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EX-31.1 - RULE 13A-14(A) CERTIFICATION - CEO - China Digital Animation Development, Inc.chinadigitalanim10qexh311.htm
EX-31.2 - RULE 13A-14(A) CERTIFICATION - CFO - China Digital Animation Development, Inc.chinadigitalanim10qexh312.htm


U. S. Securities and Exchange Commission
Washington, D. C. 20549
 
FORM 10-Q

 
[X]     QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
             For the quarterly period ended September 30, 2011

 
[   ]    TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _____ to _____

Commission File No. 0-50441
 
CHINA DIGITAL ANIMATION DEVELOPMENT INC.
(Name of Registrant in its Charter)
 
New York
84-1275578
(State of Other Jurisdiction of incorporation or organization)
(I.R.S. Employer I.D. No.)
 
15 West 39th Street, Suite 14B, New York, NY  10018
(Address of Principal Executive Offices)

Issuer's Telephone Number: (212) 391-2688

Indicate  by check mark  whether the  Registrant  (1) has filed all reports required to be filed by Sections 13 or 15(d) of the  Securities Exchange Act of 1934  during  the  preceding  12 months  (or for such shorter  period  that the Registrant was required to file such reports),  and (2) has been subject to such filing requirements for the past 90 days. Yes [X]  No [    ]     
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, 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 whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act)  Yes [ ]   No [X]  
 
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. (Check One)  
 
Large accelerated filer        Accelerated filer      Non-accelerated filer        Smaller reporting company [X]
 
APPLICABLE ONLY TO CORPORATE ISSUERS:  Indicate the number of shares outstanding of each of the Registrant's classes of common stock, as of the latest practicable date:
 
November 21, 2011
Common Voting Stock: 20, 290,000

 
 

 

CHINA DIGITAL ANIMATION DEVELOPMENT, INC.
QUARTERLY REPORT ON FORM 10Q
FOR THE FISCAL QUARTER ENDED SEPTEMBER 30, 2011
 
TABLE OF CONTENTS

 
   
Page No
Part I
Financial Information
 
Item 1.
Financial Statements (unaudited):
 
 
Condensed Consolidated Balance Sheet (Unaudited) – September 30, 2011 and June 30, 2011
2
 
Condensed Consolidated Statements of Income and Other Comprehensive Income (Unaudited) - for the Three Months Ended September 30, 2011 and 2010
3
 
Condensed Consolidated Statements of Cash Flows (Unaudited) – for the Three Months Ended September 30, 2011 and 2010
4
 
Notes to Condensed Consolidated Financial Statements (Unaudited)
5
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
21
Item 3
Quantitative and Qualitative Disclosures about Market Risk
23
Item 4.
Controls and Procedures
23
     
Part II
Other Information
 
     
Item 1.
Legal Proceedings
24
Items 1A.
Risk Factors
24
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
24
Item 3.
Defaults upon Senior Securities
24
Item 4.
Reserved
24
Item 5.
Other Information
24
Item 6.
Exhibits
25



 
1

 
 
CHINA DIGITAL ANIMATION DEVELOPMENT, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
  
   
September 30,
   
June 30,
 
   
2011
   
2011
 
   
(unaudited)
       
ASSETS
           
Current assets:
           
Cash and cash equivalents
  $ 12,253     $ 17,903  
Accounts receivable
    164,655       434,749  
Other receivables
    2,588       4,108  
Advance to suppliers
    -       25,992  
Short term investments
    6,254,691       6,188,598  
Deferred production costs
    947,351       669,529  
Tax refund receivable
    336,982       333,421  
Prepaid expenses
    -       43,900  
Total current assets
    7,718,520       7,718,200  
                 
Property, plant and equipment, net
    1,242,552       1,274,527  
Intangible assets, net
    2,285,919       2,332,316  
Total assets
  $ 11,246,991     $ 11,325,043  
                 
   LIABILITIES AND STOCKHOLDERS’ EQUITY                
Current liabilities:
               
Accounts payable
    12,822       -  
Loan payable
    355,975       345,975  
Accrued expenses and other payables
    79,398       91,337  
Total current liabilities
    448,195       437,312  
                 
Total liabilities
    448,195       437,312  
                 
Commitments and contingencies
    -       -  
                 
Stockholders' Equity
               
                 
Preferred stock ($0.001 par value, 5,000,000 shares authorized, no share issued and outstanding at September 30 and June 30, 2011)
    -       -  
Common stock ($0.001 par value, 100,000,000 shares authorized, 20,290,000 and  20,270,000 shares issued and outstanding at September 30 and June 30, 2011, respectively)
    20,290       20,270  
Additional paid-in-capital
    6,769,227       6,723,447  
Accumulated other comprehensive income
    2,618,182       2,501,344  
Statutory reserved fund
    1,156,476       1,156,476  
Retained earnings
    234,621       486,194  
                 
Total stockholders’ equity
    10,798,796       10,887,731  
                 
Total liabilities and stockholders' equity
  $ 11,246,991     $ 11,325,043  

The accompanying notes are an integral part of these condensed consolidated financial statements.  

 
2

 
 
CHINA DIGITAL ANIMATION DEVELOPMENT, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME
(UNAUDITED)
 
   
For the three months ended
 
   
September 30,
   
September 30,
 
   
2011
   
2010
 
         
(restated)
 
             
Revenue
  $ 458,429     $ 1,805,859  
                 
Cost of goods sold
    510,512       1,819,181  
                 
Gross loss
    (52,083 )     (13,322 )
                 
Operating expenses
               
                 
Selling, General and Administrative expenses
    203,182       537,876  
                 
Total operating expenses
    203,182       537,876  
                 
Loss from operations before other income (expenses)
    (255,265 )     (551,198 )
                 
Other income (expenses)
               
                 
Interest income
    497       2,015  
Other income
    3,195       -  
                 
Total other income
    3,692       2,015  
                 
Loss from operations before income taxes
    (251,573 )     (549,183 )
Provision for income taxes
    -       276,171  
                 
Net loss
    (251,573 )     (825,354 )
                 
Other comprehensive income
               
Foreign currency translation gain
    116,838       117,394  
                 
Total comprehensive loss
  $ (134,735 )   $ (707,960 )
                 
                 
Basic and diluted loss per share
  $ (0.01 )   $ (0.04 )
                 
Basic and diluted weighted average shares outstanding
    20,284,783       20,020,000  

The accompanying notes are an integral part of these condensed consolidated financial statements.
 

