidated damages of $1,201,998 at December
31, 2008, which represents the total damages payable under the agreement to
October 20, 2008. Liquidated damages of $986,699 were
accrued in the year ended December 31, 2008.
Per the
Registration Rights Agreements the Company can pay the $1,201,998 in liquidated
damages and $172,900 in interest in cash or Company common stock. The
Company issued 775,833 shares of the Company’s common stock for the based on the
closing price of the Company’s common stock on October 20, 2008 of
$1.80.
Warrants
Information
with respect to stock warrants outstanding as of December 31, 2009 are as
follows:
Exercise Price
|
Outstanding
December
31, 2008
|
Granted
|
Modified,
Expired or
Exercised
|
Outstanding
December
31, 2009
|
Expiration
Date
|
||||||||||||
$0.94
|
373,334 | -0- | -0- | 373,334 |
10/09/2010
|
||||||||||||
$1.50*
|
1,333,333 | -0- | (1,333,333 | ) | -0- |
10/09/2009
|
|||||||||||
$2.04
|
804,884 | -0- | (226,000 | ) | 578,884 |
10/09/2010
|
|||||||||||
$2.04
|
569,346 | -0- | (242,040 | ) | 327,306 |
10/19/2010
|
|||||||||||
$1.63
|
195,000 | -0- | -0- | 195,000 |
6/12/2011
|
||||||||||||
$1.63
|
75,000 | -0- | -0- | 75,000 |
6/20/2011
|
||||||||||||
$1.63
|
-0- | (a) | 97,500 | -0- | 97,500 |
12/31/2011
|
|||||||||||
$1.63
|
-0- | (b) | 100,000 | -0- | 100,000 |
11/10/2012
|
|||||||||||
$1.63
|
-0- | (c) | 120,000 | -0- | 120,000 |
11/30/2012
|
|||||||||||
$1.63
|
-0- | (d) | 536,809 | -0- | 536,809 |
12/24/2012
|
|||||||||||
$1.63
|
-0- | (e) | 789,536 | -0- | 789,536 |
12/31/2012
|
|||||||||||
$3.26*
|
2,061,227 | -0- | (2,061,227 | ) | -0- |
10/09/2009
|
|||||||||||
$3.26*
|
2,846,746 | -0- | (2,846,746 | ) | -0- |
10/19/2009
|
|||||||||||
$2.61
|
75,000 | -0- | -0- | 75,000 |
11/10/2011
|
*
|
On
January 28, 2010 the Company’s registration statement became effective
which extended the expiration date of the warrants until August
2011.
|
(a)
|
Placement
agent warrants issued June 30, 2009
|
(b)
|
Issued
in connetion with November 10, 2009 of November 2008 notes
payable
|
(c)
|
Placement
agent warrants issued in connection with November 30, 2009 notes payable
and extension of November 2008 notes
payable
|
(d)
|
Issued
in connection with December 24, 2009 notes
payable
|
(e)
|
Issued
in connection with December 31, 2009 extension of June 2008 notes
payable
|
As of
December 31, 2009 all outstanding warrants are exercisable.
F-33
Emerald
Dairy Inc. and Subsidiaries
Footnotes
to Consolidated Financial Statements
December
31, 2009 and 2008
17. Equity
(Continued)
Modification
of Warrants
On March
2, 2009, the Company entered into a Consulting Agreement with a placement agent
holding 235,583 warrants, pursuant to which, in consideration for certain
consulting services to be provided to the Company by the placement agent, the
Company agreed (i) to pay the placement agent a one-time consulting fee of
$38,000, and (ii) to reduce the per share exercise price of 235,583 warrants
received by the placement agent and its designees in connection with
the private offerings consummated by the Corporation in October 2007, from $2.04
to $1.63. Pursuant
to accounting guidance regarding equity-based payments to non-employees, the Company evaluated the
value of the warrants before and after the modification to determine the
incremental change in the value of the warrants.
The fair
value of the warrants as of March 2, 2009 before modification of the terms was
calculated to be $18,625. The following assumptions were used to
calculate the fair value of the warrants:
Dividend
yield
|
0 | % | ||
Expected
volatility
|
114.83 | % | ||
Risk-free
interest rate
|
0.75 | % | ||
Expected
life
|
1.58
years
|
|||
Stock
price
|
$ | 0.42 | ||
Exercise
price
|
$ | 2.04 |
The fair
value of the warrants as of March 2, 2009 after modification of the terms was
calculated to be $22,600. The following assumptions were used to
calculate the fair value of the warrants:
Dividend
yield
|
0 | % | ||
Expected
volatility
|
114.83 | % | ||
Risk-free
interest rate
|
0.75 | % | ||
Expected
life
|
1.58
years
|
|||
Stock
price
|
$ | 0.42 | ||
Exercise
price
|
$ | 1.63 |
The
incremental change in the value of the warrants is $22,600 less $18,625 or
$3,975, which was recorded to consulting expense.
Warrant
Tender Offers
As of
April 24, 2008, the Company commenced an offer (the “First Offer”) to the
holders (“Warrantholders”) of its then outstanding warrants, pursuant to which
the Warrantholders could tender their Warrants for shares of our Common Stock at
a reduced exercise price as follows:
|
·
|
With
respect to warrants having an exercise price of $0.94 per share, a holder
accepting the First Offer was entitled to exercise some or all of such
warrants at $0.75 per share of common
stock;
|
F-34
Emerald
Dairy Inc. and Subsidiaries
Footnotes
to Consolidated Financial Statements
December
31, 2009 and 2008
17. Equity (Continued)
|
·
|
With
respect to warrants having an exercise price of $1.50 per share, a holder
accepting the First Offer was entitled to exercise some or all of such
warrants at $1.20 per share of common
stock;
|
|
·
|
With
respect to warrants having an exercise price of $2.04 per share, a holder
accepting the First Offer was entitled to exercise some or all of such
warrants at $1.63 per share of common stock;
and
|
|
·
|
With
respect to warrants having an exercise price of $3.26 per share, a holder
accepting the First Offer was entitled to exercise some or all of such
warrants at $2.61 per share of common
stock.
|
On March
2, 2009, the Company closed on its First Offer to existing warrant holders to
exercise their warrants on amended terms. In connection with the First
Offer:
|
·
|
A
total of 183,457 warrants were tendered at the reduced exercise price of
$1.63 per share (originally $2.04 per share), for an aggregate exercise
price of $299,034; and
|
|
·
|
A
total of 175,937 warrants were tendered at the reduced exercise price of
$2.61 per share (originally $3.26 per share), for an aggregate exercise
price of $459,196.
|
As a
result, (a) a total of 359,394 shares of the Company’s common stock were issued
in connection with the exercise of such warrants and (b) the Company received
gross proceeds of $758,230 as payment of the exercise prices.
As of
June 19, 2009, the Company commenced an offer (the “Second Offer”) to the
holders of its then outstanding warrants, pursuant to which they could tender
their warrants for shares of the Company’s common stock at a reduced exercise
price as follows:
|
·
|
With
respect to warrants having an exercise price of $0.94 per share, a holder
accepting the Second Offer was entitled to exercise some or all of such
warrants at $0.75 per share of common
stock;
|
|
·
|
With
respect to warrants having an exercise price of $1.50 per share, a holder
accepting the Second Offer was entitled to exercise some or all of such
warrants at $1.20 per share of common
stock;
|
|
·
|
With
respect to warrants having an exercise price of $1.63 per share, a holder
accepting the Second Offer was entitled to exercise some or all of such
warrants at $1.30 per share of common
stock;
|
|
·
|
With
respect to warrants having an exercise price of $2.04 per share, a holder
accepting the Second Offer was entitled to exercise some or all of such
warrants at $1.63 per share of common stock;
and
|
|
·
|
With
respect to warrants having an exercise price of $3.26 per share, a holder
accepting the Second Offer was entitled to exercise some or all of such
warrants at $1.63 per share of Common
Stock.
|
F-35
Emerald
Dairy Inc. and Subsidiaries
Footnotes
to Consolidated Financial Statements
December
31, 2009 and 2008
17. Equity (Continued)
On August
13, 2009, the Company closed the Second Offer. In connection with the Second
Offer:
|
·
|
a
total of 49,000 warrants with an exercise price of $2.04 per share were
exchanged for amended warrants with a reduced exercise price of $1.63 per
share; and
|
|
·
|
a
total of 2,210,828 warrants with an exercise price of $3.26 per share were
exchanged for amended warrants with a reduced exercise price of $1.63 per
share.
|
On August
14, 2009, the holders of the amended warrants exercised 2,254,828 of the
warrants at $1.63 per share. As a result the Company received gross
proceeds of $3,675,370.
Stock
Issued for Consulting
The
Company entered into an Investor Relations Consulting Agreement (the “IR
Agreement”) with an consultant, as of January 1, 2009. Pursuant to
the IR Agreement, in consideration for investor relations services to be
provided to the Company by the consultant, the Company agreed to pay a monthly
retainer of $9,000, consisting of (i) $4,500 in cash, and (ii) such number of
shares of restricted stock of the Company to be determined by dividing $4,500 by
85% of the average closing trading price of the Company’s common stock for the
first ten trading days of the applicable month, capped at 10,588 shares per
month.
On June
30, 2009, the Company issued 37,804 shares of common stock with a fair value of
$33,475 pursuant to the IR Agreement. The fair value of the stock was
determined by the closing price of the stock on the 10th day of
each month, which is the day the number of shares is determined. The fair value
of $33,475 was charged to administrative expenses for the year ended December
31, 2009.
On
December 31, 2009, the Company issued 18,632 shares of common stock with a fair
value of $32,811 pursuant to the IR Agreement. The fair value of the
stock was determined by the closing price of the stock on the 10th day of
each month, which is the day the number of shares is determined. The fair value
of $32,811 was charged to administrative expenses for the year ended December
31, 2009.
Placement
Agent Warrants
On July
4, 2009 the Company agreed to issue 97,500 warrants to purchase the Company’s
common stock at $1.63 per share expiring December 31, 2011 to a placement agent
for assistance in the extension of the June 2008 notes. The fair value of the
warrants as of July 4, 2009 was calculated to be $117,155. The
following assumptions were used to calculate the fair value of the
warrants:
Dividend
yield
|
0 | % | ||
Expected
volatility
|
136.86 | % | ||
Risk-free
interest rate
|
1.68 | % | ||
Expected
life
|
2.5
years
|
|||
Stock
price
|
$ | 1.65 | ||
Exercise
price
|
$ | 1.63 |
F-36
Emerald
Dairy Inc. and Subsidiaries
Footnotes
to Consolidated Financial Statements
December
31, 2009 and 2008
17. Equity (Continued)
The
$117,155 fair value of the warrants were treated as loan costs to be amortized
over the life of the loan, therefore, $58,577 of the cost was recorded in
interest expense and the remaining $58,578 was amortized over the remaining life
of the loan.
Financial
Advisor Warrants
On
September 2, 2009, the Company entered into with a financial advisor in
connection with a proposed financing in the amount of $20.0 million, for a
period commencing on September 2, 2009 and continuing for six
months.
