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| EMDY.OB > SEC Filings for EMDY.OB > Form 10-Q on 14-Aug-2009 | All Recent SEC Filings |
14-Aug-2009
Quarterly Report
Forward Looking Statements
This Quarterly Report on Form 10-Q contains "forward-looking statements" that involve substantial risks and uncertainties. You can identify such statements by forward looking words such as "may," "expect," "plans," "intends," "anticipate," "believe," "estimate," and "continue" or similar words. Such statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. The forward-looking statements included herein are based on current expectations that involve numerous risks and uncertainties. Our plans and objectives are based, in part, on assumptions involving the continued growth and expansion of our business. Assumptions relating to the foregoing involve judgments with respect to, among other things, future economic, competitive and market conditions and future business decisions, all of which are difficult or impossible to predict accurately and many of which are beyond our control. Although we believe the assumptions underlying the forward-looking statements are reasonable, any of the assumptions could prove inaccurate and, therefore, there can be no assurance the forward-looking statements included in this Report will prove to be accurate. In light of the significant uncertainties inherent in the forward-looking statements included herein, the inclusion of such information should not be regarded as a representation by us or any other person that our objectives and plans will be achieved.
We are a producer of milk powder, rice powder and soybean milk powder, which currently comprise approximately 95%, 3% and 2% of our sales, respectively. Through our network of over 800 salespeople, our products are distributed throughout 20 provinces in the People's Republic of China ("PRC"), and sold in over 5,800 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 today in the PRC is over $13.0 billion 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 is expected to grow even faster, at an annual rate of approximately 23% through 2011. 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 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. In 2008, by adding a third shift to the existing two shifts working schedule, we produced approximately 9,000 tons of milk powder.
In addition, in July 2008, through our wholly-owned subsidiary, Hailun Xinganling Dairy Co., Ltd. ("HXD"), we commenced construction of a new production facility in Hailun City, Heilongjiang Province, PRC, which we expect will enable us to produce an additional 9,000 tons of milk powder in 2010 and a total of 18,000 tons of milk powder annually in 2011. As a result, 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 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.
All of our business is conducted through our wholly-owned Chinese subsidiaries:
· Heilongjiang Xing An Ling Dairy Co. Limited ("XAL"), which handles our promotion, sales and administrative functions;
· Heilongjiang Be'ian Nongken Changxing Lvbao Dairy Limited Liability Company ("Lvbao"), which handles production of our products in Be'ian City, Heilongjiang Province, PRC; and
· HXD, which will handle additional production of our products in Hailun City, Heilongjiang Province, PRC.
Recent Developments
Reverse Merger, Private Placements and Related Transactions
Prior to October 9, 2007, we were a public shell company, as defined by Rule 405 of the Securities Act of 1933 and Rule 12b-2 of the Securities Exchange Act of 1934, without material assets or activities. On October 9, 2007, we completed a reverse merger (the "Reverse Merger"), pursuant to which our wholly-owned subsidiary merged with and into a private company, American International Dairy Holding Co., Inc. ("AIDH"), with such private company being the surviving company. In connection with this Reverse Merger, we discontinued our former business and succeeded to the business of AIDH as our sole line of business. For financial reporting purposes, AIDH is considered to be the accounting acquirer. Accordingly, the historical financial statements presented and the discussion of financial condition and results of operations herein are those of AIDH and do not include our historical financial results.
Simultaneously with the Reverse Merger, we sold 1,333,333 units of our
securities to John V. Winfield, consisting of: (i) 1,333,333 shares of our
common stock, (ii) warrants to purchase 266,667 shares of our common stock, at
an exercise price of $0.94 per share ("Warrant W-1"), and (iii) warrants to
purchase 1,333,333 shares of our common stock, at an exercise price of $1.50 per
share ("Warrant W-2"), for an aggregate purchase price of $1,000,000 (the "First
Offering"). In addition, we sold 2,061,227 units of our securities to certain
additional "accredited investors" (the "Initial Purchasers"), consisting of
(i) 2,061,227 shares of our common stock, (ii) warrants to purchase 412,245 of
our common stock, at an exercise price of $2.04 per share (the "Class A
Warrants"), and (iii) warrants to purchase 2,061,227 shares of our common stock,
at an exercise price of $3.26 per share (the "Class B Warrants"), for an
aggregate purchase price of $3,359,800 (the "Initial Placement of the Second
Offering"). The rights and obligations under Warrant W-1, Warrant W-2, the Class
A Warrants, and the Class B Warrants are further described in "- Liquidity and
Capital Resources - Warrants" below.
Upon the consummation of the Reverse Merger, and the closing of the First Offering and Initial Placement of the Second Offering, 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 "Repurchased 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 are currently being held in treasury.