 
3

 
 
CHINA DIGITAL ANIMATION DEVELOPMENT, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
 
   
For the three months ended
 
   
September 30,
 
   
2011
   
2010
 
         
(restated)
 
Cash flow from operating activities:
           
Net loss
  $ (251,573 )   $ (825,354 )
Adjustments to reconcile net income to net cash provided by operating activities:
               
Depreciation
    45,460       250,010  
Amortization
    71,105       94,732  
Stock based compensation
    45,800       -  
                 
Changes in operating assets and liabilities:
               
Accounts receivable
    270,771       238,283  
Prepaid expenses
    44,245       119,260  
Advances to suppliers
    26,196       -  
Other receivables
    1,559       (3,687 )
Deferred production costs
    (269,912 )     -  
Accounts payable
    12,786       1,468,711  
Accrued expenses and other payables
    (12,140 )     11,365  
Payroll payable
    -       77  
Income tax payable
    -       (23,593 )
                 
Net cash (used in) provided by operating activities
    (15,703 )     1,329,804  
                 
Cash flows from financing activities
               
Proceeds from loans payable
    10,000       -  
                 
Net cash provided by financing activities
    10,000       -  
                 
Effect of exchange rate changes in cash
    53       1,216  
                 
Net (decrease) increase in cash and cash equivalents
    (5,650 )     1,331,020  
                 
Cash and cash equivalents, beginning of period
    17,903       6,219,438  
                 
Cash and cash equivalents, end of period
  $ 12,253     $ 7,550,458  
                 
Supplemental Disclosures:
               
                 
Cash paid during the period for:
               
                 
Income taxes
  $ -     $ 415,224  
                 
Interest
  $ -     $ -  
 
 The accompanying notes are an integral part of these condensed consolidated financial statements.  

 
4

 

CHINA DIGITAL ANIMATION DEVELOPMENT, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)


1.             ORGANIZATION AND DESCRIPTION OF BUSINESS
 
 On November 12, 2008 the Company acquired the outstanding capital stock of RDX Holdings Limited ("RDX"), a corporation organized under the laws of the British Virgin Islands. The acquisition was effected by a share exchange between Fu Qiang and Su Jianping, the shareholders of RDX, and the Company (the "Share Exchange"). In exchange for the capital stock of RDX, the Company issued 14,400,000 shares of its common stock to the Messrs. Fu and Su; the issued shares represented 72% of the outstanding shares of the Company.
 
RDX is engaged in the business of managing the assets and operations of Heilongjiang Hairong Science and Technology Development Co., Ltd. (“Hairong”), a corporation organized under the laws of The People's Republic of China. Hairong is primarily engaged in animation design and development. Hairong operates its business primarily in the PRC with its headquarters in Harbin city, Heilongjiang province.
 
Variable Interest Entity

The accounts of Hairong have been consolidated with the accounts of the Company because Hairong is a variable interest entity with respect to RDX, which is a wholly-owned subsidiary of the Company.  RDX is party to five agreements dated June 27, 2008 with the owners of the registered equity of Hairong and with Hairong.  In summary, the five agreements contain the following terms:

l
Consulting Services Agreement and Operating Agreement. These two agreements provide that RDX will be fully responsible for the management of Hairong, both financial and operational. RDX has assumed responsibility for the debts incurred by Hairong and for any shortfall in its registered capital. In exchange for these services and undertakings, Hairong pays a fee to RDX equal to the net profits of Hairong. In addition, Hairong pledges all of its assets, including accounts receivable, to RDX. Meanwhile, Hairong's shareholders pledged the equity interests of Hairong to RDX to secure the payment of the Fee.
   
l
Proxy Agreement. In this agreement, the shareholders of Hairong granted an irrevocable proxy to the person designated by RDX to exercise the voting rights and other rights of shareholder.
   
l
Option Agreement. In this agreement, the shareholders of Hairong granted to RDX the right to purchase all of their equity interest in the registered capital of Hairong or the assets of Hairong. The option may be exercised whenever the transfer is permitted under the laws of the PRC. The purchase price shall be equal to the original paid-in price of the Purchased Equity Interest by the Transferor, unless the applicable PRC laws and regulations require appraisal of the equity interests or stipulate other restrictions on the purchase price of equity interests. The agreement also contains covenants designed to prevent any material change occurring in the legal or financial condition of Hairong without the consent of RDX.
   
l
Equity Pledge Agreement. In this agreement, Hairong shareholders agree to pledge all the equity interest in Hairong to RDX as security for the performance of the obligation under the Consulting Services Agreement and the payment of Consulting Services Fees under each agreement.
 
 RDX may terminate the agreements at will.  Hairong may only terminate the agreements if (a) there is an unremedied breach by RDX, (b) the operations of RDX are terminated, (c) Hairong loses its business license, or (d) circumstances arise that materially and adversely affect the performance or objectives of the Agreement.  The Consulting Services Agreement, under which all revenues are assigned from Hairong to RDX, and the Equity Pledge Agreement have no expiration date.  The other three agreements terminate on June 27, 2018 unless extended by the parties.
 
 
5

 

CHINA DIGITAL ANIMATION DEVELOPMENT, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)


1.             ORGANIZATION AND DESCRIPTION OF BUSINESS (Continued)

In sum, the agreements transfer to RDX all of the benefits and all of the risk arising from the operations of Hairong, as well as complete managerial authority over the operations of Hairong.   RDX is the guarantor of all of the obligations of Hairong.  By reason of the relationship described in these agreements, Hairong is a variable interest entity with respect to RDX because the following characteristics identified in ASC 810-10-15-14 are present:

-
The holders of the equity investment in Hairong lack the direct or indirect ability to make decisions about the entity’s activities that have a significant effect on the success of Hairong, having assigned their voting rights and all managerial authority to RDX.  (ASC 810-10-15-14(b)(1)).
   
-
The holders of the equity investment in Hairong lack the obligation to absorb the expected losses of Hairong, having assigned to RDX all revenue and responsibility for all payables.  (ASC 810-10-15-14(b)(2).
   
-
The holders of the equity investment in Hairong lack the right to receive the expected residual returns of Hairong, having granted to RDX all revenue as well as an option to purchase the equity interests at a fixed price.  (ASC 810-10-15-14(b)(3)).

Because the relationship between Hairong and RDX is entirely contractual, the Company’s interest in Hairong depends on the enforceability of those agreements under the laws of the PRC.  We are not aware of any judicial decision as to the enforceability of similar agreements under PRC law.  However, as the owners of the registered equity of Hairong are close business associates of our management, we do not believe that there is a significant risk that Hairong will seek to terminate the relationship or otherwise breach the agreements.  Accordingly, we believe that consolidation of the financial statements of Hairong with those of the Company is appropriate.

The carrying amount and classification of Hairong’s assets and liabilities included in the Consolidated Balance Sheets are as follows:
 
   
September 30,
2011
   
June 30,
2011
 
   
(unaudited)
       
Total current assets
 
$
7,718,046
   
$
7,702,677
 
Total assets
   
11,246,517
     
11,309,520
 
Total current liabilities*
   
322,759
     
322,120
 
Total liabilities*
 
$
322,759
   
$
322,120
 
 
* Including intercompany accounts of $300,000 and $0 as at September 30 and June 30, 2011 be eliminated in consolidation.

 
6

 

CHINA DIGITAL ANIMATION DEVELOPMENT, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)


2.             BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

a.  Basis of presentation
 
The accompanying condensed consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America.
 