Pursuant
to the agreement, in consideration for the services to be provided to the
Company by the financial advisor, the Company agreed to (a) pay the advisor a
cash fee equal to $700,000, payable in 24 equal monthly installments, deferred
until the closing of a funding proposed financing; provided, however, that the
Company pay the advisor a non-refundable retainer of $15,000 (which was paid
9/15/09) to be deducted from the cash fee, (b) grant to the financial advisor
five-year warrants to purchase 714,286 shares of the Company’s common stock,
which are exercisable six months after September 2, 2009, subject to the closing
of the proposed financing, (i) at an exercise price of $1.68 per share, or (ii)
on a cashless basis; provided, however, that all of the Warrants will terminate
if a funding in proposed financing fails to close by the June 30, 2010, and (c)
reimburse AFH for up to an aggregate of $35,000 of their accountable actual
out-of-pocket reasonable expenses.
The
Company will record the fair value of the warrants as determined at the date of
the closing of the proposed financing when the warrants will become fully vested
at the closing of the proposed financing.
On
November 23, 2009 the agreement was revised to include an additional 44,643
warrants at the same terms as the warrants on September 2,
2009. The company will record the fair value of the warrants as
determined at the date of the closing of the proposed financing when the
warrants will become fully vested at the closing of the proposed
financing.
18. Common Welfare
Reserves
The
Company is required to transfer 10% of its net income, as determined in
accordance with PRC accounting rules and regulations, to the general reserve.
The Company voluntarily contributed an additional 5% in the years ended December
31, 2009 and 2008. The balance of these reserves at December 31, 2009 and
December 31, 2008, was $1,834,742 and $1,314,861, respectively. These amounts
are restricted and are included in retained earnings.
This fund
can only be utilized on capital items for the collective benefit of the
Company’s employees, such as construction of dormitories, cafeteria facilities,
and other staff welfare facilities. The fund is non-distributable other than
upon liquidation.
19. Earnings Per Share
When
calculating diluted earnings per share for stock option common stock
equivalents, the Earnings Per Share Topic, ASC 260, requires the Company to
include the potential shares that would be outstanding if all outstanding stock
options or warrants were exercised. This is offset by shares
the Company could repurchase using the proceeds from these hypothetical
exercises to obtain the common stock equivalent.
F-37
Emerald
Dairy Inc. and Subsidiaries
Footnotes
to Consolidated Financial Statements
December
31, 2009 and 2008
19. Earnings Per Share
(Continued)
The
following reconciles the components of the EPS computation:
For the
year ended December 31, 2009, dilutive shares include outstanding warrants to
purchase 373,334 shares of common stock at an exercise price of $0.94. Warrants
to purchase 3,130,618 share of common stock were not included in dilutive shares
as the effect would have been anti-dilutive.
For the
year ended December 31, 2008, dilutive shares include outstanding warrants to
purchase 373,334 shares of common stock at an exercise price of $0.94 and
warrants to purchase 1,333,333 shares at an exercise price of $1.50. Warrants to
purchase 6,627,203 share of common stock were not included in dilutive shares as
the effect would have been anti-dilutive.
The
following reconciles the components of the EPS computation:
Income
|
Shares
|
Per Share
|
||||||||||
(Numerator)
|
(Denominator)
|
Amount
|
||||||||||
For
the year ended December 31, 2009:
|
||||||||||||
Net
income
|
$
|
4,212,023
|
||||||||||
Basic
EPS income available to common shareholders
|
$
|
4,212,023
|
30,661,333
|
$
|
0.14
|
|||||||
Effect
of dilutive securities:
|
||||||||||||
Warrants
|
—
|
117,178
|
||||||||||
Stock
options
|
—
|
407,662
|
||||||||||
Diluted
EPS income available to common shareholders
|
$
|
4,212,023
|
31,001,248
|
$
|
0.14
|
|||||||
For
the year ended December 31, 2008:
|
||||||||||||
Net
income
|
$
|
2,314,507
|
||||||||||
Basic
EPS income available to common shareholders
|
$
|
2,314,507
|
29,299,332
|
$
|
0.08
|
|||||||
Effect
of dilutive securities:
|
||||||||||||
Warrants
|
—
|
218,735
|
||||||||||
Diluted
EPS income available to common shareholders
|
$
|
2,314,507
|
29,518,067
|
$
|
0.08
|
20. Equity Incentive
Plan
On March
2, 2009, the Company’s board of directors and majority stockholders adopted the
Emerald Dairy Inc. 2009 Equity Incentive Plan (the “Plan”) to attract and retain
the best available personnel, provide additional incentives to employees,
directors and consultants and promote the success of the Company’s business.
1,500,000 shares of the Company’s common stock have been reserved for issuance
under the Plan. A description of certain provisions of the Plan are
as follows:
Eligibility
The
Company may grant awards to its employees, directors and consultants, including
those of the Company’s subsidiaries. However, the Company may grant options that
are intended to qualify as incentive stock options (“ ISOs”) only to its
employees and employees of its subsidiaries.
F-38
Emerald
Dairy Inc. and Subsidiaries
Footnotes
to Consolidated Financial Statements
December
31, 2009 and 2008
20. Equity Incentive Plan
(Continued)
Acceleration of Awards upon
Corporate Transactions.
The
outstanding awards will terminate and/or accelerate upon occurrence of certain
significant corporate transactions, including amalgamations, consolidations,
liquidations or dissolutions, sales of substantially all or all of the Company’s
assets, reverse takeovers or acquisitions resulting in a change of
control.
Exercise Price and Term of
Awards.
In
general, the plan administrator will determine the exercise price of an option
in the award agreement. The exercise price may be a fixed price, or it may be a
variable price related to the fair market value of the Company’s ordinary
shares. If the Company grants an ISO to an employee, the exercise price may not
be less than 100% of the fair market value of its common stock on the date of
the grant, except that if the grantee, at the time of that grant, owns shares
representing more than 10% of the voting power of all classes of the Company’s
shares of common stock, the exercise price may not be less than 110% of the fair
market value of its common stock on the date of that grant. If the Company
grants a non-qualified share option to a grantee, the exercise price may not be
less than 100% of the fair market value of its common stock on the date of
grant.
The term
of each award under the Plan will be specified in the award agreement, but may
not exceed ten years from the earlier of the adoption or the approval of the
plan, unless sooner terminated.
Total
share-based compensation costs included on the Consolidated Statements of
Operations were $265,825 and none during the years ended December 31, 2009 and
2008, respectively. All share-based compensation costs are included in
administrative expenses.
The
Company estimates the fair value of the awards using a Black-Scholes option
pricing valuation model, consistent with accounting guidance. Key inputs and
assumptions used to estimate the fair value of stock options include the grant
price of the award, the expected option term, volatility of the Company’s stock,
the risk-free rate and the Company’s dividend yield. Estimates of fair value are
not intended to predict actual future events or the value ultimately realized by
grantees, and subsequent events are not indicative of the reasonableness of the
original estimates of fair value made by the Company.
The fair
value of each award is estimated on the date of the grant using the
Black-Scholes option pricing model. No dividends were assumed due to the nature
of the Company’s current business strategy. The following table presents the
weighted average assumptions used for options granted:
Number
of options
|
1,463,200 | |||
Risk
free interest rate
|
.50 | % | ||
Expected
life (year)
|
1.25 | |||
Expected
volatility
|
206.83 | % | ||
Weighted
average fair value per option
|
$ | 0.7434 |
The risk
free interest rate was determined from the daily interest rate of United State
Treasury securities for the expected life on the date of grant. The
expected volatility was based on the Company’s common stock past trading
history.
F-39
Emerald
Dairy Inc. and Subsidiaries
Footnotes
to Consolidated Financial Statements
December
31, 2009 and 2008
20. Equity Incentive
Plan
Share
Options and Share Appreciation Rights
A summary
of the Company’s outstanding share option and share appreciation award grants as
of December 31, 2009 and changes during the year then ended are presented
below:
Shares
|
Weighted-Average
Exercise Price
|
Weighted-Average
Remaining
Contractual Term
|
Aggregate
Intrinsic Value
|
|||||||||||||
(in
years)
|
||||||||||||||||
Outstanding
at December 31, 2008
|
-0- | $ | — | |||||||||||||
Granted
|
1,463,200 | 1.14 | ||||||||||||||
Exercised
|
-0- | — | ||||||||||||||
Expired
|
-0- | — | ||||||||||||||
Forfeited
|
-0- | — | ||||||||||||||
Outstanding
at December 31, 2009
|
1,463,200 | $ | 1.14 | 9.17 | $ | 970,416 | ||||||||||
Vested
or expected to vest at December 31, 2009
|
1,463,200 | $ | 1.14 | 9.17 | $ | — | ||||||||||
Exercisable
at December 31, 2009
|
175,800 | $ | 0.42 | 9.17 | $ | 242,604 |
As of
December 31, 2009, there was $821,954 of total unrecognized compensation
costs related to non-vested Company share options granted under Company share
option plans. The cost is expected to be recognized over a weighted-average
period of 1.26 years.
21. Commitments and
Contingencies
The
Company has various purchase commitments for materials, supplies and services
incident to the ordinary conduct of business, generally for quantities required
for the Company’s business and at prevailing market prices. No material annual
loss is expected from these commitments.
The
Company has contracted to purchase equipment from a supplier for the second
processing facility for $5,301,011 of which $3,710,707 has been
paid. The remaining $1,590,304 will be paid on delivery and
completion of installation of the equipment in 2010.
The
Company has advances to milk suppliers of $368,566 which will be offset against
future milk purchases from those suppliers (see Note 7, Advances to suppliers
and other receivables).
F-40
Emerald
Dairy Inc. and Subsidiaries
Footnotes
to Consolidated Financial Statements
December
31, 2009 and 2008
21. Commitments and Contingencies
(Continued)
In order
for the Company to conduct its current operations, an Infant & Baby Formula
Milk Powder Production Permit is required from the State General Administration
of Quality Supervision and Inspection and Quarantine of the People’s Republic of
China (the “Administration”). The Company’s current license will expire in may
2010. The Company is in the process of renewing this permit, and has no reason
to believe the permit will not be renewed. Other than the foregoing,
no government approvals are required to conduct the Company’s principal
operations, and the Company is not aware of any probable governmental regulation
of our business sectors in the near future. Although management believes that
the Company is in material compliance with the statutes, laws, rules and
regulations of every jurisdiction in which it operates, no assurance can be
given that the Company’s compliance with the applicable statutes, laws,
rules and regulations will not be challenged by governing authorities or
private parties, or that such challenges will not lead to a material adverse
effect on the Company’s financial position, results of operations, or cash
flows.
The
Company and its subsidiaries are self-insured, and they do not carry any
property insurance, general liability insurance, or any other insurance that
covers the risks of their business operations. As a result any material loss or
damage to its properties or other assets, or personal injuries arising from its
business operations would have a material adverse effect on the Company’s
financial condition and operations.
The
Company is not involved in any legal matters arising in the normal course of
business. While incapable of estimation, in the opinion of the management, the
individual regulatory and legal matters in which it might involve in the future
are not expected to have a material adverse effect on the Company’s financial
position, results of operations, or cash flows.
22. Operating Leases
The
Company leases various distribution facilities. All of these leases are for 2
years and commenced on January 1, 2010. The Company also leases office space
which expires September, 2011. For the years ended December 31, 2009
and 2008, the Company incurred rental expense of $76,098 and $17,255,
respectively. As of December 31, 2009, the Company had outstanding lease
commitments totaling $276,256, $157,328 due in 2010 and $118,928
due in 2011.