Immediately following the closing of the Repurchase Transaction, we entered into Put/Call Agreements with each of Grand Orient and Fortune Land Holding, Ltd., a PRC company controlled by Dexuan Yu (jointly, the "Put/Call Shareholders). Prior to the termination of the Put/Call Agreements on March 3, 2009, we had the right to repurchase an aggregate of 1,944,444 shares of our common stock from the Put/Call Shareholders under certain circumstances, and the Put/Call Shareholders had the right to cause us to repurchase such shares at $1.63 per share if certain events occur. The Put/Call Agreements are further described in "- Liquidity and Capital Resources - Put/Call Agreements" below.
On October 19, 2007, we sold 2,846,746 units of our securities to additional
"accredited investors" (the "Additional Purchasers"), consisting of
(i) 2,846,746 shares of our common stock, (ii) 569,346 Class A Warrants, and
(iii) 2,846,746 Class B Warrants, for an aggregate purchase price of $4,640,200
(the "Additional Placement of the Second Offering," and together with the
Initial Placement of the Second Offering, the "Second Offering").
As of March 2, 2009, an aggregate of 183,457 of the Class A Warrants and 175,937 of the Class B Warrants were tendered at reduced exercise prices, as further described in "- Recent Developments - First Warrant Tender Offer" below.
In connection with the First Offering and Second Offering (collectively, the "October Offerings"), we engaged finders and placement agents to whom we paid fees in the aggregate of $700,452, and granted (i) warrants to purchase an aggregate of 106,667 shares of our common stock, at an exercise price of $0.94 per share, the terms and conditions of which are identical to the those of Warrant W-1, and (ii) warrants to purchase 392,639 shares of our common stock, at an exercise price of $2.04, the terms and conditions of which are identical to the those of the Class A Warrants. On March 2, 2009, the exercise prices of 235,583 of these warrants were reduced from $2.04 to $1.63, as partial consideration for services rendered in connection with a consulting agreement we entered into with one of these parties.
Construction of New Production Facility
On May 22, 2008, we organized our wholly-owned subsidiary, HXD, under the laws of the PRC. In July 2008, HXD commenced construction of a production facility to be located in Hailun City, Heilongjiang Province, PRC. Initially, the new facility will have one production line, which will have the capacity to produce 9,000 tons of milk power annually. The new facility will have the capacity to accommodate a second production line, which, if and when completed, would enable us to produce an additional 9,000 tons of milk powder per year, giving us a total annual production capacity at all of our production facilities of 27,000 tons of milk powder. We anticipate that production at this new facility will commence in the fourth quarter of fiscal 2009, assuming we obtain the $6.0 million we require to complete construction and fully equip the first production line. We believe that the cost to add the second production line would be approximately 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.
Sale of Notes and Warrants
June Note Offering
In June 2008, we conducted a private offering of up to a maximum of (i) $3,000,000 of our 8% promissory notes (the "June Notes") and (ii) warrants to purchase 300,000 shares of our common stock, at an exercise price of $2.61 per share (the "June Warrants") (the "June Note Offering"). On June 12, 2008, one "accredited investor" purchased, for a purchase price of $1,500,000, a June Note in the principal amount of $1,500,000, and June Warrants to purchase 150,000 shares of our common stock. On June 20, 2008, an additional "accredited investor" purchased, for a purchase price of $750,000, a June Note in the principal amount of $750,000, and June Warrants to purchase 75,000 shares of our common stock. As of December 31, 2008, certain of the terms of the June Notes and June Warrants were amended. The rights and obligations under the June Notes, as amended, are further described in "- Liquidity and Capital Resources - Promissory Notes" below. The rights and obligations under the June Warrants, as amended as of December 31, 2008, are further described in "- Liquidity and Capital Resources - Warrants" below.
In connection with the June Note Offering, we engaged a placement agent to whom we paid a non-refundable retainer of $25,000, and a placement fee in the amount of $97,500, and granted warrants to purchase an aggregate of 45,000 shares of our common stock, the terms and conditions of which are identical to the those of the June Warrants, as amended as of December 31, 2008.
In addition, as of July 4, 2009, we granted the same placement agent warrants to
purchase an additional 97,500 shares of our common stock in consideration for
its services in connection with the amendment of the June Notes and June
Warrants as of December 31, 2008. The rights and obligations under these
additional warrants are further described in "- Liquidity and Capital Resources
- Warrants" below.
November Note Offering
On November 10, 2008, we sold to one "accredited investor," for a purchase price of $500,000, a 10% promissory note (the "November Note") in the principal amount of $500,000, and warrants to purchase 50,000 shares of our common stock, at an exercise price of $2.61 per share (the "November Warrants") (the "November Note Offering"). The rights and obligations under the November Note are further described in "- Liquidity and Capital Resources - Promissory Notes" below. The rights and obligations under the November Warrants are further described in "- Liquidity and Capital Resources - Warrants" below.
In connection with the November Note Offering, we engaged a placement agent to whom we paid a placement fee in the amount of $40,000, and granted warrants to purchase an aggregate of 25,000 shares of our common stock, the terms and conditions of which are identical to the those of the November Warrants.
