(Registrant's
telephone number, including area code)
Indicate
by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports) and (2) has been subject to such filing requirements for
the past 90 days. 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 during the preceding
12 months (or for such shorter period that the registrant was required to submit
and post such files).* Yes ¨ No ¨ *The registrant
has not yet been phased into the interactive data requirements.
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. See
the definitions of "large accelerated filer," "accelerated filer" and "smaller
reporting company" in Rule 12b-2 of the Exchange Act.
Large
Accelerated Filer ¨
Accelerated
Filer ¨
Non-Accelerated
Filer (Do not check if a smaller reporting company) ¨
Smaller
Reporting Company x
Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act). Yes ¨ No x
The
number of shares of Class A Common Stock outstanding as of July 31, 2010 was
108,142,409.
NEW
DRAGON ASIA CORP.
FORM
10-Q
FOR
THE QUARTERLY PERIOD ENDED JUNE 25, 2010
TABLE
OF CONTENTS
Page
PART
I:
FINANCIAL
INFORMATION
ITEM
1.
Consolidated
Financial Statements:
Consolidated
Balance Sheets as of June 25, 2010 (unaudited) and December 25,
2009
3
Consolidated
Statements of Operations (unaudited) for the three months and six months
ended June 25, 2010 and 2009
4
Consolidated
Statements of Stockholders’ Equity and Comprehensive Income (Loss) for the
six months ended June 25, 2010 (unaudited) and the year ended December 25,
2009
5
Consolidated
Statements of Cash Flows (unaudited) for the six months ended June 25,
2010 and 2009
6
Notes
to Consolidated Financial Statements (unaudited)
7
ITEM
2.
Management’s
Discussion and Analysis of Financial Condition and Results of
Operations
17
ITEM
3.
Quantitative
and Qualitative Disclosures About Market Risk
25
ITEM
4T.
Controls
and Procedures
25
PART
II:
OTHER
INFORMATION
ITEM
1.
Legal
Proceedings
26
ITEM
1A.
Risk
Factors
26
ITEM
2.
Unregistered
Sales of Equity Securities and Use of Proceeds
Adjustments
to reconcile net loss to net cash (used in) provided by operating
activities:
Allowance
for doubtful accounts
4,115
317
Provision
for inventory reserve
2
2,244
Depreciation
and amortization of property, machinery, equipment and land use
rights
978
864
Loss
on sale of machinery and equipment
260
—
Gain
on fair value adjustments to embedded derivatives
(51
)
(173
)
Stock
based compensation expense
75
75
Changes
in operating assets and liabilities:
Accounts
receivable
(4,925
)
(2,396
)
Deposits
and prepayments
17
5,
628
Inventories
3,924
1,506
Due
from related companies
—
30
Accounts
payable
1,292
115
Other
payables and accruals
125
(1,601
)
Taxes
payable
(101
)
287
Deferred
tax asset
—
(349
)
Net
cash (used in) provided by operating activities
(454
)
2,581
Cash
flows from investing activities:
Purchases
of property, machinery and equipment
(25
)
(6,071
)
Proceeds
from sale of property, machinery and equipment
15
5,778
Net
cash used in investing activities
(10
)
(293
)
Cash
flows from financing activities:
(Repayment
of) proceeds from shareholder loan
(206
)
607
Proceeds
from joint venture partners
36
70
Net
cash (used in) provided by financing activities
(170
)
677
Impact
of foreign currency translation on cash
395
4
Net
(decrease) increase in cash and cash equivalents
(239
)
2,969
Cash
and cash equivalents at beginning of period
3,440
4,383
Cash
and cash equivalents at end of period
$
3,201
$
7,352
Non-Cash
Investing and Financing Activities
Conversion
of preferred stock into common stock
$
1,504
$
1,504
Dividend
payments on preferred stock in the form of common stock
$
83
$
215
The
accompanying notes are an integral part of these consolidated financial
statements.
6
NEW
DRAGON ASIA CORP. AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE
1. ORGANIZATION AND NATURE OF OPERATIONS
New
Dragon Asia Corp., a corporation incorporated in the State of Florida
(collectively with its subsidiaries, the “Company,” “we,” “us,” or “our”), is
principally engaged in the milling, sale and distribution of flour and related
products, including instant noodles and soybean-derived products, to retail and
wholesale customers throughout China through its foreign subsidiaries in China.
The Company is headquartered in Shandong Province in the People’s Republic of
China (“PRC” or “China”) and has its eight manufacturing plants in Yantai,
Beijing, Chengdu, and Penglai.
NOTE
2. BASIS OF PRESENTATION
The
consolidated financial statements include the financial statements of New Dragon
Asia Corp. and all of its wholly and majority owned subsidiaries. Intercompany
balances and transactions have been eliminated in consolidation.
Accounting
Standards Codification (“ASC”) Topic 810, “Consolidation of Variable Interest
Entities” (formerly Standards of Financial Accounting Standards (“SFAS”) 167,
“Amendments to FASB Interpretation No. 46(R))” requires an investor with a
majority of the variable interests (primary beneficiary) in a variable interest
entity (“VIE”) to consolidate the entity. A VIE is an entity in which
the voting equity investors do not have a controlling financial interest or the
equity investment at risk is insufficient to finance the entity’s activities
without receiving additional subordinated financial support from other parties.