23. Subsequent Events
Warrant
Tender Offer
On
February 10, 2010 the Company commenced an offer (the “Third Offer”) to the
holders of 5,374,648 outstanding warrants to purchase shares of the Company’s
common stock originally issued in connection with the private offerings the
Company consummated in October 2007, having exercise prices of either $0.94,
$1.50, $1.63, $2.04 or $3.26 per share (the “Original Warrants”), to voluntarily
exchange any or all of the Original Warrants for amended warrants exercisable at
reduced exercise prices (“Amended Warrants”). The reduced exercise
prices of the Amended Warrants will depend on the current exercise prices
applicable to the Original Warrants. As of February 10, 2010, the Original
Warrants included:
|
·
|
373,334
Original Warrants to purchase shares of Common Stock at an exercise price
of $0.94 per share, which may be exchanged for Amended Warrants
exercisable at a reduced price of $0.75 per
share,
|
|
·
|
1,333,333
Original Warrants to purchase shares of Common Stock at an exercise price
of $1.50 per share, which may be exchanged for Amended Warrants
exercisable at a reduced price of $1.20 per
share,
|
|
·
|
235,583
Original Warrants to purchase shares of Common Stock at an exercise price
of $1.63 per share, which may be exchanged for Amended Warrants
exercisable at a reduced price of $1.30 per
share,
|
F-41
Emerald
Dairy Inc. and Subsidiaries
Footnotes
to Consolidated Financial Statements
December
31, 2009 and 2008
23. Subsequent Events
(Continued)
|
·
|
906,190
Original Warrants to purchase shares of Common Stock at an exercise price
of $2.04 per share, which may be exchanged for Amended Warrants
exercisable at a reduced price of $1.63 per share,
and
|
|
·
|
2,526,208
Original Warrants to purchase shares of Common Stock at an exercise price
of $3.26 per share, which may be exchanged for Amended Warrants
exercisable at a reduced price of $1.63 per
share.
|
The only
differences between the Original Warrants and the Amended Warrants that were
offered, related to (i) the lower exercise prices, (ii) the shortening of the
exercise period to twenty (20) days following the expiration of the Third Offer,
(iii) the deletion of the provision that holders may not exercise their warrants
if the exercise will cause them and their affiliates to beneficially own an
aggregate of more than 9.9% of the outstanding shares of Common Stock of the
Company, and (iv) the requirement that the exercise price must be paid in cash,
as a cashless exercise of the Amended Warrants will not be
accepted.
On March
17, 2010 the Company closed the Third Offer with the following warrants
exchanged:
|
·
|
a
total of 373,334 Original Warrants with exercise prices of $0.94 per share
were exchanged for Amended Warrants with reduced exercise prices of $0.75
per share;
|
|
·
|
a
total of 499,522 Original Warrants with exercise prices of $1.50 per share
were exchanged for Amended Warrants with reduced exercise prices of $1.20
per share;
|
|
·
|
no
Original Warrants with exercise prices of $1.63 per share were exchanged
for Amended Warrants with reduced exercise prices of $1.30 per
share;
|
|
·
|
a
total of 30,675 Original Warrants with exercise prices of $2.04 per share
were exchanged for Amended Warrants with reduced exercise prices of $1.63
per share; and
|
|
·
|
a
total of 153,374 Original Warrants with exercise prices of $3.26 per share
were exchanged for Amended Warrants with reduced exercise prices of $1.63
per share.
|
If all
warrants exchanged are exercised within the 20 days before expiration period
discussed above, the Company would receive $1,179,427 in proceeds.
Issuance
of Shares
On March
18, 2010 the Company issued 180,000 shares of the Company’s common stock with a
fair value of $250,200 to an employee for services in 2009. The
$250,200 has been accrued as compensation expense for the year ended December
31, 2009, and is included in accrued payroll at December 31, 2009.
Extension
of Warrants
Pursuant
to the provisions of Section 10 of the respective common stock purchase warrants
(the “Warrants”) previously issued by the Company to the investors and certain
finders and placement agents in connection with private offerings the Company
consummated in October 2007, the original expiration dates of the Warrants were
to be extended beyond their initial stated termination dates for certain
specified periods until the Company satisfied certain registration rights
provisions relating to the shares of the Company’s common stock underlying the
Warrants. As a result of the Company’s satisfaction on January 28, 2010 of
certain registration rights provisions relating to the warrants, the expiration
dates of the Warrants were adjusted to provide as follows:
F-42
Emerald
Dairy Inc. and Subsidiaries
Footnotes
to Consolidated Financial Statements
December
31, 2009 and 2008
23. Subsequent events
(Continued)
|
·
|
373,334
Warrants exercisable at $0.94 per share that would otherwise have expired
on October 9, 2010 now expire on August 1,
2012;
|
|
·
|
1,333,333
Warrants exercisable at $1.50 per share that would otherwise have expired
on October 9, 2009 now expire on August 2,
2011;
|
|
·
|
190,245
Warrants exercisable at $2.04 per share that would otherwise have expired
on October 9, 2010 now expire on August 1,
2012;
|
|
·
|
981,747
Warrants exercisable at $3.26 per share that would otherwise
have expired on October 9, 2009 now expire on August 2,
2011;
|
|
·
|
235,583
Warrants exercisable at $1.63 per share that would otherwise have expired
on October 19, 2010 now expire on August 11,
2012;
|
|
·
|
715,945
Warrants exercisable at $2.04 per share that would otherwise
have expired on October 19, 2010 now expire on August 11, 2012;
and
|
|
·
|
1,544,461
Warrants exercisable at $3.26 per share that would otherwise have expired
on October 19, 2009 now expire on August 12,
2011.
|
The
extended expiration dates have been noted on the Company’s records and it is not
necessary for the holders to exchange their original Warrants for amended
warrants. No other terms of the Warrants were
changed.
The
Company will record as an expense liquidated damages of $5,021,669
resulting from the extension of the expiration dates of the Warrants on January
28, 2010.
24. Segment Reporting
The
Company has key product lines of milk, soybean milk, and rice powder, the
Company’s chief operating decision maker reviews and evaluates one set of
combined financial information deciding how to allocate resources and in
assessing performance.
For the
years ended December 31, 2009 and 2008, the Company’s sales revenue from various
products are as follows:
Year
Ended December 31,
|
||||||||
2009
|
2008
|
|||||||
Milk
powder
|
$
|
38,590,606
|
$
|
36,245,495
|
||||
Soybean
milk powder
|
1,164,347
|
882,185
|
||||||
Rice
powder
|
1,358,127
|
1,105,837
|
||||||
Sub-contract
processing
|
3,616,196
|
6,091,662
|
||||||
$
|
44,729,276
|
$
|
44,325,179
|
F-43
Item
9. Changes In and Disagreements With Accountants on Accounting and
Financial Disclosure.
None.
Item
9A(T). Controls and Procedures.
Evaluation
of Disclosure Controls
Our
management maintains disclosure controls and procedures, as defined in Rules
13a-15(e) and 15d-15(e) of the Exchange Act that are designed to provide
reasonable assurance that the material information required to be disclosed by
us in our periodic reports filed or submitted under the Exchange Act is
recorded, processed, summarized, and reported within the time periods specified
in the SEC’s rules and forms. Disclosure controls and procedures include,
without limitation, controls and procedures designed to ensure that information
required to be disclosed by us in the reports that we file or submit under the
Exchange Act is accumulated and communicated our management, including our Chief
Executive Officer and Chief Financial Officer, to allow timely decisions
regarding required disclosure.
As of
December 31, 2009, our management, under the supervision of and with the
participation of our Chief Executive Officer and Chief Financial Officer,
evaluated the effectiveness of our disclosure controls and procedures as
required by Rules 13a-15(b) and 15d-15(b) under the Exchange Act. Based upon
this evaluation, our Chief Executive Officer and Chief Financial Officer
concluded that our disclosure controls and procedures were not effective as of December 31, 2009 as a result of the
material weaknesses identified in our internal control over financial reporting.
These material weaknesses are discussed in “Management’s Report on Internal
Control over Financial Reporting” below. Our management considers our internal
control over financial reporting to be an integral part of our disclosure
controls and procedures.
Management’s
Report on Internal Control over Financial Reporting
Our
management is responsible for establishing and maintaining adequate internal
control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f)
under the Securities Exchange Act of 1934. Our internal control over financial
reporting is designed to provide reasonable assurance to our management and
Board of Directors regarding the reliability of financial reporting and the
preparation and fair presentation of financial statements for external purposes
in accordance with generally accepted accounting principles in the United
States.
Our
internal control over financial reporting includes those policies and procedures
that (i) pertain to the maintenance of records that, in reasonable detail,
accurately and fairly reflect the transactions and dispositions of our assets;
(ii) provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of ours are being made
only in accordance with authorizations of our management and directors; and
(iii) provide reasonable assurance regarding prevention or timely detection of
unauthorized acquisition, use, or disposition of our assets that could have a
material effect on the financial statements.
The
effectiveness of any system of internal control over financial reporting is
subject to inherent limitations, including the exercise of judgment in
designing, implementing, operating, and evaluating the controls and procedures.
Because of these inherent limitations, internal control over financial reporting
cannot provide absolute assurance regarding the reliability of financial
reporting and may not prevent or detect misstatements. Also, projections of any
evaluation of effectiveness to future periods are subject to the risk that
controls may become inadequate because of changes in conditions, or that the
degree of compliance with the policies or procedures may
deteriorate.
As
disclosed in our 2008 Annual Report on Form 10-K, and in our Quarterly Reports
on Form 10-Q for each of the first three quarters of 2009, we reported a
material weakness in our internal control over financial reporting related to
the improper treatment of the effects of exchange rate changes on cash balances
held in foreign currencies in the 2006 statements of cash flows; and inadequate
or incomplete review and analysis of certain contractual and other liabilities.
We have since undertaken remediation efforts with respect to these material
weaknesses, as discussed in the section “2009 Remediation”
below.
- 48
-
As of
December 31, 2009, our management, under the supervision of and with the
participation of the Chief Executive Officer and the Chief Financial Officer,
evaluated the effectiveness of our internal control over financial reporting as
required by Rules 13a-15(c) and 15d-15(c) under the Exchange Act. In making this
assessment, our management used the criteria set forth by the Committee of
Sponsoring Organizations of the Treadway Commission (“COSO”) in Internal Control – Integrated
Framework, including the following five framework components: (i) control
environment, (ii) risk assessment, (iii) control activities, (iv) information
and communications, and (v) monitoring.
Our
management evaluated the design and operating effectiveness of its internal
controls over financial reporting as part of this assessment, using its
knowledge and understanding of our organization, operations, and processes, to
determine, in our judgment, the sources and potential likelihood of
misstatements in financial reporting. Based on this assessment, our management,
including the Chief Executive Officer and Chief Financial Officer, has concluded
that our internal control over financial reporting was not effective as of
December 31, 2009.