In the opinion of the Company’s management, the unaudited condensed consolidated financial statements include all adjustments (consisting only or normal recurring adjustments) necessary to present fairly the consolidated financial position, results of operations and cash flows of the Company for the periods presented. The results of operations for the three months ended September 30, 2011 are not necessarily indicative of operating results expected for the full year or future interim periods. These unaudited condensed consolidated financial statements should be read in conjunction with the audited financial statements and notes thereto included in the Company’s Annual Report of Form 10-K for the year ended June 30, 2011, filed on October 13, 2011 (the “Annual Report”).

b.  Principle of consolidation

The accompanying consolidated financial statements include the accounts of the Company, its wholly-owned subsidiary RDX, and Hairong, which is deemed to be a variable interest entity of which RDX is the primary beneficiary as defined by ASC 810 “Consolidation of Variable Interest Entities.” All significant inter-company accounts and transactions have been eliminated in consolidation.

c.  Use of estimates
 
In preparing the financial statements in conformity with accounting principles generally accepted in the United States of America, management makes estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the dates of the financial statements, as well as the reported amounts of revenues and expenses during the reporting year. Significant estimates, required by management, include the recoverability of long-lived assets, useful lives of property, plant and equipment and intangible assets, allowance for doubtful accounts and inventory obsolescence. Actual results could differ from those estimates.

d.  Reclassification
 
Depreciation and amortization expenses of $70,724 and $67,116 for the three months ended September 30, 2010 have been reclassified from general and administrative expenses to cost of goods sold to conform to the current period presentation.  Such reclassifications had no impact on previously reported total assets, liabilities, stockholders’ equity or net income. 

e.  Cash and cash equivalents
 
For purposes of the statement of cash flows, the Company considers all highly liquid investments with original maturities of three months or less to be cash equivalents.  The Company maintains cash and cash equivalents with financial institutions in the PRC. The Company performs periodic evaluation of the relative credit standing of financial institutions that are considered in the Company’s investment strategy.

f.  Concentration of credit risk
 
 Financial instruments that potentially subject the Company to significant concentrations of credit risk consist of cash and cash equivalents and accounts and other receivables. As of September 30, 2011, substantially all the Company’s cash and cash equivalents are deposited at major banks located in the PRC. The Company’s management believes they are all of high credit quality. With respect to accounts receivable, the management extends credit based on an evaluation of the customer’s financial condition and customer payment practices to minimize collection risk on accounts receivable.
 

 
7

 

CHINA DIGITAL ANIMATION DEVELOPMENT, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)


2.             BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

g.  Accounts receivable and allowance for doubtful accounts
 
Accounts receivable are uncollateralized, non-interest bearing customer obligations typically due under terms requiring payment from the invoice date.  Payments of accounts receivable are allocated to the specific invoices identified on the customer’s remittance advice or, if unspecified, are applied to the oldest unpaid invoices.

The carrying amount of accounts is reduced by allowance for doubtful accounts receivable, if any. The Company's policy is that for amounts that are aged between 6 months and 12 months, the Company records a 3% allowance for doubtful accounts.  If the receivable is aged over 12 months, the Company reserves 5% of the account as an allowance for doubtful accounts. In addition, the Company reviews balances in excess of payment terms.  Based on this review, which includes customer credit worthiness and history, general economic conditions and changes in customer payment patterns, the Company estimates the portion, if any, of the balance that will not be collected and records that amount as an additional reserve.

There was no allowance made for doubtful accounts as of September 30 and June 30, 2011.

h.  Short-term Investments and Deferred Production Costs

In June 2011, we entered into three collaborative arrangements for total of RMB 77,210,000 (approximately $12.1 million) investment in television programs production.  As of September 30, 2011, we have paid RMB 46,058,500 (approximately $7.2 million).  The production for all three arrangements ends within one year.

The Company’s accounting policy is to evaluate the income statement classification for amounts due from or owed to other participants of the collaborative arrangements based on the nature of each activity.  For arrangements where the Company is responsible for the initial investment and entitle to a fixed return on investment and the other participants manage the day-to-day production and distribution activities as well as bear any additional cost overrun, the Company determines that it is not the principal in the transaction and therefore records the fixed return on investment as investment income. The initial investment is recorded as short-term investment. For two of the arrangements, the Company will recoup its investment cost plus 20% of return on investment before the other participant at the end of the contract period.

For arrangements where we jointly participate in production and distribution, as well as sharing the profit and loss in the arrangements, the Company records its pro-rata share of the distribution revenue as gross revenue and associated production and distribution costs in cost of revenue. The initial investment in the production of the TV program is recorded as deferred production costs on the consolidated balance sheets.

i.  Property, plant and equipment
 
Property, plant and equipment are stated at cost, net of accumulated depreciation.  Maintenance, repairs and betterments, including replacement of minor items, are charged to expense; major additions to physical properties are capitalized. Depreciation and amortization are provided using the straight-line method over the following estimated useful lives:
 
Buildings and improvements
40 years
Machinery, equipment and automobiles
5-10 years
 
j.  Intangible assets

Intangible assets include purchased software and are being amortized using the straight-line method over useful life of 10 years.


 
8

 

CHINA DIGITAL ANIMATION DEVELOPMENT, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)


2.
BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

k.  Income taxes
 
The Company accounted for income tax under the provisions of FASB ASC 740 "Accounting for Income Taxes", which requires recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements or tax returns.  Under this method, deferred income taxes are recognized for the tax consequences in future years of differences between the tax bases of assets and liabilities and their financial reporting amounts at each period end based on enacted tax laws and statutory tax rates applicable to the periods in which the differences are expected to affect taxable income. Valuation allowances are established, whenever necessary, against net deferred tax assets when it is more likely than not that some portion or the entire deferred tax asset will not be realized. There are no deferred tax amounts at September 30 and June 30, 2011.

l.  Revenue recognition
 
The Company’s revenue recognition policies are in compliance with FASB ASC 605, “Revenue Recognition.”  Sales revenue is recognized when the services are provided and the contracts are performed. The Company considers revenue realized or realizable and earned when (1) it has persuasive evidence of an arrangement, (2) delivery has occurred, (3) the sales price is fixed or determinable, and (4) collectability is reasonably assured.

Our animation design and development contracts are unit-price contracts which set forth a price per minute of labor, an estimate of total labor, and the resulting sales price.  Revenue is recognized when the outcome of a contract can be estimated reliably and the stage of completion at the balance sheet date can be measured reliably. Revenue is recognized on the percentage of completion method, measured on units of delivery basis by reference to the contractual unit price (RMB per minute) of work carried out during the period. When the outcome of a contract cannot be estimated reliably, revenue is recognized only when the contract is completed or substantially completed, and pending completion billings are accumulated on our balance sheets.

Cost of goods sold with reference to animation design and development includes direct labor costs and costs associated with any outsourcing of services. Since our animation design department is dedicated to that business, department overhead, including depreciation and amortization of assets, is also recorded as cost of goods sold. When the outcome of a contract can be estimated reliably and the stage of contract completion at the balance sheet date can be measured reliably, costs are charged to the income statement by reference to the stage of completion of the contract activity at the balance sheet date on the same basis as revenue from the contract is recognized. When the outcome of a contract cannot be estimated reliably, costs are recognized only when the contract is completed or substantially completed, and pending completion costs are accumulated on our balance sheet, except that provision is made for expected losses.   The normal period of a contract is approximately one to six months.

m.  Fair value measurements and fair value of financial instruments
 
The Company defines fair value as the price that would be received from selling an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. When determining the fair value measurements for assets and liabilities, which are required to be recorded at fair value, the Company considers the principal or most advantageous market in which the Company would transact and the market-based risk measurements or assumptions that market participants would use in pricing the asset or liability, such as inherent risk, transfer restrictions and credit risk.