VIEs are required to be consolidated by their primary beneficiaries if they do
not effectively disperse risks among the parties involved. The
primary beneficiary of a VIE is the party that absorbs a majority of the
entity’s expected losses or receives a majority of its expected residual
returns. The Company has completed a review of its investments in
both non-marketable and marketable equity interests as well as other
arrangements to determine whether it is the primarily beneficiary of any
VIEs. The review did not identify any VIEs.
These
Consolidated Financial Statements for interim periods are unaudited and were
prepared in accordance with accounting principles generally accepted in the
United States and the rules and regulations of the Securities and Exchange
Commission. In the opinion of management, the consolidated financial
statements include all adjustments, consisting only of normal, recurring
adjustments, necessary for their fair presentation. The results
reported in these Consolidated Financial Statements are not necessarily
indicative of the results that may be reported for the entire
year. The preparation of financial statements requires management to
make estimates and assumptions that affect the reported amounts of assets and
liabilities, the disclosure of contingent assets and liabilities as of the date
of the financial statements and the reported amounts of revenues and expenses
during the reporting period. The Company regularly evaluates
estimates and assumptions related to allowances for doubtful accounts, sales
returns and allowance, and inventory reserves. Although management believes
these estimates and assumptions are adequate and reasonable under the
circumstances, actual results could differ from those estimates.
Contractual
Joint Ventures
A
contractual joint venture is an entity established between the Company and
another joint venture partner, with the rights and obligations of each party
governed by a contract. Currently, the Company has established three contractual
joint ventures with three Chinese partners in China, with percentage of
ownership ranging from 79.64% to 90%. Pursuant to each Chinese joint venture
agreement, each Chinese joint venture partner is entitled to receive a
pre-determined annual fee and is not responsible for any profit or loss,
regardless of the ownership in the contractual joint venture. In view of such
contracted profit sharing arrangement, the three contractual joint ventures are
regarded as 100% owned by the Company for income statement purposes. The Company
consolidates financial statements of the contractual joint ventures and accounts
for the portion of the contractual joint ventures not wholly-owned by the
Company as non-controlling interest.
Accounting
for Derivative Instruments
Derivatives
are recorded on the Company’s balance sheet at fair value. These derivatives,
including embedded derivatives in the Company’s Series A and B Redeemable
Convertible Preferred Stock are separately valued and accounted for on the
Company’s balance sheet.
The
pricing models the Company uses for determining fair values of its derivatives
are a combination of the Black-Scholes and Binomial Pricing Models. Valuations
derived from this model are subject to ongoing internal and external review. The
model uses market-sourced inputs such as interest rates and option volatilities.
Selection of these inputs involves management’s judgment and may impact net
earnings. The Company has obtained a valuation report from a valuation firm to
support its estimates.
The
consolidated financial statements also reflect additional non-operating gains
and losses related to the classification of and accounting for: (1) the
conversion features of the Series A and B Preferred Stock and associated
warrants, and (2) the amortization associated with the discount recorded with
respect to the Series A and B Preferred Stock as a preferred stock dividend.
Fair
Value of Financial Instruments
The
Company adopted ASC Topic 820, “Fair Value Measurements and Disclosure”
(formerly SFAS 157, “Fair Value Measurements”) on January 1, 2008 to
account for and record fair values of financial instruments. This ASC
establishes a framework for measuring fair value, and expands disclosures about
fair value measurements. The ASC establishes a fair value hierarchy
that prioritizes the inputs to valuation techniques used to measure fair value
into three levels as follows:
Level
1 -
quoted
prices (unadjusted) in active markets for identical asset or
liabilities that the Company has the ability to access as of the
measurement date. Financial assets and liabilities utilizing Level 1
inputs include active exchange-traded securities and exchange-based
derivatives.
Level
2 -
inputs
other than quoted prices included within Level 1 that are directly
observable for the asset or liability or indirectly observable through
corroboration with observable market data. Financial assets and
liabilities utilizing Level 2 inputs include fixed income securities,
non-exchange-based derivatives, mutual funds, and fair-value
hedges.
Level
3 -
unobservable
inputs for the asset or liability only used when there is little, if any,
market activity for the asset or liability at the measurement date.
Financial assets and liabilities utilizing Level 3 inputs include
infrequently-traded, non-exchange-based derivatives and commingled
investment funds, and are measured using present value pricing
models.
The
Company determines the level in the fair value hierarchy within which each fair
value measurement in its entirety falls, based on the lowest level input that is
significant to the fair value measurement in its entirety.