Specifically,
our management identified certain matters involving internal control and our
operations that it considered to be material weaknesses. As defined in the
Exchange Act, a material weakness is a deficiency, or a combination of
deficiencies, in internal control over financial reporting such that there is a
reasonable possibility that a material misstatement of the registrant's annual
or interim financial statements will not be prevented or detected on a timely
basis. The material weaknesses identified by our management are described
below:
|
·
|
We
did not design, implement or maintain effective entity-level controls
related to our control environment, including the
following:
|
|
o
|
An
absence of independence and financial expertise on the Board of Directors
and related Audit Committee, limiting our ability to provide effective
oversight of our management;
|
|
o
|
A
lack of a consistent code of business conduct across all corporate
entities that is specifically designed for public company applicability,
including policies related to insider trading, conflicts of interest,
legal compliance, and related-party transactions;
and
|
|
o
|
A
lack of consistent, formalized human resources policies and procedures
across its corporate entities which specifically detail required financial
reporting competencies and the importance of complying with our objectives
regarding internal controls over financial
reporting.
|
Our
management believes that the pervasive nature of these control deficiencies,
when aggregated, impact all significant accounts and rise to the level of
material weakness.
|
·
|
We
lacked sufficient accounting personnel at the Chinese operating unit level
with the experience and training to effectively address the GAAP
accounting, financial reporting, internal control, and other regulatory
compliance requirements we are subject to as a U.S. listed public company.
Because this control deficiency, and the related segregation of duties
constraints, is pervasive in nature and impacts all significant accounts,
our management believes this deficiency rises to the level of material
weakness.
|
|
·
|
We
lacked sufficient IT personnel with the experience and training to provide
for adequate segregation of duties and effective oversight of core IT
functions, including controls over access, change, data, and security
management. In addition, we lacked formalized polices and procedures to
ensure that all relevant financial information is secure, identified,
captured, processed, and reported within the accounting system. Because
this control deficiency, and the related segregation of duties
constraints, is pervasive in nature and impacts all significant accounts,
our management believes this deficiency rises to the level of material
weakness.
|
- 49
-
Our
management has taken and is continuing to take the following actions to improve
our internal controls over financial reporting, including actions to remediate
the identified material weaknesses in 2009.
2009
Remediation
|
·
|
Our
management engaged the services of qualified consultants with China GAAP,
U.S. GAAP, and SEC reporting experience to assist and support our
management’s financial reporting and SOX compliance requirements for 2009,
including the following:
|
|
o
|
Identifying
and resolving non-routine or complex accounting
matters;
|
|
o
|
Controlling
period-end financial closing and reporting
processes;
|
|
o
|
Identifying,
assessing, and applying accounting
principles;
|
|
o
|
Formalizing
its accounting policies and procedures, including defined roles and
responsibilities and required managerial reviews and
approvals;
|
|
o
|
Providing
review and analysis of all significant contractual
obligations;
|
|
o
|
Preparing
white papers to document all material transactions;
and
|
|
o
|
Providing
comparison review of China GAAP and U.S. GAAP
standards.
|
|
·
|
Our
management implemented a consistent set of policies and procedures related
to accounting, finance, and internal control, most notably in our
period-end financial closing and reporting processes, including defined
roles and responsibilities, documented segregations of duties, required
managerial reviews and approvals, and related checklists and other tools
to be used. Our management implemented these revised policies and
procedures across all of its corporate entities with appropriate staff
training to ensure that financial reporting competencies were
strengthened.
|
|
·
|
Our
management implemented a formalized process to manage our internal
controls over financial reporting and improve our compliance with the
Sarbanes-Oxley Act.
|
2010
Planned Remediation
|
·
|
As
financial conditions permit, our management will recruit an independent
financial expert to the Board of Directors to chair the Audit Committee
and formalize roles and responsibilities over our internal controls over
financial reporting for the Board and our management. Our management also
intends to develop and implement a formal corporate internal audit
capability, eventually reporting directly to an independent Audit
Committee, to provide more effective oversight of our internal control
over financial reporting.
|
|
·
|
Our
management will implement a Code of Conduct specifically designed for
public company applicability across all corporate entities. Company
directors, management and staff will be required to certify receipt of the
Code by signature. Thereafter, our management will periodically require
employees to acknowledge that they understand the contents of the Code,
and disclose whether they are aware of anyone in the Company that might
have violated some part of the
Code.
|
|
·
|
Our
management will formalize finance-related job descriptions for all staff
levels that specifically identify required financial reporting roles,
responsibilities, and competencies, and clarify responsibility for
maintaining our internal controls over financial reporting. Our management
will implement these revised policies and procedures across all of its
corporate entities with appropriate staff training to ensure that
financial reporting competencies are
strengthened.
|
- 50
-
|
·
|
Our
management will hire additional, qualified accounting personnel at the
Chinese operating unit level to enhance our financial reporting
competencies. Our management will also continue to provide training to
existing accounting personnel regarding our significant accounting
policies and procedures.
|
|
·
|
Our
management will continue to engage the services of qualified consultants
with China GAAP, U.S. GAAP and SEC reporting experience to assist with and
support our financial reporting and SOX compliance requirements in 2010,
including assistance with the
following:
|
|
o
|
Remediating
identified material weaknesses;
|
|
o
|
Monitoring
our internal controls over financial reporting on an ongoing
basis;
|
|
o
|
Managing
our period-end financial closing and reporting processes;
and
|
|
o
|
Identifying
and resolving non-routine or complex accounting
matters.
|
|
·
|
Our
management will determine and hire the staff competencies required to
ensure that essential IT general controls are maintained over our
accounting system. In addition, our management will formalize its policies
and procedures over core IT functions, including access, change, data, and
security management, to ensure that all relevant financial information is
secure, identified, captured, processed, and reported within the
accounting system.
|
Our
management will continue to monitor and evaluate the effectiveness of its
disclosure controls and procedures, as well as its internal controls over
financial reporting, on an ongoing basis, and is committed to taking further
action and implementing additional improvements, as necessary and as funds
allow. However, our management cannot guarantee that the measures taken or any
future measures will remediate the material weaknesses identified or that any
additional material weaknesses or significant deficiencies will not arise in the
future due to a failure to implement and maintain adequate internal controls
over financial reporting.
Notwithstanding
the material weaknesses described above, our management believes that there are
no material inaccuracies or omissions of material fact and, to the best of its
knowledge, believes that the consolidated financial statements included in this
annual report present fairly, in all material respects, our financial position,
results of operations, and cash flows for the periods presented in conformity
with accounting principles generally accepted in the United States.
Attestation
Report of the Company’s Registered Public Accounting Firm
This
Annual Report on Form 10-K does not include an attestation report of our
registered public accounting firm regarding internal control over financial
reporting. Our management’s report was not subject to attestation by our
registered public accounting firm pursuant to temporary rules of the SEC that
permit us to provide only our management’s report in this Annual Report on Form
10-K.
Changes
in Internal Control over Financial Reporting
Other
than the changes described in “Management's Report on Internal Control Over
Financial Reporting” above, there were no changes in our internal control over
financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the
Exchange Act) that occurred during the year ended December 31, 2009, that have
materially affected, or are reasonably likely to materially affect, our internal
control over financial reporting.
Item
9B. Other Information.
Not Applicable.
- 51
-
PART
III
Item
10. Directors, Executive Officers and Corporate Governance.
Identification
of Directors and Executive Officers
The
following table sets forth the name, age and position of each of the members of
our board of directors and executive officers as of the date of this
prospectus:
Name
|
Age
|
Position
|
||
Yang
Yong Shan
|
43
|
Chief
Executive Officer, President and Chairman of the Board
|
||
Shu
Kaneko
|
44
|
Chief
Financial Officer, Secretary and Director
|
||
Niu
Wan Chen
|
34
|
Vice
President of Sales and Director
|
||
Qin
Si Bo
|
46
|
Vice
President of Production and Director
|
||
Yuan
Yong Wei
|
55
|
Vice
President of Operation and
Director
|
YANG YONG SHAN, has been the
President and Chief Executive Officer of AIDH, and the Chairman of AIDH’s Board
of Directors since July 2000. As a result of our Reverse Merger, effective as of
October 9, 2007, he became our Chief Executive Officer, President and Chairman.
He obtained his bachelors degree from the Northeast Agricultural University in
1990.
SHU KANEKO, has been the Chief
Financial Officer and Secretary, and a Director, of ours since November 1, 2007.
Prior to joining us, Mr. Kaneko was a Manager with Ernst & Young Financial
Services Advisory Group, commencing in June 2001. He earned his M.B.A. degree
from Georgetown University in 2001.
NIU WAN CHEN, has been Vice
President of Sales, and a Director, of AIDH since October 2005. As a result of
our Reverse Merger, effective as of October 9, 2007, he became our Vice
President of Sales and Director. Prior to this, from January 2000 through
September 2005, he was Sales Manager at American Dairy, Inc. He obtained his
bachelors degree in business administration from Northeast Forest University in
1995.
QIN SI BO, has been Vice
President of Production, and a Director, of AIDH since July 2000. As a result of
our Reverse Merger, effective as of October 9, 2007, he became our Vice
President of Production and Director. He graduated with a major in Food and
Nutrition from the Northeast Agricultural University in 1993.
YUAN YONG WEI, has been Vice
President of Operation, and a Director, of AIDH since July 2000. As a result of
our Reverse Merger, effective as of October 9, 2007, he became our Vice
President of Operation and Director.
- 52
-
Director
Qualifications, Experience and Skills
All of
our directors bring to our Board of Directors a wealth of experience derived
from their services in industry specific operational businesses. Each of our
Board members has demonstrated strong acumen and an ability to exercise sound
judgment and has a reputation for integrity, honesty and adherence to ethical
standards. When considering whether directors and nominees have the experience,
qualifications, attributes and skills, taken as a whole, to enable the Board to
satisfy its oversight responsibilities effectively in light of our business and
structure, we focused primarily on the information discussed in each of the
director’s individual biographies set forth above and the specific individual
qualifications, experience and skills as described below:
|
·
|
Yang
Yong Shan has over 18 years of experience in the dairy industry in the
PRC, which provides us with invaluable industry contacts and know-how, in
addition to insight into our customers’ needs and
requirements.
|
|
·
|
Shu
Kaneko’s U.S. accounting background gives him knowledge of financial
reporting requirements and financial strategies which are integral for us
to meet our requirements as a public
company.
|
|
·
|
Niu
Wan Chen has over 10 years of experience handling sales of dairy products
in the PRC, which is instrumental in establishing our sales program and
sales network.
|
|
·
|
Qin
Si Bo’s extensive experience with respect to production process and
equipment maintenance in the dairy business has provided us with
invaluable information on these elements of our business, including with
respect to the equipping of the production line at out newly-constructed
facility in Hailun City.
|
|
·
|
Yuan
Yong Wei has over 20 years of experience in operations in the dairy
industry in the PRC, which provides us with key industry specific contacts
and information.
|
Family
Relationships
There are no family relationships among
our directors, executive officers, or persons nominated to become directors of
executive officers.
Involvement
in Certain Legal Proceedings.
There
have been no events under any bankruptcy act, no criminal proceedings and no
judgments, injunctions, orders or decrees material to the evaluation of the
ability and integrity of any director, executive officer, promoter or control
person of ours during the past five years.
Compliance
with Section 16(a) of the Exchange Act
To our
knowledge, based solely on a review of such materials as are required by the
SEC, none of our officers, directors or beneficial holders of more than 10% of
our issued and outstanding shares of common stock failed to timely file with the
SEC any form or report required to be so filed pursuant to Section 16(a) of the
Exchange Act, during the fiscal year ended December 31, 2009 except that: (i)
Yang Yong Shan did not file a Form 4 to report the grant of 360,000 stock
options under the Plan as of March 2, 2009, (ii) Shu Kaneko did not file a Form
4 to report the grant of 300,000 stock options under the Plan as of March 2,
2009, (iii) Niu Wan Chen did not file a Form 4 to report the grant of 15,200
stock options under the Plan as of March 2, 2009, (iv) Qin Si Bo did not file a
Form 4 to report the grant of 15,200 stock options under the Plan as of March 2,
2009, (v) Yuan Yong Wei did not file a Form 4 to report the grant of 12,800
stock options under the Plan as of March 2, 2009, (vi) Yang Yong Shan did not
file a Form 4 to report the grant of 380,000 stock options under the Plan as of
November 10, 2009, and (vii) Shu Kaneko did not file a Form 4 to report the
grant of 380,000 share appreciation rights under the Plan as of November 10,
2009. All of these transactions have been reported on Form 5s filed by the
respective reporting persons on February 16, 2010.