 The Company applies the following fair value hierarchy, which prioritizes the inputs used to measure fair value into three levels and bases the categorization within the hierarchy upon the lowest level of input that is available and significant to the fair value measurement:


 
9

 

CHINA DIGITAL ANIMATION DEVELOPMENT, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)


2.
BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

m.  Fair value measurements and fair value of financial instruments (continued)

Level 1 - Quoted prices in active markets for identical assets or liabilities.

Level 2 - Observable inputs other than quoted prices in active markets for identical assets and liabilities, quoted prices for identical or similar assets or liabilities in inactive markets, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

Level 3 - Inputs that are generally unobservable and typically reflect management’s estimates of assumptions that market participants would use in pricing the asset or liability.
 
The Company’s financial instruments include cash and cash equivalents, accounts receivable, advances to suppliers, other receivables, accounts payable, accrued expenses, taxes payable and other loans payable. Management has estimated that the carrying amounts approximate their fair value due to the short-term nature.
 
n.  Foreign currency translation

The Company’s functional currency is the Renminbi (“RMB”). Foreign currency transactions are translated at the applicable rates of exchange in effect at the transaction dates. Monetary assets and liabilities denominated in foreign currencies at the balance sheet date are translated at the applicable rates of exchange in effect at that date. Revenues and expenses are translated at the average exchange rates in effect during the reporting period. Translation adjustments arising from the use of different exchange rates from period to period are included as a component of stockholders' equity as "Accumulated Other Comprehensive Income".  Gains and losses resulting from foreign currency translations are included in Accumulated Other Comprehensive Income.

RMB is not a fully convertible currency. All foreign exchange transactions involving RMB must take place either through the People’s Bank of China (the “PBOC”) or other institutions authorized to buy and sell foreign exchange. The exchange rates adopted for the foreign exchange transactions are the rates of exchange quoted by the PBOC, which are determined largely by supply and demand. Translation of amounts from RMB into US dollar has been made at the following exchange rates for the respective years:
 
September 30, 2011
Balance sheet
RMB 6.3952 to US $1.00
Statement of income and other comprehensive income
RMB 6.4132 to US $1.00
 
June 30, 2011
Balance sheet
RMB 6.4635 to US $1.00
Statement of income and other comprehensive income
RMB 6.6278 to US $1.00

September 30, 2010
Balance sheet
RMB 6.68 to US $1.00
Statement of income and other comprehensive income
RMB 6.7613 to US $1.00
 
 
10

 

CHINA DIGITAL ANIMATION DEVELOPMENT, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)


2.             BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

o.  Statement of cash flows
 
FASB issued ASC 230, “Statement of Cash Flows,” cash flows from the Company’s operations is calculated based upon the local currencies. As a result, amounts related to assets and liabilities reported on the statement of cash flows will not necessarily agree with changes in the corresponding balances on the balance sheet.

p.  Earnings (Loss) per share

Basic earnings (loss) per share is computed by dividing income available to common shareholders by the weighted-average number of common shares outstanding during the period.
 
Diluted earnings (loss) per share is computed similar to basic earnings per share except that the denominator is increased to include the number of additional common shares that would have been outstanding if the potential common shares had been issued and if the additional common shares were dilutive. There are no common stock equivalents available in the computation of earnings (loss) per share for the three months ended September 30, 2011 and 2010.
 
q.  Reserve Fund
 
Before June 20, 2006, Hairong was required to transfer 15% of its profit after taxation, as determined in accordance with Chinese accounting standards and regulations, to the surplus reserve fund. Subject to certain restrictions set out in the Chinese Companies Law, the surplus reserve fund may be distributed to stockholders in the form of share bonus issues and/or cash dividends.

r.  Comprehensive Income
 
 Comprehensive income is defined to include changes in equity except those resulting from investments by owners and distributions to owners. Among other disclosures, items that are required to be recognized under current accounting standards as components of comprehensive income are required to be reported in a financial statement that is presented with the same prominence as other financial statements. Comprehensive income includes net income and the foreign currency translation gain, net of tax.

s.  Recently Adopted Accounting Pronouncements

In January 2010, FASB issued ASU No. 2010-06, Fair Value Measurements and Disclosures (Topic 820): Improving Disclosures about Fair Value Measurements. This update provides amendments to ASC Topic 820 that provide disclosures about purchases, sales, issuances, and settlements in the roll forward of activity in Level 3 fair value measurements. Those disclosures are effective for fiscal years beginning after December 15, 2010, and for interim periods within those fiscal years. The adoption of this update did not have a material impact to the Company’s financial results as they relate only to additional disclosures.

In December 2010, FASB issued ASU No. 2010-29, Business Combinations (Topic 805): Disclosure of Supplementary Pro Forma Information for Business Combinations. The amendments in this Update specify that if a public entity presents comparative financial statements, the entity should disclose revenue and earnings of the combined entity as though the business combination(s) that occurred during the current year had occurred as of the beginning of the comparable prior annual reporting period only. The amendments also expand the supplemental pro forma disclosures to include a description of the nature and amount of material, nonrecurring pro forma adjustments directly attributable to the business combination included in the reported pro forma revenue and earnings. The amendments in this Update are effective prospectively for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2010. The adoption of this amendment did not have a material impact to the Company’s financial position.

 
11

 

CHINA DIGITAL ANIMATION DEVELOPMENT, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)



2.
BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

t.  Recently Issued Accounting Pronouncements Not yet Adopted
 
In May 2011, the FASB issued ASU No. 2011-04, Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRS. The amendments change the wording used to describe the requirements in U.S. GAAP for measuring fair value and for disclosing information about the fair value measurements. The amendments include the following:

l
Those that clarify the Board’s intent about the application of existing fair value measurement and disclosure requirements.
   
l
Those that change a particular principle or requirement for measuring fair value or for disclosing information about fair value measurements.

The amendments in this Update are to be applied prospectively. For public entities, the amendments are effective during interim and annual periods beginning after December 15, 2011. For nonpublic entities, the amendments are effective for annual periods beginning after December 15, 2011. Early application by public entities is not permitted. Nonpublic entities may apply the amendments in this Update early, but no earlier than for interim periods beginning after December 15, 2011.

The Company is currently evaluating the impact, and do not expect the adoption of this amendment have a material impact on the Company’s financial position and results of operations.

In June 2011, the FASB issued ASU No. 2011-05, Comprehensive Income (Topic 220): Presentation of Comprehensive Income. Under the amendments, an entity has the option to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. The presentation option under current GAAP to present the components of other comprehensive income as part of the statement of changes in stockholders’ equity has been eliminated.

The amendments in this Update should be applied retrospectively. For public entities, the amendments are effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. For nonpublic entities, the amendments are effective for fiscal years ending after December 15, 2012, and interim and annual periods thereafter. Early adoption is permitted because compliance with amendments is already permitted. The Company already complies with this presentation.
 