The
following table presents the embedded derivative, the Company only financial
assets measured and recorded at fair value on the Company’s Consolidated Balance
Sheets on a recurring basis and their level within the fair value hierarchy
during the period ended June 25, 2010 and 2009:
(In thousands)
Fair Value
Level 1
Level 2
Level 3
Total
Embedded
derivative liabilities as of June 25, 2010
$
—
$
—
$
16
$
16
Embedded
derivative liabilities as of June 25, 2009
$
—
$
—
$
93
$
93
NOTE
3. RECENT ACCOUNTING PRONOUNCEMENTS
In
January 2010, FASB issued ASU 2010-2, “Accounting and Reporting for Decreases in
Ownership of a Subsidiary- a Scope Clarification”. ASU 2010-2 addresses
implementation issues related to the changes in ownership provisions in the
Consolidation—Overall Subtopic (Subtopic 810-10) of the FASB ASC, originally
issued as SFAS 160, “Noncontrolling Interests in Consolidated Financial
Statements”. Subtopic 810-10 establishes the accounting and reporting guidance
for noncontrolling interests and changes in ownership interests of a subsidiary.
An entity is required to deconsolidate a subsidiary when the entity ceases to
have a controlling financial interest in the subsidiary. Upon deconsolidation of
a subsidiary, an entity recognizes a gain or loss on the transaction and
measures any retained investment in the subsidiary at fair value. The gain or
loss includes any gain or loss associated with the difference between the fair
value of the retained investment in the subsidiary and its carrying amount at
the date the subsidiary is deconsolidated. In contrast, an entity is required to
account for a decrease in ownership interest of a subsidiary that does not
result in a change of control of the subsidiary as an equity transaction.
ASU 2010-2 is effective for the Company starting January 3, 2010. The
adoption of ASU 2010-2 will not have a material impact on the Company's results
of operations or financial position.
8
In
January 2010, FASB issued ASU 2010-6, “Improving Disclosures about Fair
Measurements". ASU 2010-6 provides amendments to subtopic 820-10 that require
separate disclosure of significant transfers into and out of Level 1 and
Level 2 fair value measurements and the presentation of separate
information regarding purchases, sales, issuances and settlements on a gross
basis in the reconciliation of Level 3 fair value measurements.
Additionally, ASU 2010-6 provides amendments to subtopic 820-10 that clarify
existing disclosures about the level of disaggregation and inputs and valuation
techniques. ASU 2010-6 is effective for financial statements issued for annual
reporting periods beginning after December 15, 2009, except for Level 3
reconciliation disclosures which are effective for annual periods beginning
after December 15, 2010. The adoption of ASU 2010-06 will not have a
material impact on the Company’s results of operations or financial
position.
In
February 2010, FASB issued ASU 2010-9 “Subsequent Events (Topic 855) Amendments
to Certain Recognition and Disclosure Requirements”. ASU 2010-9 amends
disclosure requirements within Subtopic 855-10. An entity that is an SEC filer
is not required to disclose the date through which subsequent events have been
evaluated. This change alleviates potential conflicts between Subtopic 855-10
and the SEC's requirements. ASU 2010-9 is effective for interim and annual
periods ending after June 15, 2010. The Company expects the adoption of ASU
2010-06 will not have a material impact on the Company’s results of operations
or financial position.
In March
2010, FASB issued ASU 2010-11 “Derivatives and Hedging (Topic 815) Scope
Exception Related to Embedded Credit Derivatives”. ASU 2010-11 clarifies the
type of embedded credit derivative that is exempt from embedded derivative
bifurcation requirements. Only one form of embedded credit derivative qualifies
for the exemption—one that is related only to the subordination of one financial
instrument to another. As a result, entities that have contracts containing an
embedded credit derivative feature in a form other than such subordination may
need to separately account for the embedded credit derivative feature. The
amendments in this Update are effective for each reporting entity at the
beginning of its first fiscal quarter beginning after June 15, 2010. Early
adoption is permitted at the beginning of each entity’s first fiscal quarter
beginning after issuance of this Update. The Company expects the adoption of ASU
2010-11 will not have a material impact on the Company’s results of operations
or financial position.
In April
2010, FASB issued ASU 2010-13 “Compensation-Stock Compensation (Topic 718)
Effect of Denominating the Exercise Price of a Share-Based Payment Award in the
Currency of the Market in Which the Underlying Equity Security Trades”. ASU
2010-13 addresses the classification of a share-based payment award with an
exercise price denominated in the currency of a market in which the underlying
equity security trades. Topic 718 is amended to clarify that a share-based
payment award with an exercise price denominated in the currency of a market in
which a substantial portion of the entity’s equity securities trades shall not
be considered to contain a market, performance, or service condition. Therefore,
such an award is not to be classified as a liability if it otherwise qualifies
as equity classification. The amendments in this Update should be effective for
fiscal years, and interim periods within those fiscal years, beginning on or
after December 15, 2010. The guidance should be applied by recording a
cumulative-effect adjustment to the opening balance of retained earnings for all
outstanding awards as of the beginning of the fiscal year in which the
amendments are initially applied. The Company expects the adoption of ASU
2010-13 will not have a material impact on the Company’s results of operations
or financial position.