- 53
-
Code
of Ethics
As of the date hereof, we have not
adopted a written code of ethics that applies to our principal executive
officer, principal financial officer, principal accounting officer or
controller, or persons performing similar functions. We intend to adopt a
written code of ethics in the near future.
Board
Committees
As of the date hereof, we do not have
any committees to our Board of Directors. We intend to appoint such
persons to the Board of Directors and committees of the Board of Directors as
are expected to be required to meet the corporate governance requirements
imposed by a national securities exchange, although we are not required to
comply with such requirements until we elect to seek listing on a securities
exchange. We intend that a majority of our directors will be independent
directors, of which at least one director will qualify as an “audit committee
financial expert,” within the meaning of Item 407(d)(5) of Regulation S-B, as
promulgated by the SEC. Additionally, the Board of Directors is expected to
appoint an audit committee, nominating committee and compensation committee, and
to adopt charters relative to each such committee, in the near future. We do not
currently have an “audit committee financial expert” since we currently do not
have an audit committee in place.
- 54
-
Item
11. Executive Compensation.
Summary
Compensation Table
The table below sets forth, for the
last two fiscal years, the compensation earned by (1) Yang Yong Shan, who
was appointed as our Chairman, Chief Executive Officer and President on October
9, 2007, (2) Shu Kaneko, who was appointed as our Chief Financial
Officer and Secretary on November 1, 2007 and (3) Niu Wan Chen, who was
appointed as our Vice President of Sales on October 9, 2007 (the “Named
Executive Officers”). Except as provided below, none of our executive officers
received annual compensation in excess of $100,000 during the last two fiscal
years.
SUMMARY
COMPENSATION TABLE
Name
and Principal Position
|
Year
|
Salary
($)
|
Bonus
($)
|
Stock
Awards
($)
|
Option
Awards
($)
|
Non-Equity
Incentive Plan
Compensation
($)
|
Total
($)
|
|||||||||||||||||||
Yang
Yong Shan
|
2009
|
$ | 0.00 | $ | 0.00 | $ | 0.00 | $ | 134,818 | $ | 0.00 | $ | 134,818 | |||||||||||||
Chairman,
Chief Executive Officer and President (1)
|
2008
|
$ | 0.00 | $ | 0.00 | $ | 0.00 | $ | 0.00 | $ | 0.00 | $ | 0.00 | |||||||||||||
Shu
Kaneko
|
2009
|
$ | 150,000 | $ | 37,500 | $ | 0.00 | $ | 121,211 | $ | 0.00 | $ | 308,711 | |||||||||||||
Chief
Financial Officer, Secretary and Director (2)
|
2008
|
$ | 150,000 | $ | 0.00 | $ | 0.00 | $ | 0.00 | $ | 0.00 | $ | 150,000 | |||||||||||||
Niu
Wan Chen
|
2009
|
$ | 11,137 | $ | 0.00 | $ | 250,200 | $ | 3,447 | $ | 0.00 | $ | 264,784 | |||||||||||||
Vice
President of Sales and Director (3)
|
2008
|
$ | 7,067 | $ | 0.00 | $ | 0.00 | $ | 0.00 | $ | 0.00 | $ | 7,067 |
|
(1)
|
Yang
Yong Shan was appointed as our Chairman, Chief Executive Officer and
President as of October 9, 2007. We do not have an Employment Agreement
with Mr. Yang. On March 2, 2009, Mr. Yang was granted 360,000 stock
options under our 2009 Equity Incentive Plan (the "Plan"), exercisable at
a price of $0.42 per share, of which (a) 90,000 vested on each of
September 2, 2009 and March 2, 2010 and (b) an additional 90,000 will vest
on each of September 2, 2010 and March 2, 2011. On November 10, 2009, Mr.
Yang was granted an additional 380,000 stock options under the Plan,
exercisable at a price of $1.80 per share, of which 95,000 will vest on
each of May 10, 2010, November 10, 2010, May 10, 2011 and November 10,
2011. Mr. Yang did not receive any other compensation in the fiscal years
ended December 31, 2007, 2008 or
2009.
|
|
(2)
|
Shu
Kaneko was appointed as our Chief Financial Officer, Secretary, and a
member of our board of directors, on November 1, 2007. As of November 1,
2007, we entered into an Employment Agreement with Mr. Kaneko, pursuant to
which he is entitled to receive a base salary of $150,000 per annum. For
more information, see “-- Employment Contracts and Termination of
Employment and Change-in-Control Arrangements -- Employment Agreement with
Shu Kaneko” below. On March 2, 2009, Mr. Kaneko was granted 300,000 stock
options under the Plan, exercisable at a price of $0.42 per share, of
which (a) 75,000 vested on each of September 2, 2009 and March 2, 2010 and
(b) an additional 75,000 will vest on each of September 2, 2010 and March
2, 2011. On November 10, 2009, Mr. Kaneko was granted 380,000 share
appreciation rights, exercisable at a price of $1.80 per share, which will
vest with respect to 25% of the underlying shares on each of May 10, 2010,
November 10, 2010, May 10, 2011 and November 10,
2011.
|
|
(3)
|
Niu
Wan Chen was appointed as our Vice President of Sales and a member of our
board of directors as of October 9, 2007. We do not have an Employments
Agreement with Mr. Niu. On March 2, 2009, Mr. Niu was granted 15,200 stock
options under the Plan, exercisable at a price of $0.42 per share, of
which (a) 3,800 vested on each of September 2, 2009 and March 2, 2010 and
(b) an additional 3,800 will vest on each of September 2, 2010 and March
2, 2011. As of March 18, 2010, the board authorized the issuance of
180,000 shares of our common stock to Mr. Niu as additional compensation
for services in fiscal 2009.
|
- 55
-
Employment
Contracts and Termination of Employment and Change-in-Control
Arrangements
Employment Agreement with Shu
Kaneko
On November 1, 2007 (the “Effective
Date”), we entered into an Employment Agreement with Shu Kaneko (the “Employment
Agreement”), pursuant to which Mr. Kaneko will serve as our Chief Financial
Officer. The Employment Agreement commenced on the Effective Date and will
terminate on the second anniversary thereof (the “Employment Period”), unless
extended as provided for in the Employment Agreement.
In consideration for Mr. Kaneko’s
services, we will pay Mr. Kaneko a minimum annual salary of $150,000 (the “Base
Salary”). In addition to the Base Salary, Mr. Kaneko may receive a discretionary
bonus at our fiscal year end, in an amount up to three (3) months of his Base
Salary. As additional consideration, Mr. Kaneko may receive issuances and/or
grants of our securities, in amounts, and subject to terms and conditions, to be
determined by the Board of Directors, in its sole discretion.
During the Employment
Period:
|
·
|
Mr.
Kaneko will serve as a member of our Board of Directors, for no additional
consideration, except as may be provided to all directors
generally;
|
|
·
|
We
will provide Mr. Kaneko with all benefits generally made available to our
senior executives;
|
|
·
|
We
will reimburse Mr. Kaneko for all reasonable business expenses;
and
|
|
·
|
Mr.
Kaneko will be entitled to twenty-five (25) days of paid vacation per
year.
|
Mr. Kaneko’s employment may be
terminated prior to the expiration of the Employment Period as
follows:
|
·
|
Mr.
Kaneko’s employment will terminate immediately upon his
death;
|
|
·
|
We
will have the right to terminate Mr. Kaneko’s employment during the
continuance of Mr. Kaneko’s “Disability” (as defined in the Employment
Agreement), upon fifteen (15) days’ prior
notice;
|
|
·
|
We
will have the right to terminate Mr. Kaneko’s employment with or without
“Good Cause” (as such term is defined in the Employment Agreement) by
written notice Mr. Kaneko; and
|
|
·
|
Mr.
Kaneko will have the right to voluntarily resign his employment with or
without “Good Reason” (as such term is defined in the Employment
Agreement) by written notice to us.
|
In each case, the “Termination Date”
will be date as of which Mr. Kaneko’s employment terminates.
In the event we terminate Mr. Kaneko’s
employment without Good Cause, or Mr. Kaneko resigns for Good Reason, we will
pay Mr. Kaneko his Base Salary for the period of six (6) months, and any Base
Salary, bonuses, vacation and unreimbursed expenses accrued but unpaid as of the
Termination Date. In addition, we will, at its sole expense, provide Mr. Kaneko
(and his dependents) with coverage under our medical and health insurance plans
for the period of twelve (12) months.
Upon termination of Mr. Kaneko’s
employment upon his death, as a result of his Disability, for Good Cause, or as
a result of his voluntary resignation, we will have no payment or other
obligations to Mr. Kaneko, except for the payment of any Base Salary, bonuses,
benefits or unreimbursed expenses accrued but unpaid as of the Termination
Date.
- 56
-
Mr. Kaneko has agreed to standard
confidentiality, non-compete and non-solicitation provisions. He has also agreed
that all “Work Product” he develops during the Employment Period belongs to
us.
We have agreed to indemnify and hold
Mr. Kaneko harmless to the full extent permitted by the Nevada Revised Statutes,
and other relevant statutes. In addition, we may, for our own benefit, in our
sole discretion, maintain “key-man” life and disability insurance policies
covering Mr. Kaneko.
Through December 31, 2009, and the
interim period ending on the date hereof, we had no other employment contracts,
compensatory plans or arrangements, including payments to be received from us,
with respect to any director or executive officer of ours which would in any way
result in payments to any such person because of his or her resignation,
retirement or other termination of employment with us or any subsidiary, any
change in control, or a change in the person’s responsibilities following a
change in control.
Stock
Incentive Plans
In March 2009, our board of directors
adopted and our stockholders approved the Plan to attract and retain the best
available personnel, provide additional incentives to employees, directors and
consultants and promote the success of our business. 1,500,000 shares of the
Company’s common stock have been reserved for issuance under the Plan. The
following paragraphs describe the principal terms of the Plan.
Types of
Awards
We may grant the following types of
awards under the Plan:
|
·
|
options
to purchase shares of our common
stock;
|
|
·
|
share
appreciation rights, which entitle the grantee the right to common stock
or cash compensation measured by the appreciation in the value of the
shares;
|
|
·
|
dividend
equivalent rights, which entitle the grantee to compensation equivalent to
dividends paid with respect to common
stock;
|
|
·
|
restricted
shares, which are shares of common stock issued to the grantee that are
subject to transfer restrictions, right of first refusal, repurchase,
forfeiture, and other terms and conditions as established by our plan
administrator;
|
|
·
|
restricted
share units, which may be earned upon the passage of time or the
attainment of performance criteria and which may be settled for cash,
common stock or other securities, or a combination of cash, common stock
or other securities as established by the plan
administrator;
|
|
·
|
share
payments, which may be (a) payments in the form of common stock; or (b)
options or other rights to purchase common stock, as part of any bonus,
deferred compensation or other arrangement, made in lieu of all or any
portion of the compensation; and
|
|
·
|
deferred
shares, which are rights to receive a specified number of shares of common
stock during specified time
periods.
|
Plan
Administration
Our compensation committee will serve
as plan administrator for purposes of administering the Plan and determining the
provisions and terms and conditions of each award grant. If no compensation
committee exists, the Plan shall be administered by our full board of
directors.