First Warrant Tender Offer
As of April 24, 2008, we commenced an offer (the "First Warrant Tender Offer") to the holders of our then outstanding warrants, pursuant to which the holders had the opportunity to exchange their existing warrants for amended warrants to be exercised at reduced exercise prices as follows:
· With respect to eligible warrants having an exercise price of $0.94 per share, a holder accepting the First Warrant Tender Offer could exercise some or all of the amended warrants at $0.75 per share of common stock;
· With respect to eligible warrants having an exercise price of $1.50 per share, a holder accepting the First Warrant Tender Offer could exercise some or all of the amended warrants at $1.20 per share of common stock;
· With respect to eligible warrants having an exercise price of $2.04 per share, a holder accepting the First Warrant Tender Offer could exercise some or all of the amended warrants at $1.63 per share of common stock; and
· With respect to eligible warrants having an exercise price of $3.26 per share, a holder accepting the First Warrant Tender Offer could exercise some or all of the amended warrants at $2.61 per share of common stock.
On March 2, 2009, we closed the First Warrant Tender Offer. In connection with the First Warrant Tender 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 $299,035; 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, we received gross proceeds of $758,231 and issued an aggregate of 359,394 shares of our common stock.
Second Warrant Tender Offer
As of June 19, 2009, we commenced an offer (the "Second Warrant Tender Offer") to all holders of warrants to purchase shares of our common stock, having exercise prices of either $0.94, $1.50, $1.63, $2.04 or $3.26 per share, originally issued in connection with the October Offerings (the "Original Warrants"), the opportunity to voluntarily exchange any or all of the Original Warrants for amended warrants exercisable at reduced exercise prices ("Amended Warrants"), for a limited period of time.
The terms of the Amended Warrants, include the following:
· With respect to the 373,344 warrants having an exercise price of $0.94 per share, a holder accepting the Second Warrant Tender Offer may exchange some or all of the warrants for amended warrants exercisable at $0.75 per share;
· With respect to the 1,333,333 warrants having an exercise price of $1.50 per share, a holder accepting the Second Warrant Tender Offer may exchange some or all of the warrants for amended warrants exercisable at $1.20 per share;
· With respect to the 235,583 warrants having an exercise price of $1.63 per share, a holder accepting the Second Warrant Tender Offer may exchange some or all of the warrants for amended warrants exercisable at $1.30 per share;
· With respect to the 955,190 warrants having an exercise price of $2.04 per share, a holder accepting the Second Warrant Tender Offer may exchange some or all of the warrants for amended warrants exercisable at $1.63 per share; and
· With respect to the 4,732,036 warrants having an exercise price of $3.26 per share, a holder accepting the Second Warrants Tender Offer may exchange some or all of the warrants for amended warrants exercisable at $1.63 per share.
On August 13, 2009, we closed the Second Warrant Tender Offer. In connection with the Second Warrant Tender Offer:
· a total of 49,000 Original 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 2,205,828 Original 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.
The rights and obligations under the Amended Warrants are further described in "- Liquidity and Capital Resources - Warrants" below.
Trends and Uncertainties
Economic Downturn
The recent worldwide economic downturn and market instability 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 may be adversely affected by unpredictable and unstable market conditions. If the current equity and credit markets deteriorate further, or do not improve, it may make any necessary debt or equity financing more difficult, more costly, and more dilutive. 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.
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.
Industry Growth
The dairy market today in the PRC is over $13.0 billion. According to the website of China National Bureau of Statistics, between 2000 and 2007 the dairy industry in the PRC experienced an average growth of 16% per year. English-language copies of the reports of the China National Bureau of Statistics are available on its website, free of charge, at www.stats.gov.cn/english. The dairy industry in the PRC is projected to grow at rate of 15% per year from 2008 to 2012, to reach $32 billion by 2012.
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.
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 fourth quarter of 2009. 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.
This project is expected to cost an aggregate of approximately $20.0 million, including land use rights, construction expenses and equipment costs. We have applied the net proceeds we received from the June Note Offering and November Note Offering, further described in "- Recent Developments - Sale of Notes and Warrants" above, and from the First Warrant Tender Offer, further described in "- Recent Developments - First Warrant Tender Offer" above, toward the construction of this new production facility. We have no additional commitments for the additional $6.0 million we expect to need to complete the construction and equipping of the first production line at our new production facility. There can be no assurance that that any additional financing will become available to us, and if available, on terms acceptable to us.
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. However, we believe the recent worldwide increases in the cost and availability of commodities, such as rice and oil, will lead to increases in prices for such commodities. To some extent, we believe we will be able to increase the prices for our products to pass on 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.
Organic 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 beginning in 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 very 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.
Contamination of Milk Powder Products Produced in the PRC
Recently, 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. 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, 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
Three-Month Period Ended June 30, 2009 Compared to Three-Month Period Ended June 30, 2008
Net income increased by $564,786, from $698,350 in the three months ended June 30, 2008, to $1,263,136 for the three months ended June 30, 2009. The increase in net income during the three months ended June 30, 2009, as compared to the same time period in the prior year, was due to an increase in gross profit, . . .
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