In April
2010, FASB issued ASU 2010-18
“Effect of a Loan Modification When the Loan Is Part of a Pool That Is
Accounted for as a Single Asset (A consensus of the FASB Emerging Issues
Task)”. ASU 2010-18
clarifies that modifications of loans that are accounted for within a pool under
Subtopic 310-30, which provides guidance on accounting for acquired loans that
have evidence of credit deterioration upon acquisition, do not result in the
removal of those loans from the pool even if the modification would otherwise be
considered a troubled debt restructuring. An entity will continue to be required
to consider whether the pool of assets in which the loan is included is impaired
if expected cash flows for the pool change. The amendments do not affect the
accounting for loans under the scope of Subtopic 310-30 that are not accounted
for within pools. Loans accounted for individually under Subtopic 310-30
continue to be subject to the troubled debt restructuring accounting provisions
within Subtopic 310-40. The amendments in this Update are effective for
modifications of loans accounted for within pools under Subtopic 310-30
occurring in the first interim or annual period ending on or after July 15,
2010. The Company expects the adoption of ASU 2010-18 will not have a material
impact on the Company’s results of operations or financial
position.
Condensed
balance sheet information as of June 25, 2010 consisted of the following (in
thousands):
Inside China
Outside China
Total
Assets
-
Cash and cash equivalents
$
3,189
$
12
$
3,201
-
Others
64,770
20
64,790
Total
assets
67,959
32
67,991
Liabilities,
excluding Series A and B Redeemable Convertible Preferred
Stock
9,082
3,340
12,422
Equity
39,996
13,714
53,710
Assets
located outside of China consist primarily of cash and cash equivalents.
Liabilities located outside of China consist primarily of embedded derivatives,
net of the related beneficial conversion feature and fair value of the warrants.
9
Condensed
statement of operation information for the six months ended June 25, 2010
consisted of the following (in thousands):
Inside China
Outside China
Total
Net
revenue
$
12,593
$
—
$
12,593
Cost
of goods sold
(12,633
)
—
(12,633
)
General
and administrative expenses
(4,968
)
(335
)
(5,303
)
Loss
from operations
(5,432
)
(335
)
(5,767
)
Provision
for income taxes
(1
)
—
(1
)
Other
income (expense)
(448
)
51
(397
)
Net
loss attributable to controlling interest
(5,881
)
(284
)
(6,165
)
The
Company does not believe that providing additional information regarding cash
flows is meaningful to the reader, in light of the nature of the assets and
operations located inside China and outside China.
The
calculation of diluted weighted average common shares outstanding for the three
and six months ended June 25, 2010 and 2009 is based on the average of the
closing price of the Company’s common stock during such periods applied to
warrants and options using the treasury stock method to determine if they are
dilutive. The Redeemable Convertible Preferred stock is included on an “as
converted “basis when these shares are dilutive.
The
following table is a reconciliation of the weighted average shares used in the
computation of basic and diluted earnings per share for the periods presented
(amounts in thousands, except per share data):
Three Months Ended June 25,
2010
2009
Weighted
Weighted
Average
Average
Loss
Shares
Per-Share
Loss
Shares
Per-Share
Loss per
share – basic
Loss
available to common stockholders
$
(3,705
)
96,807
$
(0.04
)
$
(1,744
)
69,742
$
(0.03
)
Effect
of dilutive securities
Redeemable
convertible preferred stock
—
—
—
—
Options
and warrants
—
—
—
—
Loss
per share – diluted
$
(3,705
)
96,807
$
(
0.04
)
$
(1,744
)
69,742
$
(0.03
)
Six Months Ended June 25,
2010
2009
Weighted
Weighted
Average
Average
Loss
Shares
Per-Share
Loss
Shares
Per-Share
Loss
per share – basic
Loss
available to common stockholders
$
(6,440
)
93,124
$
(0.07
)
$
(4,558
)
66,815
$
(0.07
)
Effect
of dilutive securities
Redeemable
convertible preferred stock
—
—
—
—
Options
and warrants
—
—
—
—
Loss
per share – diluted
$
(6,440
)
93,124
$
(0.07
)
$
(4,558
)
66,815
$
(0.07
)
10
NOTE
6. ACCOUNTS RECEIVABLE
Accounts
receivable consisted of the following (in thousands):
June 25, 2010
December 25, 2009
(Unaudited)
Accounts
receivable
$
21,086
$
16,162
Less:
Allowance for doubtful accounts
(6,758
)
(2,725
)
$
14,328
$
13,437
The
activity in the Company’s allowance for doubtful accounts is summarized as
follows (in thousands):
June 25, 2010
December 25, 2009
(Unaudited)
Balance
at the beginning of the period
$
2,725
$
1,184
Add:
provision during the period
4,154
1,551
Less:
write-offs during the period
(121
)
(10
)
Balance
at the end of the period
$
6,758
$
2,725
NOTE
7. DEPOSITS AND PREPAYMENTS
Deposits
and prepayments consisted of the following (in thousands):
June 25, 2010
December 25, 2009
(Unaudited)
Deposits
for raw materials
$
4,815
$
4,794
Prepayments
and advances
832
838
$
5,647
$
5,632
NOTE
8. INVENTORIES
Inventories
consisted of the following (in thousands):
June 25, 2010
December 25, 2009
(Unaudited)
Raw
materials (including packing materials)
$
9,597
$
13,488
Finished
goods
1,175
1,490
10,772
14,978
Less:
Inventory reserve
(173
)
(512
)
$
10,599
$
14,466
The
activity in the Company’s provision for inventory reserve is summarized as
follows (in thousands):
June 25, 2010
December 25, 2009
(Unaudited)
Balance
at the beginning of the period
$
512
$
565
Add:
provision during the period
4
510
Less:
write-offs during the period
(343
)
(563
)
Balance
at the end of the period
$
173
$
512
11
NOTE
9. DUE FROM RELATED COMPANIES
Due from
related companies consisted of the following (in thousands):
June 25, 2010
December 25, 2009
(Unaudited)
Xinlong
Asia Food (Dalian) Co., Ltd.*
904
899
Xinlong
Asia Food (Luoyang) Co., Ltd.*
53
53
Due
from related companies for sales
$
957
$
952
* Subsidiaries of Shandong
Longfeng Group Company.