In September 2011, the FASB issued ASU No. 2011-08, Intangibles – Goodwill and Other (Topic 350): Testing Goodwill for Impairment. The objective of this Update is to simplify how entities, both public and nonpublic, test goodwill for impairment. The amendments in the Update permit an entity to first assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount as a basis of determining whether it is necessary to perform the two-step goodwill impairment test described in Topic 350. The more-likely-than-not threshold is defined as having a likelihood of more than 50 percent. The amendments are effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. Early adoption is permitted, including for annual and interim goodwill impairment tests performed as of a date before September 15, 2011, if an entity’s financial statements for the most recent annual or interim period have not yet been issued or, for nonpublic entities, have not yet been made available for issuance. The Company intends to adopt the amendments in this Update effective July 1, 2012.

 
12

 
 
CHINA DIGITAL ANIMATION DEVELOPMENT, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)


3.             GOING CONCERN

The Company has incurred significant continuing losses during the three months ended September 30, 2011 and the year ended June 30, 2011 and has relied on the Company’s registered capital to fund operations. As of September 30, 2011, we had cash and equivalents on hand of $12,253. These conditions raise substantial doubt about the Company’s ability to continue as a going concern.

The financial statements have been prepared assuming that the Company will continue as a going concern and, accordingly, do not include any adjustments that might result from the outcome of this uncertainty. As of September 30, 2011, our working capital of $7.3 million is mostly attributable to the three TV series production collaborative arrangements, which are recorded in short term investments and deferred production costs totaling $7.2 million.  In addition, as of September 30, 2011, we have contractual commitment to invest an additional $4.9 million in these arrangements. There is a possibility that we might not be able to recoup our investment cost or the return on investments on these collaborative arrangements may not materialize. As of September 30, 2011, the Company had limited cash resources, and management has not yet determined how the company will fund these obligations.
 
4.             PROPERTY, PLANT AND EQUIPMENT, NET
 
Property, plant and equipment consist of the following:
 
   
September 30,
2011
   
June 30,
2011
 
Buildings and Improvements
 
$
1,760,254
   
$
1,741,653
 
Office Furniture and Equipment
   
223,571
     
221,208
 
Vehicles
   
129,647
     
128,277
 
     
2,113,472
     
2,091,138
 
Less: Accumulated depreciation
   
(870,920
)
   
(816,611
)
Property, plant and equipment, net
 
$
1,242,552
   
$
1,274,527
 

Depreciation expense for the three months ended September 30, 2011 and 2010 were $45,460 and $250,010, respectively.
 
5.             INTANGIBLE ASSETS, NET

Intangible assets consist of the following:

September 30, 2011
 
At Cost
   
Accumulated
Amortization
   
Net
 
Animation Software
 
$
2,838,385
   
$
560,652
   
$
2,277,733
 
Other Software
   
13,817
     
5,631
     
8,186
 
   
$
2,852,202
   
$
566,283
   
$
2,285,919
 
June 30, 2011
 
At Cost
   
Accumulated
Amortization
   
Net
 
Animation Software
 
$
2,808,391
   
$
484,516
   
$
2,323,875
 
Other Software
   
13,671
     
5,230
     
8,441
 
   
$
2,822,062
   
$
489,746
   
$
2,332,316
 
                         


 
13

 

CHINA DIGITAL ANIMATION DEVELOPMENT, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)


5.             INTANGIBLE ASSETS, NET (Continued)

Total amortization expenses related to intangible assets for the three months ended September 30, 2011 and 2010 were $71,105 and $94,732, respectively.

The following schedule sets forth the estimated amortization expense for the periods presented:

For the year ending June 30,
     
2012
   
213,915
 
2013
   
285,220
 
2014
   
285,220
 
2015
   
285,220
 
2016
   
285,220
 
Thereafter
   
931,124
 
     
2,285,919
 
 
6.             LOAN PAYABLE
 
   
September 30,
   
June 30,
 
   
2011
   
2011
 
Loan payable to shareholder, Fu Zhiguo
 
$
270,000
   
$
260,000
 
Loan payable to former shareholder, Fu Qiang
   
85,975
     
85,975
 
   
$
355,975
   
$
345,975
 

The loan payable is interest free and the Company intends to repay this note when repayment is demanded.  The carrying amount of the loan payable approximates their fair values.
 
7.             INCOME TAXES
 
Hairong is subject to income tax at the PRC statutory rate of 25% on income reported in the statutory financial statements after appropriate tax adjustments.
 
The Company’s provisions for income taxes for the three months ended September 30, 2011 and 2010 as follows:

   
For the three months ended
 
   
September 30,
 
   
2011
   
2010
 
         
(restated)
 
Current – PRC and US
 
$
-
   
$
276,171
 
Deferred – PRC and US
   
-
     
-
 
  Total provision for income taxes
 
$
-
   
$
276,171
 


 
14

 

CHINA DIGITAL ANIMATION DEVELOPMENT, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)


7.             INCOME TAXES (Continued)
 
Deferred taxes are comprised of the following:
 
   
September 30,
   
June 30,
 
   
2011
   
2011
 
             
Net of operating loss carryforward
 
$
1,519,366
   
$
1,419,182
 
Less: Valuation allowance
   
(1,519,366
)
   
(1,419,182
)
Total deferred income tax assets
 
$
-
   
$
-
 

The Company was incorporated in United States of America and is subject to United States of America tax law. No provisions for income taxes have been provided for the U.S. parent company as it has a taxable loss for the three months ended September 30, 2011. No tax benefit has been realized since a valuation allowance has offset the deferred tax asset. As of September 30, 2011, the Company had a net operating loss from continuing operations for United States federal income tax purposes of $670,764 which are available to carry back five years or offset future taxable income, if any, through 2030.  The valuation allowance for deferred tax assets as of September 30, 2011 and June 30, 2011 was $228,060 and $203,887, respectively.  The change in total allowance for the three months ended September 30, 2011 was an increase of $24,173.

Hairong incurred net operating loss from continuing operations for PRC income tax purpose of $5,165,224 as of September 30, 2011, which are available to carry forward to offset future taxable income, if any, through 2016.  The valuation allowance for deferred tax assets as of September 30, 2011 and 2010 was $1,291,306 and $0, respectively. The change in total allowance for the three months ended September 30, 2011 was an increase of $76,011.

The Company did not recognize any interest or penalties related to unrecognized tax benefits for the three months ended September 30, 2011 and 2010.  The Company had no uncertain positions that would necessitate recording of tax related liability.  The Company is subject to examination by the respective tax authorities.
 
8.             STOCKHOLDERS’ EQUITY
 
In May 2011, Fu Qiang, the Company’s former Chairman and Chief Executive Officer, entered into a Resignation and Stock Transfer Agreement with Ieong Waifong and the Company. Pursuant to the Agreement, Fu Qiang transferred to Ieong Waifong five million shares of the Company’s common stock, representing 24.7% of the outstanding shares. Fu Qiang transferred the shares to Ieong Waifong without compensation. However, in the same Agreement Ieong Waifang granted to the Company an option to purchase the shares for a price of $.001 per share. The Company may exercise the option at any time prior to December 31, 2020. Ieong Waifong is not an employee or agent of the Company, nor does he have any other relationship with the Company other than ownership of the shares transferred to him by Fu Qiang.

The option can be settled only in shares and there are no circumstances under which any other settlement arrangement would arise.  Accordingly, pursuant to ASC 815-15-25-20, the “purchased call option that enables the issuer of an equity instrument (such as common stock) to reacquire the equity instrument would not be considered to be a derivative instrument by the issuer of the equity instrument.”