- 57
-
Award
Agreement
Awards granted under the Plan will be
evidenced by an award agreement that sets forth the terms, conditions and
limitations for each award.
Eligibility
We may grant awards to our employees,
directors and consultants, including those of our subsidiaries. However, we may
grant options that are intended to qualify as incentive stock options (“ISOs”)
only to our employees and employees of our subsidiaries.
Acceleration of Awards upon
Corporate Transactions.
The outstanding awards will terminate
and/or accelerate upon occurrence of certain significant corporate transactions,
including amalgamations, consolidations, liquidations or dissolutions, sales of
substantially all or all of our assets, reverse takeovers or acquisitions
resulting in a change of control. If the successor entity following one of these
transactions assumes or replaces our outstanding awards under the Plan, such
assumed or replaced awards will become fully vested and immediately exercisable
and payable, and be released from repurchase or forfeiture rights immediately
upon termination of the grantee’s continuous service to us if the grantee’s
service is terminated by the successor entity without cause within twelve (12)
months after the effective date of the transaction. Furthermore, if the
successor entity does not assume or replace our outstanding awards, each
outstanding award will become fully vested and immediately exercisable and
payable, and will be released from any repurchase or forfeiture rights
immediately before the effective date of the corporate transaction, as long as
the grantee’s continuous service with us is not terminated before this
date.
Exercise Price and Term of
Awards.
In general, the plan administrator will
determine the exercise price of an option in the award agreement. The exercise
price may be a fixed price, or it may be a variable price related to the fair
market value of our common shares. If we grant an ISO to an employee, the
exercise price may not be less than 100% of the fair market value of our common
stock on the date of the grant, except that if the grantee, at the time of that
grant, owns shares representing more than 10% of the voting power of all classes
of the shares of our common stock, the exercise price may not be less than 110%
of the fair market value of our common stock on the date of that grant. If we
grant a non-qualified share option to a grantee, the exercise price may not be
less than 100% of the fair market value of its common stock on the date of
grant.
The term of each award under the Plan
will be specified in the award agreement, but may not exceed ten years from the
earlier of the adoption or the approval of the Plan, unless sooner
terminated.
Vesting
Schedule.
In general, the plan administrator will
determine, or the award agreement specify, the vesting schedule.
Equity Compensation
Grants
As of the date hereof, we have issued
and outstanding under the Plan:
|
·
|
703,200
stock options, exercisable at a price of $0.42 per share, of which: (i)
175,800 vested on each of September 2, 2009 and March 2, 2010, and (ii) an
additional 175,800 will vest on each of September 2, 2010 and March 2,
2011;
|
|
·
|
380,000
stock options, exercisable at a price of $1.80 per share, of which 95,000
will vest on each of May 10, 2010, November 10, 2010, May 10, 2011 and
November 10, 2011; and
|
- 58
-
|
·
|
380,000
share appreciation rights, exercisable at a price of $1.80 per share,
which will vest with respect to 25% of the underlying shares on each of
May 10, 2010, November 10, 2010, May 10, 2011 and November 10,
2011.
|
The
following table sets forth the equity awards outstanding at December 31, 2009
for each of the named executive officers.
Option Awards
|
||||||||||||||
Name
|
Number of
Securities
Underlying
Unexercised
Options (#)
Exercisable
|
Number of
Securities
Underlying
Unexercised
Options (#)
Unexercisable
|
Option
Exercise
Price ($)
|
Option
Expiration Date
|
||||||||||
Yang
Yong Shan(1)
|
180,000
|
180,000
|
0.42
|
March
2, 2019
|
||||||||||
|
0
|
380,000
|
1.80
|
November
10, 2019
|
||||||||||
Shu
Kaneko(2)
|
150,000
|
150,000
|
0.42
|
March
2, 2019
|
||||||||||
|
0
|
380,000
|
1.80
|
November
10, 2019
|
||||||||||
Niu
Wan Chen(3)
|
7,600
|
7,600
|
0.42
|
March
2,
2019
|
|
(1)
|
Yang
Yong Shan was appointed as our Chairman, Chief Executive Officer and
President as of October 9, 2007. We do not have an Employment Agreement
with Mr. Yang. On March 2, 2009, Mr. Yang was granted 360,000 stock
options under the Plan, exercisable at a price of $0.42 per share, of
which (a) 90,000 vested on each of September 2, 2009 and March 2, 2010 and
(b) an additional 90,000 will vest on each of September 2, 2010 and March
2, 2011. On November 10, 2009, Mr. Yang was granted an additional 380,000
stock options under the Plan, exercisable at a price of $1.80 per share,
of which 95,000 will vest on each of May 10, 2010, November 10, 2010, May
10, 2011 and November 10, 2011. Mr. Yang did not receive any other
compensation in the fiscal years ended December 31, 2007, 2008 or
2009.
|
|
(2)
|
Shu
Kaneko was appointed as our Chief Financial Officer, Secretary, and a
member of our board of directors, on November 1, 2007. As of November 1,
2007, we entered into an Employment Agreement with Mr. Kaneko, pursuant to
which he is entitled to receive a base salary of $150,000 per annum. For
more information, see “-- Employment Contracts and Termination of
Employment and Change-in-Control Arrangements -- Employment Agreement with
Shu Kaneko” below. On March 2, 2009, Mr. Kaneko was granted 300,000 stock
options under the Plan, exercisable at a price of $0.42 per share, of
which (a) 75,000 vested on each of September 2, 2009 and March 2, 2010 and
(b) an additional 75,000 will vest on each of September 2, 2010 and March
2, 2011. On November 10, 2009, Mr. Kaneko was granted 380,000 share
appreciation rights, exercisable at a price of $1.80 per share, which will
vest with respect to 25% of the underlying shares on each of May 10, 2010,
November 10, 2010, May 10, 2011 and November 10,
2011.
|
|
(3)
|
Niu
Wan Chen was appointed as our Vice President of Sales and a member of our
board of directors as of October 9, 2007. We do not have an Employments
Agreement with Mr. Niu. On March 2, 2009, Mr. Niu was granted 15,200 stock
options under the Plan, exercisable at a price of $0.42 per share, of
which (a) 3,800 vested on each of September 2, 2009 and March 2, 2010 and
(b) an additional 3,800 will vest on each of September 2, 2010 and March
2, 2011.
|
- 59
-
Pension
Benefits
We do not
provide any company-sponsored retirement benefits to any employee, including the
named executive officers (other than a mandatory state pension scheme in which
all of our employees in China participate).
Nonqualified
Deferred Compensation
We do not
provide any deferred compensation programs to any employee, including the named
executive officers.
Compensation
of Directors
We do not
currently pay any cash fees to our directors. During 2009, there was no director
compensation paid other than the stock grants. The common stock is recorded at
its fair value based on the date the stocks were granted. The following table
sets forth certain information regarding the compensation we paid to our
directors whom are not also Named Executive Officer’s for the year ended
December 31, 2009:
Name
|
Fees
earned or
paid in cash
($)
|
Stock
Awards
($)
|
Option
Awards ($)
|
Total
|
||||||||||||
Qin
Si Bo
|
$ | 0 | $ | 0 | $ | 3,447 | (1) | $ | 3,447 | |||||||
Yuan
Yong Wei
|
$ | 0 | $ | 0 | $ | 2,902 | (2) | $ | 2,902 |
|
(1)
|
On
March 2, 2009, Mr. Qin was granted 15,200 stock options under the Plan,
exercisable at a price of $0.42 per share, of which (a) 3,800 vested on
each of September 2, 2009 and March 2, 2010 and (b) an additional 3,800
will vest on each of September 2, 2010 and March 2,
2011.
|
|
(2)
|
On
March 2, 2009, Mr. Yuan was granted 12,800 stock options under the Plan,
exercisable at a price of $0.42 per share, of which (a) 3,200 vested on
each of September 2, 2009 and March 2, 2010 and (b) an additional 3,200
will vest on each of September 2, 2010 and March 2,
2011.
|
- 60
-
Item
12. Security Ownership of Certain Beneficial Owners and Management
and Related Stockholder Matters.
Securities
Authorized for Issuance Under Equity Compensation Plans
The
following table provides certain information with respect to our equity
compensation plans as of December 31, 2009:
Equity
Compensation Plan Information
(a)
|
(b)
|
(c)
|
||||||||||
Plan Category
|
Number of securities to
be issued upon exercise
of outstanding options,
warrants and rights
|
Weighted-average
exercise price of
outstanding
options, warrants
and rights
|
Number of securities
remaining available
for future issuance
under equity
compensation plans
(excluding securities
reflected in column
(a))
|
|||||||||
Equity
compensation plans approved by security holders (1)
|
1,463,200 | $ | 1.14 | 36,800 | ||||||||
Equity
compensation plans not approved by security holders (2)
|
0 | N/A | 0 | |||||||||
Total
|
1,463,200 | $ | 1.14 | 1,463,200 |
|
(1)
|
Our
board of directors adopted the 2009 Equity Incentive Plan, to be effective
on March 2, 2009. The Plan was approved by the shareholders on March 11,
2009. To date, we have made the following grants under the
Plan:
|
|
(a)
|
703,200
stock options, exercisable at a price of $0.42 per share, of which 175,800
vested on September 2, 2009 and March 2, 2010 and an additional 175,800
will vest on each of, September 2, 2010 and March 2,
2011;
|
|
(b)
|
380,000
stock options, exercisable at a price of $1.80 per share, of which 95,000
will vest on each of May 10, 2010, November 10, 2010, May 10, 2011 and
November 10, 2011; and
|
|
(c)
|
380,000
share appreciation rights, exercisable at a price of $1.80 per share,
which will vest with respect to 25% of the underlying shares on each of
May 10, 2010, November 10, 2010, May 10, 2011 and November 10,
2011.
|
(2)
|
We
do not have any equity compensation plans not approved by our security
holders.
|
- 61
-
SECURITY
OWNERSHIP OF CERTAIN
BENEFICIAL
OWNERS AND MANAGEMENT
The following table sets forth certain
information regarding the beneficial ownership of our common stock by (i) each
person who, to our knowledge, owns more than 5% of our common stock, (ii) each
of our directors and executive officers, and (iii) all of our executive officers
and directors as a group. Unless otherwise indicated in the footnotes to the
following table, each person named in the table has sole voting and investment
power. Shares of our common stock subject to options, warrants, or other rights
currently exercisable, or exercisable within 60 days of the date hereof, are
deemed to be beneficially owned and outstanding for computing the share
ownership and percentage of the person holding such options, warrants or other
rights, but are not deemed outstanding for computing the percentage of any other
person. As of the date hereof, we had 32,945,823 shares of common stock issued
and outstanding (not including an additional 1,944,444 shares of common stock
currently being held in treasury).
Unless otherwise noted, the address for
each of the persons listed below is: c/o Emerald Dairy Inc., 10 Huashan-lu,
Xiangfang-qu, 9th floor, Wanda Building, Harbin City, Heilongjiang Province, PRC
150001.