Depreciation
and amortization expense was approximately $506,000, $388,000, $892,000 and
$771,000 for the three and six months ended June 25, 2010 and 2009
respectively.
Amortization
expense was approximately $60,000, $42,000, $86,000 and $93,000 for the three
and six months ended June 25, 2010 and 2009 respectively.
NOTE
12. OTHER PAYABLES AND ACCRUALS
Other
payables and accruals consisted of the following (in thousands):
June 25, 2010
December 25, 2009
(Unaudited)
Deposits
from customers
$
757
$
465
Accruals
for payroll, bonus and benefits
290
413
Utilities
and accrued expenses
1,123
1,184
$
2,170
$
2,062
12
NOTE
13. REDEEMABLE CONVERTIBLE PREFERRED STOCK
On July
11, 2005, the Company issued 6,000 shares of Series A 7% Redeemable Convertible
Preferred Stock (“Series A Preferred Stock”); initially convertible into an
aggregate of 6,315,789 shares of Class A Common Stock at a conversion price of
$0.95 per share, raising $6 million in gross proceeds. Six-year warrants to
purchase an aggregate of 3,157,895 shares of Class A Common Stock at an exercise
price of $1.04 per share were also issued to the investors. As part of the
compensation to the placement agent, five-year warrants to purchase an aggregate
of 378,947 shares of Class A Common Stock at an exercise price of $1.04 share
were also issued. As of June 25, 2010, all of the warrants issued to the
placement agent have been exercised cashless, and 5,867 shares of Series A
Preferred Stock have been converted into 11,113,425 shares of Class A Common
Stock.
On
December 22, 2005, the Company issued 9,500 shares of Series B 7% Redeemable
Convertible Preferred Stock (“Series B Preferred Stock”), initially convertible
into an aggregate of 5,937,500 shares of Class A Common Stock at a conversion
price of $1.60 per share, raising $9.5 million in gross proceeds. Six-year
warrants to purchase an aggregate of 2,968,750 shares of Class A Common Stock at
an exercise price of $1.76 per share were also issued to the investors. As part
of the compensation to the placement agent, five-year warrants to purchase an
aggregate of 356,250 shares of Class A Common Stock at an exercise price of
$1.76 per share were also issued. As of June 25, 2,010, 7,643 shares
of Series B Preferred Stock have been converted into 30,402,092 shares of Class
A Common Stock, and no warrants have been exercised.
The key
terms of the Series A Preferred Stock and Series B Preferred Stock are as
follows:
Series A Preferred Stock
Series B Preferred Stock
Preferred
Dividend
7%
per annum, payable quarterly in arrears in cash or, at the Company’s
option subject to satisfaction of certain conditions, shares of Class A
Common Stock valued at 95% of the volume-weighted current market
price.
7%
per annum, payable quarterly in arrears in cash or, at the Company’s
option subject to satisfaction of certain conditions, shares of Class A
Common Stock valued at 95% of the volume-weighted current market
price.
Redemption
July
11, 2010
December
22, 2010
Beginning
on the 24th month following closing and each month thereafter, the Company
shall redeem 1/37th of the face value of the Preferred Stock in either
cash or Class A Common Stock valued at 90% of the volume-weighted current
market price.
Beginning
at the end of the 24th month following closing and on each third monthly
anniversary of that date (quarterly) thereafter, the Company shall redeem
1/13th of the face value of the Preferred Stock in either cash or Class A
Common Stock valued at 90% of the volume-weighted current market
price.
Mandatory
Conversion
The
Company may at any time force the conversion of the Preferred Stock if the
volume-weighted current market price of the Class A Common Stock exceeds
300% of the then applicable conversion price.
The
Company may at any time force the conversion of the Preferred Stock if the
volume-weighted current market price of the Class A Common Stock exceeds
200% of its price at issuance of the Preferred Stock.
Registration
The
Company shall file to register the underlying Class A common shares within
30 days of the closing date and make its best efforts to have the
Registration declared effective at the earliest date. In the
event such Registration is not continuously effective during the period
such shares are subject to transfer restrictions under the U.S. federal
securities laws, then (subject to certain exceptions) the holders are
entitled to receive liquidated damages equal to 2.0% of the purchase price
of the Preferred Stock per month.
The
Company shall file to register the underlying Class A common shares with
30 days of the closing date and make its best efforts to have the
Registration declared effective at the earliest date. In the
event such Registration is not continuously effective during the period
such shares are subject to transfer restrictions under the U.S. federal
securities laws, then (subject to certain exceptions) the holders are
entitled to receive liquidated damages equal to 2.0% of the purchase price
of the Preferred Stock per month.