On July 25, 2011, the Company issued 20,000 shares of common stock to two independent directors for their past and future services as independent directors. Fair value of the common stock issued totaled $58,400.  As of and for the three months ended September 30, 2011, the Company recognized $45,800 as stock based compensation expense.  The remaining $12,600 will be recognized as stock based compensation expense ratably over the reminder service period through April 2012.

 
15

 

CHINA DIGITAL ANIMATION DEVELOPMENT, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)


9.             SEGMENT INFORMATION
 
FASB ASC 280, Disclosures about Segments of an Enterprise and Related Information, establishes standards for reporting information about operating segments. This standard requires segmentation based on our internal organization and reporting of revenue and operating income based upon internal accounting methods. Our financial reporting systems present various data for management to operate the business, including internal profit and loss statements prepared on a basis not consistent with U.S. GAAP. The segments are designed to allocate resources internally and provide a framework to determine management responsibility. Amounts for prior periods have been recast to conform to the current management view. Operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker, or decision making group, in deciding how to allocate resources and in assessing performance. Our chief operating decision maker is our Chief Executive Officer.

The Company has two segments, Animation Design and Development and TV Programs Production.  The TV Programs Production segment was started in June 2011 when the Company entered into a collaborative arrangement to produce and distribute TV program, as discussed in Note 2h. As of September 30 and June 30, 2011, the TV Programs Production segment was in production stage and has not begun to generate revenue.

Segment revenue was as follows:
 
   
Three months ended
 
   
September 30,
 
   
2011
   
2010
 
Revenue:
       
(restated)
 
Animation Design and Development
 
$
458,429
   
$
1,805,859
 
   Consolidated revenue
 
$
458,429
   
$
1,805,859
 

Segment profit was as follows:
 
   
Three months ended
 
   
September 30,
 
   
2011
   
2010
 
Segment profit:
       
(restated)
 
Animation Design and Development
 
$
(180,478)
   
$
(484,432)
 
    Consolidated segment profit
 
$
(180,478)
   
$
(484,432)
 

Segment assets were as follows:
 
   
September 30
   
June 30,
 
   
2011
   
2011
 
Assets:
           
Animation Design and Development
 
$
4,044,476
   
$
4,451,394
 
TV Programs Production
   
947,351
     
669,529
 
Corporate
   
6,255,164
     
6,204,120
 
    Consolidated assets
 
$
11,246,991
   
$
11,325,043
 


 
16

 

CHINA DIGITAL ANIMATION DEVELOPMENT, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)


9.             SEGMENT INFORMATION (Continued)

A reconciliation of the Company’s segment profit to the consolidated income before taxes for the three months ended September 30, 2011 and 2010, is as follows:

   
For the three months ended
 
   
September 30,
 
   
2011
   
2010
 
         
(restated)
 
Segment (loss)
 
$
(180,478)
   
$
(484,432)
 
Other corporate (expenses) income
   
(71,095)
     
(64,751)
 
    Total (loss) income before taxes
 
$
(251,573)
   
$
(549,183)
 
 
10.  RISKS AND UNCERTAINTIES
 
The Company's operations are carried out 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, and by the general state of the PRC's economy.
 
The Company's operations in the PRC are subject to specific considerations and significant risks not typically associated with companies in the North America and Western Europe. These include risks associated with, among others, the political, economic and legal environments and foreign currency exchange. The Company's results may be adversely affected by changes in governmental policies with respect to laws and regulations, anti-inflationary measures, currency conversion and remittance abroad, and rates and methods of taxation, among other things.

Concentration of credit risk
 
Financial instruments that potentially subject the Company to significant concentrations of credit risk consist of cash and cash equivalents. As of September 30, 2011 and June 30, 2011, substantially all of the Company’s cash and cash equivalents were held by major banks located in the PRC of which the Company’s management believes are of high credit quality. With respect to accounts receivable, the Company extends credit based on an evaluation of the customer’s financial condition and customer payment practices to minimize collection risk on account receivable.
 
The Company has the following concentrations of business with suppliers constituting 10% or greater of net purchases:

   
For the three months ended
 
   
September 30,
 
   
2011
   
2010
 
          (restated)  
Beijing Chenyang Animation Technologies Company
    93 %     52.01 %
Beijing Star Animation Studio
    *       47.99 %
 
* Constitute less than 10% of the Company's purchases value.

The amount of the Company’s accounts payable for the supplier is nil as of September 30, 2011.

 
17

 

CHINA DIGITAL ANIMATION DEVELOPMENT, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)


10.  RISKS AND UNCERTAINTIES (Continued)
 
The Company has the following concentrations of business with customers constituting 10% or greater of the Company’s sales value:

   
For the three months ended
 
   
September 30,
 
   
2011
   
2010
 
Beijing Wanfang Xingxing Digital Tech.
    80.00 %     10.65 %
Harbin Sinwen Animation Co., Ltd.
    *       17.20 %
Shenzhen Global Digital Tech Co., Ltd.
    10.00 %     41.36 %
Shanghai Animation Production Co., Ltd.
    10.00 %     30.79 %
 
* Constitute less than 10% of the Company's sales value.
 
The Company has not experienced any significant difficulty in collecting its accounts receivable in the past and is not aware of any financial difficulties of its major customers.  The Company’s accounts receivable value for the customers constituting 10% or greater of the Company’s sales value as of September 30, 2011:

   
Amount
   
Percentage
 
Beijing Wanfang Xingxing Digital Tech.
  $ 164,655       100 %
 
11.           EARNINGS PER SHARE
 
Basic earnings per share are computed on the basis of the weighted average number of shares of common stock outstanding during the period.  Diluted earnings per share is computed on the basis of the weighted average number of shares of common stock plus the effect of dilutive potential common shares outstanding during the year using the if-converted method for the convertible notes and preferred stock and the treasury stock method for warrants and options.  The following table sets forth the computation of basic and diluted net loss per share:

   
For The Three Months Ended
 
   
September 30,
 
   
2011
   
2010
 
         
(restated)
 
Net loss
  $ (251,573 )   $ (825,354 )
                 
Basic weighted-average common shares outstanding
    20,284,783       20,020,000  
Dilutive effect of options, warrants, and contingently issuable shares
    -       -  
Diluted weighted-average common shares outstanding
    20,284,783       20,020,000  
                 
Loss per share:
               
Basic and diluted
  $ (0.01 )   $ (0.04 )

For the three months ended September 30 2011 and 2010, no options, warrants, and contingently issuable shares were included in the calculation of the Company’s diluted loss per share because the Company did not have these financial instruments.
 

 
18

 

CHINA DIGITAL ANIMATION DEVELOPMENT, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)


12.           COMMITMENTS AND CONTINGENCIES

Collaborative Arrangements

As discussed in Note 2h, in June 2011, the Company entered into three collaborative arrangements to invest in and participate in television programs production.  Total commitment in the three arrangements is RMB 77,210,000 (approximately $12.1 million).  As of September 30, 2011, the Company has paid RMB 46,058,500 (approximately $7.2 million), the remaining RMB 31,151,500 (approximately $4.9 million investment will be paid at various time period within one year.
 