Common Stock Beneficially
Owned
|
||||||||
Name and Address
|
Number
|
Percent
|
||||||
5%
Stockholders:
|
||||||||
John
Winfield (1)
820
Moraga Drive
Los
Angeles, CA 90049
|
3,473,621 | 9.9 | % | |||||
JAG
Multi Investments LLC (2)
163
Washington Valley Road, Suite 103
Warren,
N.J. 07059
|
2,395,156 | 7.1 | % | |||||
Named
Executive Officers and Directors:
|
||||||||
Yang
Yong Shan (3)
Chief
Executive Officer, President and Chairman of the Board
|
13,978,329 | 42.1 | % | |||||
Shu
Kaneko (4)
Chief
Financial Officer, Secretary and Director
|
245,000 | * | ||||||
Niu
Wan Chen (5)
Vice
President of Sales and Director
|
187,600 | * | ||||||
Qin
Si Bo (6)
Vice
President of Production and Director
|
7,600 | * | ||||||
Yuan
Yong Wei (7)
Vice
President of Operations and Director
|
6,400 | * | ||||||
All
Executive Officers and Directors as a Group (5 persons)
(8)
|
14,424,929 | 43.1 | % |
*Less
than 1%
(1) Consists
of (i) 1,673,621 shares of common stock held by John Winfield, and (ii)
1,800,000 shares of common stock issuable upon exercise of currently exercisable
warrants held by Mr. Winfield. Does not include 313,229 shares of common
stock issuable upon exercise of additional currently exercisable warrants held
by Mr. Winfield, because they are the subject of agreements with us that such
warrants can not be exercised at any time when the result would be to cause the
holder to beneficially own more than 9.9% of our outstanding common
stock.
- 62
-
(2)
Consists of (i) 1,718,650 shares of common stock held by JAG Multi Investments
LLC, and (ii) 676,506 shares of common stock issuable upon exercise of currently
exercisable warrants held by JAG Multi Investments LLC. Alexander M. Goren is
the Manager of JAG Multi Investments LLC, and has sole voting and investment
power over the shares owned thereby. Mr. Goren disclaims beneficial ownership of
these shares, except to the extent of his pecuniary interest
therein.
(3)
Consists of (i) 13,703,329 shares of common stock, and (ii) 275,000 shares of
common stock underlying stock options which have vested, or will vest within 60
days of the date hereof. Does not include shares underlying stock options to
purchase 465,000 shares of our common stock, which will not vest within 60 days
of the date hereof. 9,040,754 of the shares of common stock held by Mr. Yang are
pledged to secure our repayment of promissory notes in the aggregate principal
amount of $4,323,301, as further described in “Certain Relationships and Related
Transactions -- Pledge of Shares by Chief Executive Officer”.
(4)
Consists of (i) 150,000 shares of common stock underlying stock options which
have vested, or will vest within 60 days of the date hereof and (ii) 95,000
share appreciation rights which have vested, or will vest within 60 days of the
date hereof. Does not include shares underlying (i) stock options to purchase
150,000 shares of our common stock, which will not vest within 60 days of the
date hereof, or (ii) 285,000 share appreciation rights, which will not vest
within 60 days of the date hereof.
(5)
Consists of (i) 180,000 shares of common stock, and (ii) 7,600 shares of common
stock underlying stock options which have vested, or will vest within 60 days of
the date hereof. Does not include shares underlying stock options to purchase
7,600 shares of our common stock, which will not vest within 60 days of the date
hereof.
(6)
Consists of 7,600 shares of common stock underlying stock options which have
vested, or will vest within 60 days of the date hereof. Does not include shares
underlying stock options to purchase 7,600 shares of our common stock, which
will not vest within 60 days of the date hereof.
(7)
Consists of 6,400 shares of common stock underlying stock options which have
vested, or will vest within 60 days of the date hereof. Does not include shares
underlying stock options to purchase 6,400 shares of our common stock, which
will not vest within 60 days of the date hereof.
(8)
Consists of (i) 13,883,329 shares of common stock, (ii) 446,600 shares of common
stock underlying stock options which have vested, or will vest within 60 days of
the date hereof, and (iii) 95,000 shares of common stock underlying share
appreciation rights which have vested, or will vest within 60 days of the date
hereof. Does not include shares underlying (i) stock options to purchase 636,600
shares of our common stock, which will not vest within 60 days of the date
hereof, or (ii) 285,000 share appreciation rights, which will not vest within 60
days of the date hereof.
- 63
-
Item
13. Certain Relationships and Related Transactions, and Director
Independence.
Since the beginning of our fiscal year
ended December 31, 2009, there have been no transactions between members of
management, five percent stockholders, “affiliates,” promoters and finders,
except as set forth below. Each of the transactions listed below was negotiated
on an “arm’s length” basis.
Transactions
with Management and Others
Share Repurchase Agreement and Put/Call
Agreements
On October 9, 2007, we entered into a
Share Repurchase Agreement with Grand Orient Fortune Investment, Ltd. (“Grand
Orient”), a PRC company controlled by Mingwen Song, pursuant to which we
repurchased 1,944,444 shares (the “Repurchase Shares”) of our issued and
outstanding common stock from Grand Orient for an aggregate purchase price of
$3,169,444 (the “Repurchase Transaction”). We determined to repurchase these
shares, to reduce the overall dilution created by the First Offering and Second
Offering. The repurchased shares were initially held in treasury, but have now
been returned to our number of authorized but unissued shares.
Immediately following the closing of
the Repurchase Transaction, we entered into Put/Call Agreements with Grand
Orient and Fortune Land Holding, Ltd., a PRC company controlled by Dexuan Yu
(jointly, the “Put/Call Shareholders). Pursuant to the Put/Call Agreements the
Put/Call Shareholders granted us an option to repurchase an aggregate of
1,944,444 shares (the “Put/Call Shares”) from the Put/Call Shareholders (the
“Call Option”), for a price of $1.63 per share (the “Call Option Price”), if the
following conditions were met (the “Call Option Conditions”):
|
·
|
Either
(i) a registration statement (“Registration Statement”) covering the
resale of the Put/Call Shares had been declared effective by the SEC, and
has been kept continuously effective by us, or (ii) all of the Put/Call
Shares were available for sale without registration pursuant to Rule
144; and
|
|
·
|
The
closing price of a share of our common stock as traded on the OTCBB (or
such other exchange or stock market on which the common stock may then be
listed or quoted) equaled or exceeded $4.08 (appropriately
adjusted for any stock split, reverse stock split, stock dividend or other
reclassification or combination of the common stock occurring after the
date hereof) for at least ten (10) consecutive trading days immediately
preceding the date that a Call Option exercise notice was given by
us.
|
In
addition, the Put/Call Shareholders had the right to cause us to repurchase
the Put/Call Shares from the Put/Call Shareholders (the “Put Right”), for a
price of $1.63 per share (the “Put Purchase Price”), if:
|
·
|
We
failed to exercise the Call Option within ten (10) days of a date on
which all of the Call Option Conditions have been met;
or
|
|
·
|
We
consummated a private offering of not less than $5,000,000 of its
securities (a “Qualified Offering”);
or
|
|
·
|
We
fail to consummated a Qualified Offering on or before October 9, 2009
(each of the aforementioned conditions, a “Put Right
Trigger”).
|
- 64
-
Initially, our failure to (i) file the
Registration Statement within thirty (30) business days of October 9, 2007 (the
“Filing Date”), (ii) have the Registration Statement declared effective within
ninety (90) calendar days from the Filing Date, or, if reviewed by the SEC,
within one hundred eighty (180) calendar days after the Filing Date, or (iii)
keep the Registration Statement continuously effective until all of the
“Registrable Securities” were available for sale without registration pursuant
to Rule 144, would also have served as a Put Right Trigger. However, as of April
9, 2008, the Put/Call Shareholders agreed to amend the Put/Call Agreements to
delete this provision. We did not pay any consideration to the Put/Call
Shareholders in connection with their waiver of this provision.
We had recorded the value of the
Put/Call Agreements as a liability in the aggregate amount of $3,169,444 as of
October 9, 2007, based on the fair market value of the underlying common stock
of $1.63 as of such date. The parties mutually agreed that it was in the best
interests of the Company and its stockholders for the Put/Call Agreements to be
terminated. Therefore, as of March 3, 2009, the Put/Call Agreements were
terminated.
Pledges
of Shares by Chief Executive Officer
On December 24, 2009, we sold the
December 2009 Noteholders the December 2009 Notes, in the aggregate principal
amount of $1,750,000, and December 2009 Warrants to purchase an aggregate of
536,809 shares of our common stock in the December 2009 Note Offering, as
further described in “Management’s Discussion and Analysis of Financial
Condition and Results of Operations -- Recent Developments – December 2009 Note
Offering” above. Our repayment of amounts due under the December 2009 Notes is
secured by a pledge of 5,883,329 shares of our common stock beneficially owned
by Yang Yong Shan, our Chairman, Chief Executive Officer and
President.
As of
December 31, 2009, we amended the June 2008 Notes originally issued in the June
2008 Note Offering, previously amended on December 31, 2008, to, among other
things, (i) extend the maturity date of the indebtedness represented by the June
2008 Notes from December 31, 2009 to December 31, 2010, and (ii) add the accrued
and unpaid interest on the June 2008 Notes, in the aggregate amount of $323,301,
to the principal amount outstanding (resulting in an aggregate principal balance
of $2,573,301). The June 2008 Note Offering is further described in
“Management’s Discussion and Analysis of Financial Condition and Results of
Operations -- Recent Developments – June 2008 Note Offering” above. Our
repayment of amounts due under the June 2008 Notes, as amended, is secured by a
pledge of 3,157,425 shares
of our common stock beneficially owned by Mr. Yang.
Review,
Approval and Ratification of Related Party Transactions
We have not adopted formal policies and
procedures for the review, approval or ratification of transactions, such as
those described above, with our executive officers, directors and significant
shareholders. However, we intend that such transactions will, on a going-forward
basis, be subject to the review, approval or ratification of our board of
directors, or an appropriate committee thereof.
As of the date hereof, we have not
adopted a written conflict of interest policy that applies to our executive
officers and directors. We intend to adopt a written conflict of interest policy
in the future.
Director
Independence
Our common stock is currently approved
for quotation on the OTCBB maintained by the FINRA under the symbol “EMDY.OB.”
As soon as practicable, and assuming we satisfy all necessary initial listing
requirements, we intend to apply to have our common stock listed for trading on
either the New York Stock Exchange, NYSE Amex Equities or the Nasdaq Stock
Market.
None of the directors currently on its
board of would qualify as independent directors under the rules of the New York
Stock Exchange, NYSE Amex Equities or The Nasdaq Stock Market because they all
(i) currently own a significant percentage of our shares, and/or (ii) are
currently employed by us, and/or (iii) have been actively involved in our
management, and/or (iv) otherwise fall into one or more of the enumerated
categories of people who cannot be considered independent
directors.
- 65
-
Item
14. Principal Accounting Fees and Services
Murrell, Hall, McIntosh & Co., PLLP
served as the principal accountant to audit our financial statements through
January 25, 2008, when they were replaced by the firm of Windes & McClaughry
Accountancy Corporation.