Anti-dilution
In
the event the Company issues, at any time while Preferred Stock are still
outstanding, Common Stock or any type of securities giving rights to
Common Stock at a price below the Issue Price, the Company agrees to
extend full-ratchet anti-dilution protection to the
investors.
In
the event the Company issues, at any time while Preferred Stock are still
outstanding, Common Stock or any type of securities giving rights to
Common Stock at a price below the Issue Price, the Company agrees to
extend full-ratchet anti-dilution protection to the
investors.
In
connection with the issuance of the Redeemable Convertible Series A Preferred
Stock and Series B Preferred Stock, the Company paid professional fees,
placement agent fees and associated expenses amounting to $1.83 million since
the issuance of the Redeemable Convertible Preferred Stock. The Company also
identified freestanding financial instruments included in the issuances that
were required to be recorded as liabilities. These included the embedded
conversion feature and warrants included in the Series A & B Preferred Stock
issuances. The Company has evaluated the fair value of these liabilities using
combination of the Black Scholes and Binomial Pricing Models. The summary of
activity in the Series A & B Preferred Stock is as follows:
13
Redeemable Convertible Preferred Stock
Preferred shares
Balance
(in
thousand)
2009
Series
A
399
$
399
Series
B
3,095
3,095
Less
unamortized discount
-
(486
)
Balance
December 25, 2009
3,494
$
3,008
2010
Series
A
133
$
133
Series
B
1,857
1,857
Less
unamortized discount
(131
)
Balance June
25, 2010
1,990
$
1,859
Embedded
derivatives relate to redeemable convertible preferred stock. We determined that
the conversion features of our redeemable convertible preferred stock and
warrants to purchase our common stock are derivatives that we are required to
account for as freestanding instruments under U.S. GAAP. We have also determined
that we are required to designate these derivatives as liabilities in our
financial statements. As a result, we report the value of these embedded
derivatives as current liabilities on our balance sheet and we report changes in
the value of these derivatives as non-operating gains or losses on our statement
of operations. The value of the derivatives is required to be recalculated (and
resulting non-operating gains or losses reflected in our statement of operations
and resulting adjustments to the associated liability amounts reflected on our
balance sheet) on a quarterly basis, and is based on the market value of our
common stock. Due to the nature of the required calculations and the large
number of shares of our common stock involved in such calculations, changes in
our common stock price may result in significant changes in the value of the
derivatives and resulting gains and losses on our statements of operations. We
were required to report a change of $41,000, $53,000, $51,000 and $173,000
as gain on the embedded derivative liability in other income on our statement of
operations for the three and six months ended June 25, 2010 and 2009,
respectively.
The
pricing model we use for determining fair values of our derivatives is a
combination of the Black Scholes and Binomial Pricing Models. Valuations derived
from this model are subject to ongoing internal and external review. The model
uses market-sourced inputs such as interest rates and option volatilities.
Selection of these inputs involves management’s judgment and may impact net
income. The Company has obtained a valuation report from a third-party valuation
firm to support its estimates. The principal assumptions used to value these
complex freestanding financial instruments were as follows:
Warrants
Embedded Conversion Feature
Expected
life (in years)
Remaining
term at valuation date
Remaining
Term to conversion or redemption
date
at each valuation date
Expected
volatility
105%
80%
to 105%
Risk-free
interest rate
0.32%
to 0.50%
0.05%
to 0.22%
Dividend
yield
0
0
The
Company considered all of the other minor features of the conversion option
associated with the Company’s Series A and Series B Preferred Stock, including
adjustments for: (i) stock dividends and splits, (ii) the sale of the Company’s
securities, (iii) the subsequent issuance of rights, options, or warrants to
Common shareholders, and (iv) forced conversion and redemption features. We
ultimately determined that these features were insignificant and did not have a
material impact on the concluded values of the Series A and Series B Preferred
Stock.
The
changes in the derivative liabilities during the period are as
follows:
Fair
Value at December 25, 2008
$
287
Gain
on change in value of derivatives during the period
(177
)
Conversion
of 3,007 shares of Series A & B Preferred Stock to common stock during
2009
(34
)
Fair
Value at December 25, 2009
$
76
Gain
on change in value of derivatives during the period
(51
)
Conversion
of 1,504 shares of Series A & B Preferred Stock to common stock during
2010
(9
)
Fair
Value at June 25, 2010
$
16
NOTE
14. COMMON STOCK
During
the six months ended June 25, 2010 and 2009, 266 shares and 266 shares of Series
A Preferred Stock have been converted into 2,375,551 shares and 1,283,016 shares
of Class A Common Stock, respectively.
14
During
the six months ended June 25, 2010 and 2009, 1,238 shares and 1,238 shares of
Series B Preferred Stock have been converted into 11,052,298 shares and
5,969,265 shares of Class A Common Stock, respectively.
The
number of shares of Class A Common Stock issuable under warrants related to the
private placements and respective exercise prices are summarized as
follows:
Shares of Class A Common Stock
Exercise
Issuable Under Warrants
Price
July
2005 private placement 6-year warrants
3,157,895
$
1.04
December
2005 private placement 6-year warrants
2,968,750
1.76
5-year
warrants
356,250
1.76
Warrants
exercisable at June 25, 2010
6,482,895
As of
June 25, 2010, these warrants had no intrinsic value.