13.           RESTATEMENT

The financial statements of the Company for the three months ended September 30, 2010 that are included in this Report have been restated to effectuate changes from the statements filed in the Company’s Annual Report on Form 10-Q for the three months ended September 30, 2010.  The restatements were:

l
To adjust prepaid rent of $637,161 incorrectly recorded as leasehold improvements, resulted in reclassification from property, plant and equipment to prepaid expenses and $125,900 was amortized as rent expense. The related accumulated depreciation totaling $41,615 was reversed. 
   
l
To record the previously omitted cost of goods sold totaled $1,444,689 incurred and payable during the three months ended September 30, 2010. 

The effect of the restatement on specific line items in our Statement of Operations for the three months ended September 30, 2010 was:

Statements of Operations
 
As Reported
   
As Restated
 
             
Cost of Goods Sold
  $ 236,653     $ 1,819,181  
Gross (Loss) Profit
    1,569,206       (13,322 )
                 
Selling, General and Administrative expenses
    531,288       537,876  
                 
(Loss) Income from Operations before Other Income (Expenses)
    1,037,918       (551,198 )
                 
(Loss) Income from Operations before Income Taxes
    1,039,933       (549,183 )
                 
Net (Loss) Income
    763,762       (825,354 )
                 
Foreign Currency Translation Gain
    254,476       117,394  
                 
Total Comprehensive (Loss) Income
    1,018,238       (707,960 )
                 
(Loss) Earnings Per Common Share
               
- Basic and Diluted
  $ 0.05     $ (0.04 )


 
19

 

CHINA DIGITAL ANIMATION DEVELOPMENT, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)


13.           RESTATEMENT (Continued)

The effect of the restatement on specific line items in our Consolidated Statement of Cash Flows for the three months ended September 30, 2010 was:

Statements of Cash Flows
 
As Reported
   
As Restated
 
             
Net (Loss) Income
  $ 763,762     $ (825,354 )
                 
Adjustments to reconcile net income to net cash provided by operating activities:
               
Depreciation and amortization
    326,214       344,742  
                 
Changes in operating assets and liabilities:
               
Prepaid expenses
    -       119,260  
Accounts payable
    6,441       1,468,711  
Income tax payable
    (134,132 )     (23,593 )
Net cash provided by operating activities
    1,208,323       1,329,804  
                 
Effect of exchange rate changes in cash
    122,697       1,216  
 
 
20

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULT OF OPERATIONS

Forward-Looking Statements: No Assurances Intended
 
In addition to historical information, this Quarterly Report contains forward-looking statements, which are generally identifiable by use of the words “believes,” “expects,” “intends,” “anticipates,” “plans to,” “estimates,” “projects,” or similar expressions. These forward-looking statements represent Management’s belief as to the future of China Digital Animation Development, Inc.  Whether those beliefs become reality will depend on many factors that are not under Management’s control.  Many risks and uncertainties exist that could cause actual results to differ materially from those reflected in these forward-looking statements. Factors that might cause such a difference include, but are not limited to, those discussed in Item 1A - “Risk Factors” in the Company’s Annual Report on Form 10-K for the year ended June 30, 2011.  Readers are cautioned not to place undue reliance on these forward-looking statements. We undertake no obligation to revise or publicly release the results of any revision to these forward-looking statements.

Outline of Our Business

China Digital Animation Development Inc. (“China Digital”), through its operating company, Heilongjiang Hairong Science and Technology Development Co., Ltd., a joint stock company organized under the laws of The People’s Republic of China (“Hairong”), has, for the past three years, engaged primarily in the business of digital animation production.  

Recently we re-assessed our position in the animation development marketplace.  Our perception was that the animation industry in China has grown to a point at which we will soon be no longer able to compete effectively.  In recent years, however, due to the emphasis that the Chinese government has placed on the development of the animation industry, the market has become thick with competition.  Despite the funds and efforts that we devoted to marketing, in fiscal 2011 we found it impossible to secure the quantity of contracts that we required at bid prices that would yield profits to us.  Moreover, due to constant and rapid improvements in the equipment and software used in our industry, to remain competitive would require us to devote continual capital expenditures for upgrades and additions to our animation production facilities.  Management’s decision, therefore, was to re-orient our business model from one based on utilization of a state-of-the-art in-house capacity, to one in which we utilize our long-standing customer contacts and project management skills to obtain and manage project contracts while outsourcing most of the actual development work.   With this new business model, we will be able to more selectively choose the projects we work on, as we will no longer have the need to make constant use of an extended staff and expensive facilities.  To reorient our business model in this manner, during fiscal year 2011 we liquidated a large portion of our animation development property and equipment, and reduced our animation development staff to a modest crew.  As a result, in the first quarter of fiscal year 2012, we had much lower selling, general and administrative expenses than in the first quarter of the prior fiscal year.

With our existing cash resources and the proceeds obtained from liquidating some of our animation development property and equipment, we have invested in three media projects:
 
·
On June 15, 2011 we agreed to invest 19,710,000 RMB ($3,092,000) in production of a made-for-television movie titled “Yuan Da Qian Cheng.”  We were at the same time engaged to provide animation production services for the movie.
·
On June 20, 2011 we agreed to invest 19,000,000 RMB ($2,980,000) in production of a made-for-television movie titled “Xu’s Legal Marriage.”
·
On June 23, 2011 we agreed to invest 38,500,000 RMB ($6,040,000) in production of a general circulation movie titled “Xiao Naao Tian Gong.”


 
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To date, we have paid 46,058,500 RMB (approximately $7.2 million) on account of these investments.  The production of all three is scheduled to be completed within one year.  At that time, on the two projects in which we are non-participating investors, we are entitled to recoup our investment plus a 20% profit from the income earned by the properties before other participants share in income.  In the “Yuan Da Qian Cheng” project, for which we are providing both cash and development services, we are entitled to a share in the profits from distribution.

Results of Operations

All of our revenue in the three month periods ended September 30, 2011 and 2010 was earned by our animation developers.  Our investments in media projects will not produce revenue until calendar year 2012.  The 75% reduction in our revenue from the first quarter of fiscal 2011 to the first quarter of fiscal 2012, however, reflects our decision to significantly reduce our involvement in the animation development industry.  In each period the costs of outsourcing most of the production, combined with allocation of our remaining development overhead, led to a gross loss, $52,083 in the three months ended September 30, 2011, $13,322 in the three months ended September 30, 2010.

During the first quarter of fiscal 2011, before we liquidated a large portion of our animation development operation, we needed to keep our facilities occupied and our large staff of animation developers busy, which necessitated that we obtain a steady flow of contracts.  Toward that end, we devoted a large allocation of resources to marketing.  Currently, with our reduced facilities and reduced staff, we can rely primarily on our business contacts for marketing.  The change is reflected in the reduction of selling, general and administrative expenses from $537,876 in the first quarter of fiscal 2011 to $203,182 in the first quarter of fiscal 2012.

After adding our operating expenses to our gross loss, we realized a net loss of $251,573 for the three months ended September 30, 2011, or $.01 per share.  During the three months ended September 30, 2010 we realized a net loss of $825,354, or $.04 per share.