The following is a summary of the
combined fees billed to us by Murrell, Hall, McIntosh & Co., PLLP and Windes
& McClaughry Accountancy Corporation for professional services rendered for
the fiscal years ended December 31, 2009 and 2008:
Aggregate fees rendered for the fiscal
years ended December 2009 and 2008 were as follows:
2009
|
2008
|
|||||||
Audit
Fees
|
$ | 185,000 | $ | 175,000 | ||||
Audit
Related Fees
|
$ | 34,490 | $ | 102,235 | ||||
Tax
Fees
|
— | $ | 6,330 | |||||
Other
Fees
|
— | — | ||||||
Total
Fees:
|
$ | 219,490 | $ | 283,565 |
Audit Fees. Consists of fees
billed for professional services rendered for the audit of our consolidated
financial statements and review of the interim consolidated financial statements
included in quarterly reports, services that are normally provided by our
independent registered public accounting firm in connection with statutory and
regulatory filings or engagements.
Audit-Related Fees. Consists
of fees billed for assurance and related services that are reasonably related to
the performance of the audit or review of our consolidated financial statements
and are not reported under “Audit Fees.”
Tax Fees. Consists of fees
billed for professional services for our corporate tax returns and extensions,
tax compliance, tax advice and tax planning. No such fees were billed by our
independent registered public accounting firm in fiscal 2009.
All Other Fees. No fees were
billed to us by our independent registered public accounting firm for products
and services other than the services reported above. No such fees were billed by
our independent registered public accounting firm in fiscal 2009 or
2008.
The board of directors has the sole
authority to review in advance and grant any pre-approvals of (i) all auditing
services to be provided by the independent auditor, (ii) all significant
non-audit services to be provided by the independent auditors as permitted by
Section 10A of the Exchange Act, and (iii) all fees and the terms of engagement
with respect to such services. All audit and non-audit services performed by
Murrell, Hall, McIntosh & Co., PLLP and Windes & McClaughry Accountancy
Corporation during fiscal 2009 and 2008 were pre-approved pursuant to the
procedures outlined above.
- 66
-
Item
15. Exhibits, Financial Statement Schedules
Exhibit
No.
|
Description
|
|
2.1
|
Agreement
and Plan of Merger and Reorganization, dated October 9, 2007, by and among
the Company, AIDH Acquisition, Inc., Tryant LLC and American International
Dairy Holding Co., Inc. - Incorporated by reference from our Current
Report on Form 8-K, filed on October 15, 2007
|
|
2.2
|
Articles
of Merger, dated October 9, 2007, of AIDH Acquisition, Inc. with and into
American International Dairy Holding Co., Inc. - Incorporated by reference
from our Current Report on Form 8-K, filed on October 15,
2007
|
|
3.1
|
Bylaws
- Incorporated by reference from our Registration Statement on Form 10-SB
filed August 10, 2006
|
|
3.2
|
Articles
of Incorporation - Incorporated by reference from our Registration
Statement on Form 10-SB filed August 10, 2006
|
|
3.3
|
Certificate
of Amendment to Articles of Incorporation of the Company, dated October 9,
2007 - Incorporated by reference from our Current Report on Form 8-K,
filed on October 15, 2007
|
|
3.4
|
Certificate
of Amendment to Articles of Incorporation of the Company, dated January
25, 2008 - Incorporated by reference from our Current Report on Form 8-K,
filed on January 30, 2008
|
|
4.1
|
Warrant
No. W-2 - Incorporated by reference from our Current Report on Form 8-K,
filed on October 15, 2007
|
|
4.2
|
Form
of Class A Warrant - Incorporated by reference from our Current Report on
Form 8-K, filed on October 15, 2007
|
|
4.3
|
Form
of Class B Warrant - Incorporated by reference from our Current Report on
Form 8-K, filed on October 15, 2007
|
|
4.4
|
Form
of June 2008 Note — Incorporated by reference from our Current Report
on Form 8-K, filed on June 12, 2008
|
|
4.5
|
Form
of First Amended and Restated Note — Incorporated by reference from our
amended Current Report on Form 8-K/A, filed on January 7,
2009
|
|
4.6
|
Form
of Second Amended and Restated Promissory Note — Incorporated by reference
from our Current Report on Form 8-K, filed on January 7,
2010
|
|
4.7
|
Form
of June 2008 Warrant — Incorporated by reference from our Current Report
on Form 8-K, filed on June 12, 2008
|
|
4.8
|
Form
of Amended and Restated June 2008 Warrant — Incorporated by reference from
our amended Current Report on Form 8-K/A, filed on January 7,
2009
|
|
4.9
|
Form
of Warrants — Incorporated by reference from our Current Report on Form
8-K, filed on January 7, 2010
|
|
4.10
|
Form
of 10% Promissory Note — Incorporated by reference from our Quarterly
Report on Form 10-Q, filed on November 14,
2008
|
- 67
-
Exhibit
No.
|
Description
|
|
4.11
|
Form
of First Amended and Restated Note – Incorporated by reference to
Amendment No. 2 to our Registration Statement on Form S-1 (Registration
No. 333-162432), filed on January 14, 2010
|
|
4.12
|
Form
of Warrant — Incorporated by reference from our Quarterly Report on
Form 10-Q, filed on November 14, 2008
|
|
4.13
|
10%
Promissory Note — Incorporated by reference from our Current Report on
Form 8-K, filed on December 4, 2009
|
|
4.14
|
Form
of 10% Promissory Note — Incorporated by reference from our Current Report
on Form 8-K, filed on December 31, 2009
|
|
4.15
|
Form
of Warrant — Incorporated by reference from our Current Report on Form
8-K, filed on December 31, 2009
|
|
10.1
|
Form
of Securities Purchase Agreement for $1,000,000 Unit Offering —
Incorporated by reference from our Current Report on Form 8-K, filed on
October 15, 2007
|
|
10.2
|
Form
of Securities Purchase Agreement for Minimum $3,000,000, Maximum
$8,000,000 Unit Offering - Incorporated by reference from our Current
Report on Form 8-K, filed on October 15, 2007
|
|
10.3
|
Form
of Registration Rights Agreement - Incorporated by reference from our
Current Report on Form 8-K, filed on October 15, 2007
|
|
10.4
|
Share
Repurchase Agreement, dated October 9, 2007, by and between the Company
and Grand Orient Fortune Investment Ltd. - Incorporated by reference from
our Current Report on Form 8-K, filed on October 15,
2007
|
|
10.5
|
Put/Call
Agreement, dated October 9, 2007, by and between the Company and Grand
Orient Fortune Investment, Ltd. - Incorporated by reference from our
Current Report on Form 8-K, filed on October 15, 2007
|
|
10.6
|
Waiver
and First Amendment the Put/Call Agreement, dated April 9, 2008, by and
between the Company and Grand Orient Fortune Investment, Ltd. -
Incorporated by reference from our Form 10-KSB filed on April 15,
2008
|
|
10.7
|
Put/Call
Agreement, dated October 9, 2007, by and between the Company and Fortune
Land Holding, Ltd. - Incorporated by reference from our Current Report on
Form 8-K, filed on October 15, 2007
|
|
10.8
|
Waiver
and First Amendment the Put/Call Agreement, dated April 9, 2008, by and
between the Company and Fortune Land Holding, Ltd. - Incorporated by
reference from our Form 10-KSB filed on April 15, 2008
|
|
10.9
|
Employment
Agreement, dated November 1, 2007, by and between the Company and Shu
Kaneko - Incorporated by reference to our Current Report on Form 8-K,
filed November 7, 2007 *
|
|
10.10
|
Amendment,
dated March 19, 2010, to Employment Agreement between the Company and Shu
Kaneko *
|
- 68
-
Exhibit
No.
|
Description
|
|
10.11
|
Form
of June 2008 Securities Purchase Agreement for Sale of up to $3,000,000 of
8% Promissory Notes and 300,000
Warrants — Incorporated by reference from our
Current Report on Form 8-K, filed on June 12, 2008
|
|
10.12
|
First
Amendment to June 2008 Securities Purchase Agreement, dated December 31,
2008 – Incorporated by reference from our amended Current Report on
Form 8-K/A, filed January 7, 2009
|
|
10.13
|
Second
Amendment to June 2008 Securities Purchase Agreement, dated December 31,
2009 — Incorporated by reference from our Current Report on Form 8-K,
filed January 7, 2010
|
|
10.14
|
Form
of November 2008 Securities Purchase Agreement for Sale of up to
$2,000,000 of 10% Promissory Notes and 200,000
Warrants — Incorporated by reference from our
Quarterly Report on Form 10-Q, filed on November 14,
2008
|
|
10.15
|
First
Amendment to November 2008 Securities Purchase Agreement – Incorporated by
reference to Amendment No. 2 to our Registration Statement on Form S-1
(Registration No. 333-162432), filed on January 14,
2010
|
|
10.16
|
Loan
Agreement for Loan of $1,750,000 — Incorporated by reference from our
Current Report on Form 8-K, filed on December 4, 2009
|
|
10.17
|
Securities
Purchase Agreement for Sale of $1,750,000 of 10% Promissory Notes and
536,809 Warrants – Incorporated by reference from
our Current Report on Form 8-K, filed on December 31,
2009
|
|
10.18
|
2009
Equity Incentive Plan — Incorporated by reference from our Current Report
on Form 8-K, filed on March 6, 2009 *
|
|
16.1
|
Letter
from Mantyla McReynolds, LLC, dated November 19, 2007 - Incorporated by
reference from Amendment No. 2 to our Current Report on Form 8-K/A, filed
on November 19, 2007
|
|
16.2
|
Letter
from Murrell, Hall, McIntosh & Co., PLLP, dated January 29, 2008
- Incorporated by reference from our Current Report on Form
8-K, filed on January 30, 2008
|
|
21.1
|
List
of Subsidiaries – Incorporated by reference from our Annual Report on Form
10-K, filed on March 31, 2010
|
|
31.1
|
Certification
of principal executive officer pursuant to Section 13a-14(a) - Filed
herewith
|
|
31.2
|
Certification
of principal financial and accounting officer pursuant to Section
13a-14(a) - Filed herewith
|
|
32.1
|
Certification
of principal executive officer pursuant to Section 1350 - Filed
herewith
|
|
32.2
|
Certification
of principal financial and accounting officer pursuant to Section 1350 -
Filed herewith
|
|
* Denotes a management contract or
compensatory plan or arrangement
- 69
-
Pursuant
to the requirements of Section 13 or 15(d) of the Exchange Act, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
EMERALD
DAIRY INC.
|
||
Dated:
April 1, 2010
|
By:
|
/s/ Yang Yong Shan |
Yang
Yong Shan
Chairman,
Chief Executive Officer and President (Authorized
Representative)
|
Pursuant
to the requirements of the Exchange Act, this report has been signed below by
the following persons on behalf of the registrant and in the capacities and on
the dates indicated.
Name
|
Title
|
Date
|
||
/s/
Yang Yong Shan
|
President,
Chief Executive Officer
|
April
1, 2010
|
||
Yang
Yong Shan
|
and
Director (Principal Executive Officer)
|
|||
/s/
Shu Kaneko
|
Chief
Financial Officer and
|
April
1, 2010
|
||
Shu
Kaneko
|
Secretary
(Principal Financial and Accounting Officer)
|
|||
/s/ Niu Wan Chen |
Director
|
April
1, 2010
|
||
Niu
Wan Chen
|
||||
/s/ Qin Si Bo |
Director
|
April
1, 2010
|
||
Qin
Si Bo
|
||||
/s/ Yuan Yong Wei |
Director
|
April
1, 2010
|
||
Yuan
Yong Wei
|
- 70
-