NOTE
16. STOCK-BASED COMPENSATION
The
Company measures the cost of services received in exchange for an award of
equity instruments based on the grant-date fair value of the award. The Company
used the Black-Scholes option-pricing model to estimate the fair value of the
options at the date of grant.
The
Company issued 2,000,000 Class A Common Shares to the CFO as annual compensation
for the service term from April 1, 2009 to March 31, 2010. The fair value
of such common shares was $300,000. The Company recognized $225,000 as
compensation expense for the year ended December 25, 2009 and $75,000 for the
six months ended June 25, 2010.
NOTE
17. RELATED PARTY TRANSACTIONS
Parties
are considered to be related if one party has the ability, directly or
indirectly, to control the other party or exercise significant influence over
the other party in making financial and operational decisions. Parties are also
considered to be related if they are subject to common control or common
significant influence.
Transactions
between New Dragon Asia Corp. and related companies are summarized below (in
thousands):
Three months ended
June 25,
Six months ended
June 25,
2010
2009
2010
2009
Pre-determined annual fee charged by joint venture partners:
(b)
Shandong Longfeng Flour Company Limited is a subsidiary of Shandong Longfeng
Group Company.
As of
June 25, 2010, loans from the Company’s major shareholder New Dragon Asia Food
Limited of $3,514,000 are for working capital, are unsecured and bear no
interest, and are payable if requested, and funds are available. The Company and
the major shareholder have agreed that no repayments will take place in
2010.
As of
June 25, 2010, the amounts due to the Company’s joint venture partners of
$502,000 are also unsecured and bear no interest, and no repayment is expected
in 2010.
As of
June 25, 2010, the amounts due from the Company’s related companies of $957,000
are unsecured, bear no interest and no fix terms of repayment.
15
NOTE
18. TAXATION
The PRC
subsidiaries within the Company are subject to PRC income taxes on an entity
basis on income arising in or derived from the tax jurisdiction in which they
operate. The group companies that are incorporated under the International
Business Companies Act of the British Virgin Islands are exempt from payment of
the British Virgin Islands income tax.
Substantially
all of the Company’s income was generated in the PRC, which is subject to PRC
income taxes at rates ranging from 24% to a statutory rate of 25%. Two of the
PRC subsidiaries of the Company are eligible to be exempt from income taxes for
a two-year period commencing with the year in which their operations are
profitable and then subject to a 50% reduction in income taxes for the next
three years, starting from their first profitable year. Several PRC subsidiaries
receive preferential tax rates in regions in which they operated and are also
entitled to partial tax refunds from those tax bureaus.
New
Dragon Asia Corp. is a Florida corporation with wholly-owned operating
subsidiaries. As a result, the Company is not subject to PRC tax for the
activities at the Florida company level. Costs or expenses incurred at the
Florida company level, such as the stock-based compensation and the amortization
of financing costs and derivative accounting related to Series A Preferred Stock
and Series B Preferred Stock, cannot be used to offset any income derived in the
PRC when measuring the PRC income tax liabilities. As of June 25, 2010 and
December 25, 2009, there were no material deferred tax assets or deferred tax
liabilities. The expenses of the United States company are not recoverable
against future taxable income in the United States or the PRC and meet the
definition of permanent differences for tax accounting purposes. The Company has
never been audited by the taxing authority in the United States or the PRC. The
Company believes that it has filed properly in all required
jurisdictions.
NOTE
19. COMPREHENSIVE INCOME
The
following table summarizes the comprehensive income for the six months ended
June 25, 2010 and 2009:
June 25, 2010
June 25, 2009
Net
loss
$
(6,165
)
$
(3,964
)
Foreign
currency translation adjustment
396
34
Comprehensive
loss
$
(5,769
)
$
(3,930
)
NOTE
20. SEGMENT INFORMATION
The
Company classifies its products into three core business segments; namely
instant noodles, flour and soybean. In view of the fact that the Company
operates principally in Mainland China, no geographical segment information is
presented.
For the three months ended
June 25,
For the six months ended
June 25,
2010
2009
2010
2009
(US$'000)
(US$'000)
(US$'000)
(US$'000)
Net
revenue
Instant
noodles
1,060
1,001
2,072
2,065
Flour
4,388
3,356
7,717
5,355
Soybean
1,099
1,273
2,804
2,173
6,547
5,630
12,593
9,593
Loss
from operation
Instant
noodles
(450
)
(884
)
(1,027
)
(2,457
)
Flour
(2,077
)
(205
)
(3,687
)
(1,163
)
Soybean
(994
)
(384
)
(1,053
)
(793
)
(3,521
)
(1,473
)
(5,767
)
(4,413
)
Depreciation
and amortization
Instant
noodles
263
246
451
444
Flour
112
95
202
243
Soybean
191
90
325
177
566
431
978
864
June 25,
December 25,
2010
2009
(US$'000)
(US$'000)
Identifiable
long-term assets
Instant
noodles
16,913
17,510
Flour
7,634
8,268
Soybean
9,669
9,769
34,216
35,547
16
Item
2. Management’s Discussion and Analysis of Financial Condition and Results of
Operations.