For the coming year, the greater portion of our assets will be invested in film and television program production.  The value of broadcasting rights and license of films and TV programs has increased, and the sales from distribution of copies of films and TV series over the internet have also jumped in the past few years.  In June 2011, we entered into three collaborative arrangements requiring us to invest a total of RMB 77,210,000 (approximately $12.19 million) in television program production.  As of September 30, 2011, we have paid RMB 46,058,500 (approximately $7.2 million).  The production for all three arrangements ends within one year, at which time the Company will obtain back its investment cost plus 20% of return on investment for two of the arrangements.  For one of the arrangements, the Company is entitled to its pro-rata share of the profits from distribution of the TV series. Our current plan is to re-dedicate the proceeds of the investments to our animation development business.  Management will spend the interim period, however, reviewing the Company’s prospects in that industry and determining the appropriate future course for our business.

Our business operates in Chinese Renminbi, but we report our results in our SEC filings in U.S. Dollars.  The conversion of our accounts from RMB to Dollars results in translation adjustments, which are reported as a middle step between net income and comprehensive income.  The net income is added to the retained earnings on our balance sheet; while the translation adjustment is added to a line item on our statement of stockholders equity labeled “accumulated other comprehensive income,” since it is more reflective of changes in the relative values of U.S. and Chinese currencies than of the success of our business.  During the three months ended September 30, 2011, the unrealized gain on foreign currency translations added $116,838 to our accumulated other comprehensive income.

Liquidity and Capital Resources

To date, our operations have been funded primarily by capital contributions from Hairong’s management and employees.  Approximately 54% of the capital contribution has been made by members of management and their business associates.  The remaining 46% was contributed by the employees, acting through a trustee.  The Company expects that in the future it will issue equity to the employees to compensate them for their financial contributions to the growth of Hairong, and to incentivize them for future loyalty to Hairong.

 
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In addition, the operations of our New York office, including the legal and accounting expenses attendant to our status as a public company, had, until June 2011, been funded by a $500,000 private placement of common stock in November 2010 and in part by loans from Fu Qiang, who was our Chief Executive Officer until early in June 2011, and Fu Zhiguo, who is a shareholder.  These loans were payable on demand and do not bear interest.  The Messrs. Fu made the loans to cover the costs of the New York office because the process of obtaining approval from the Chinese government for transfer of funds from China to the U.S. would be burdensome and delay our ability to pay our U.S. expenses.  We will continue to rely on loans from affiliates to pay our U.S. expenses until we can fund those expenses from Dollars obtained by a financing in the U.S. or after government approval of a conversion of a portion of our Renminbi balances into Dollars.

This program of internal financing has left us with a balance sheet that, at September 30, 2011, included no debt, either short-term or long-term, other than the $355,975 in loans payable to either Fu Qiang or Fu Zhiguo.  It also left us with working capital of $7,270,325 at September 30, 2011, a decrease of $10,563 during the three months then ended.  Included in our working capital at September 30, 2011 was $6,254,691 in short-term investments, specifically investments in two media production projects, and $947,351 in deferred production costs that represent our cash contribution to a media project in which we are both participating and investing.  These investments represent our efforts to achieve a reasonable return on our cash resources, better at least than the 0.4% interest offered by China’s banks, while we determine the future direction of our Company.

Despite the loss of $251,573 that we incurred in the three months ended September 30, 2011, our operations used only $15,702 in cash.  The disparity occurred primarily because we reduced our accounts receivable by $270,094 as our level of operations fell, and we used $43,900 in prepaid credits that we had funded in prior years, both of which events reduced our cash usage.

Going forward, we have a contractual obligation to provide an additional 31,151,500 RMB ($4,871,000) to fund the three media production projects in which we have invested.  We have not yet determined how we will fund those obligations.

Off-Balance Sheet Arrangements

We do not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition or results of operations.

ITEM 3
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Not applicable.

ITEM 4.    CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures.  Our Chief Executive Officer and Chief Financial Officer carried out an evaluation of the effectiveness of the Company’s disclosure controls and procedures as of September 30, 2011 (the “Evaluation Date”).  Pursuant to Rule13a-15(e) promulgated by the Securities and Exchange Commission pursuant to the Securities Exchange Act of 1934, “disclosure controls and procedures” means controls and other procedures that are designed to insure that information required to be disclosed by the Company in the reports that it files with the Securities and Exchange Commission is recorded, processed, summarized and reported within the time limits specified in the Commission’s rules.  “Disclosure controls and procedures” include, without limitation, controls and procedures designed to insure that information the Company is required to disclose in the reports it files with the Commission is accumulated and communicated to our Chief Executive Officer and Chief Financial Officer as appropriate to allow timely decisions regarding required disclosure.  That evaluation revealed that management of the Company on a number of occasions failed to apply appropriate accounting principles when preparing the Company’s financial statements, which resulted in the restatement described in Note 12 to the financial statements as well as errors in the presentation of the Company’s financial results for the interim quarters of fiscal 2011.  Accordingly, based on their evaluation, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that, as of the Evaluation Date, the Company’s disclosure controls and procedures were not effective.

 
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Changes in Internal Controls.  There was no change in internal controls over financial reporting (as defined in Rule 13a-15(f) promulgated under the Securities Exchange Act or 1934) identified in connection with the evaluation described in the preceding paragraph that occurred during the Company’s first fiscal quarter that has materially affected or is reasonably likely to materially affect the Company’s internal control over financial reporting.

 PART II   -   OTHER INFORMATION

Item 1.   Legal Proceedings
 
None.
 
Item 1A    Risk Factors
 
There have been no material changes from the risk factors included in the Annual Report on Form 10-K for the year ended June 30, 2011.
 
Item 2.  Unregistered Sale of Securities and Use of Proceeds

(a) Unregistered sales of equity securities

   . In July 2011 the Company issued a total of 20,000 shares of common stock to two of the members of its board of directors.  The shares were granted in consideration of services, and were valued at the market value on the date when the obligation to issue the shares accrued.  The issuance of the shares was exempt from registration pursuant to Section 4(2) of the Securities Act, as the issuance did not involve a public offering of securities.
 
 (c) Purchases of equity securities

The Company did not repurchase any of its equity securities that were registered under Section 12 of the Securities Exchange Act during the 1st quarter of fiscal 2012.
 
Item 3.   Defaults Upon Senior Securities.
 
None.

Item 4.  Reserved.
 

Item 5.  Other Information.
 
None.

 
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Item 6.
Exhibits
   
31.1
Rule 13a-14(a) Certification – CEO
   
31.2
Rule 13a-14(a) Certification – CFO
   
32
Rule 13a-14(b) Certification
   
101.ins
XBRL Instance
   
101.xsd
XBRL Schema
   
101.cal
XBRL Calculation
   
101.def
XBRL Definition
   
101.lab
XBRL Label
   
101.pre
XBRL Presentation
 

 
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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned thereunto duly authorized.
    
CHINA DIGITAL ANIMATION DEVELOPMENT INC.
 
Date: November 21, 2011
By: /s/ Sheng Zhai
 
 Sheng Zhai, Chief Executive Officer
   
 
By: /s/ Hu Yumei
 
 Hu Yumei, Chief Financial Officer, Chief Accounting Officer
 
 
 
 
 

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