In
addition to historical information, the matters discussed in this Form 10-Q
contain forward-looking statements that involve risks or uncertainties.
Generally, the words "believes," "anticipates," "may," "will," "should,"
"expect," "intend," "estimate," "continue," and similar expressions or the
negative thereof or comparable terminology are intended to identify
forward-looking statements. Such statements are subject to certain risks and
uncertainties, including the matters set forth in this report or other reports
or documents we file with the Securities and Exchange Commission from time to
time, which could cause actual results or outcomes to differ materially from
those projected. Undue reliance should not be placed on these forward-looking
statements, which speak only as of the date hereof. We undertake no obligation
to update these forward-looking statements. Readers should carefully review the
risks described in other documents we file from time to time with the Securities
and Exchange Commission, including the Annual Report on Form 10-K for the fiscal
year ended December 25, 2009, the Quarterly Reports on Form 10-Q and Current
Reports on Form 8-K (including any amendments to such reports) filed by the
Company. References in this filing to the “Company”, “Group”, “we”, “us”, and
“our” refer to New Dragon Asia Corp. and its subsidiaries.
Critical
Accounting Policies
Our
discussion and analysis of our financial condition and results of operations is
based upon our consolidated financial statements, which have been prepared in
accordance with accounting principles generally accepted in the United
States. The preparation of these consolidated financial statements
requires us to make estimates, judgments and assumptions that affect the
reported amounts of assets, liabilities, revenues and expenses, and the related
disclosure of contingent assets and liabilities. We base our
estimates on historical experience and on various other assumptions that we
believe are reasonable under the circumstances, the results of which form the
basis for making judgments about the carrying values of assets and liabilities
that are not readily apparent from other sources. Actual results may
differ from these estimates.
An
accounting policy is considered to be critical if it requires an accounting
estimate to be made based on assumptions about matters that are highly uncertain
at the time the estimates are made, and if different estimates that reasonably
could have been used, or changes in the accounting estimates that are reasonably
likely to occur, could materially impact the consolidated financial
statements. We believe the following critical accounting policies
reflect the more significant estimates and assumptions used in the preparation
of the consolidated financial statements.
Contractual
Joint Ventures
A
contractual joint venture is an entity established between the Company and
another joint venture partner, with the rights and obligations of each party
governed by a contract. Currently, the Company has established three
contractual joint ventures with three Chinese partners in China, with percentage
of ownership ranging from 79.64% to 90%. Pursuant to each Chinese
joint venture agreement, each Chinese joint venture partner is entitled to
receive a pre-determined annual fee and is not responsible for any profit or
loss, regardless of the ownership in the contractual joint
venture. In view of such contracted profit sharing arrangement, the
three contractual joint ventures are regarded as 100% owned by the
Company. Hence, the Company’s consolidated financial statements
include the financial statements of the contractual joint ventures.
Revenue
Recognition
Our
revenues are generated from sales of flour, soybean products and instant
noodles. All of our revenue transactions contain standard business terms and
conditions. We determine the appropriate accounting for these transactions after
considering (1) whether a contract exists; (2) when to recognize revenue on the
deliverables; and (3) whether all elements of the contract have been fulfilled
and delivered. In addition, our revenue recognition policy requires an
assessment as to whether collection is reasonably assured, which inherently
requires us to evaluate the creditworthiness of our customers. Changes in
judgments on these assumptions and estimates could materially impact the timing
or amount of revenue recognition.
Accounting
for Derivative Instruments
Derivatives
are recorded on the Company’s balance sheet at fair value. These derivatives,
including embedded derivatives in the Company’s Series A and B Redeemable
Convertible Preferred Stock are separately valued and accounted for on the
Company’s balance sheet.
The
Company has determined that the conversion features of its redeemable
convertible preferred stock and warrants to purchase common stock are
derivatives that the Company is required to account for as if they were
free-standing instruments. The Company has also determined that it is required
to designate these derivatives as liabilities in its financial statements. As a
result, the Company reports the value of these embedded derivatives as current
liabilities on its balance sheet and reports changes in the value of these
derivatives as non-operating gains or losses on its statement of operations. The
value of the derivatives is required to be recalculated (and resulting
non-operating gains or losses reflected in the statement of operations and
resulting adjustments to the associated liability amounts reflected on the
balance sheet) on a quarterly basis, and is based on the market value of the
Company’s common stock. Due to the nature of the required calculations and the
large number of shares of the Company’s common stock involved in such
calculations, changes in the Company’s common stock price may result in
significant changes in the value of the derivatives and resulting gains and
losses on the Company’s statement of operations.
17
The
pricing models the Company uses for determining fair values of its derivatives
are a combination of the Black-Scholes and Binomial Pricing Models. Valuations
derived from this model are subject to ongoing internal and external review. The
model uses market-sourced inputs such as interest rates and option volatilities.
Selection of these inputs involves management’s judgment and may impact net
earnings. The Company has obtained a valuation report from a valuation firm to
support its estimates as of June 25, 2010 and December 25, 2009.
