During the three months ended September 30, 2006, we generated revenues of $4,832,984, as compared to revenues of $4,622,110 for the three months ended September 30, 2005, an increase of $210,874 or 4.6%. For the three months ended September 30, 2006, we recorded revenues of approximately $125,469 from our JinKui subsidiary acquired effective June 30, 2006. The remaining increases during the three months ended September 30, 2006 of $85,405 were attributable to sales to new customers and improved sales efforts over the three months ended September 30, 2006.
For the three months ended September 30, 2006, gross profit for the period was $372,514, as compared to gross profit of $106,446 for the three months ended September 30, 2005, an increase of $266,068. For the three months ended September 30, 2006, gross profit on a percentage basis increased to 7.7% from 2.3% for the same period ended September 30, 2005, an increase as a percentage of our revenues.
For the three months ended September 30, 2006, total operating expenses amounted to $515,071 or 10.7% of net revenues compared to $305,170 or 6.6% of revenues for the three months ended September 30, 2005, an increase of $209,901. The increase was attributable to the following:
• For the three months ended September 30, 2006, we recorded non-cash compensation expenses of $86,878 as compared to $26,000 for the three months ended September 30, 2005, an increase of $60,878 or 234.1%. This amount represented the value amortized, for the shares of our common stock issued and warrants granted, as compensation for consulting services and professional services being rendered to us. While we anticipate that we will enter into similar agreements during fiscal 2007, we cannot predict the amount of expense that will be attributable to such agreements.
• For the three months ended September 30, 2006, selling expenses amounted to $114,833, as compared to $48,835 for the three months ended September 30, 2005, an increase of $65,998 or 135.1%. This increase is attributable to the increase in shipping costs of approximately $66,960, which is caused by the increase in the shipping industry for costs on a per unit shipped basis.
For the three months ended September 30, 2006, general and administrative expenses were $313,360, as compared to $230,335 for the three months ended September 30, 2005, an increase of $83,025, or approximately 36%. The increase was attributable to the following:
• For the three months ended September 30, 2006, consulting expenses amounted to $0 as compared to $31,894 for the three months ended September 30, 2005. In Fiscal 2005, we received a refund of consulting fees amounting to $31,894 from NingBo HaiShu HeSheng Consulting Company that reduced our general and administrative expenses.
• For the three months ended September 30, 2006, rental expenses amounted to $21,039 as compared to $9,901 for the three months ended September 30, 2005, an increase of approximately $11,138. The increase is primarily attributable to the rental expenses incurred by JinKui, a new subsidiary acquired effective June 30, 2006. The rental expense for JinKui during the three months ended September 30, 2006 amounted to $9,067. Additionally, rental expenses incurred by YongXin were increased approximately $2,800 from three months ended September 30, 2005 to September 30, 2006. YongXin was acquired on July 1, 2005, for the three months ended September 30, 2005, the rent expenses for YongXin only included August and September expenses since July rental was paid before the acquisition. For the three months ended September 30, 2006, the rental expenses for YongXin included all three months during the quarter.
• For the three months ended September 30, 2006, research and development expenses amounted to $20,497, as compared to $960 for the three months ended September 30, 2005, an increase of approximately $19,500. The increase is primarily attributable to the operation of the R& D Center which was acquired on August 1, 2005. The R&D Center was not under fully operation until July 2006.
• For the three months ended September 30, 2006, salary and wages amounted to $36,799, as compared to $17,415 for the three months ended September 30, 2005, an increase of $19,384. During the three months ended September 30, 2006 we incurred $8,783 salary and wages associated with JinKui that was acquired effective June 30, 2006. Additionally, we increased salary and wages for employees for about 40% to 45% effective October 1, 2005. For the three months ended September 30, 2006, the salary and wages are affected by the new rate while for the three months ended September 30, 2005, the salary and wages were under the original rate.
Total Other Income
For the three months ended September 30, 2006, we reported total other income of $60,231, as compared to total other expenses of $249,967 for the three months ended September 30, 2005. This other income is primarily associated with the following reasons:
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Income recognized from the value added tax rebates received from the respective tax authority. For the three months ended September 30, 2006, the income recognized from the value added tax rebate was $76,157, compared to $182,464 for the three months ended September 30, 2005. We accrued for value-added taxes (“VAT”) recorded on the sale of our paper products. Our paper products are subject to VAT, as imposed by the PRC or the local provincial tax authorities in the PRC. We charge, collect and remit VAT on the sales of our products. We routinely receive abatements of VAT, as we participate in our local provincial program of hiring employees with physical handicaps. The respective tax authorities in the PRC notify us of our VAT abatements after the VAT is collected. We pass the VAT on to the customer, incorporating the tax in our cost. Until we receive notification of the amount of VAT abated from the respective tax authorities, this VAT remains accrued. Upon notification from the tax authorities that VAT had been either abated, or has been partially abated, as determined by the respective tax authority, the excess of accrued VAT is then reclassified into other income as this rebate is not remitted to the customer. Under PRC tax regulations; in the event that VAT collected by us from customers are either abated, or partially abated, the amount of VAT abated is not required to be refunded to customers.
For the three months ended September 30, 2006, debt issuance costs were $0 as compared to $55,295 for the three months ended September 30, 2005. For the three months ended September 30, 2005, the debt issuance costs was related to the amortization of placements fees paid in connection with our March 2005 Private Placement and the July 2005 Private Placement. In February 2006, upon conversion of the July Notes to common stock, we expensed all unamortized debt issuance costs. For the three months ended September 30, 2006, we did not have any debt issuance costs.
For the three months ended September 30, 2006, interest expense was $33,432, as compared to $377,136 for the three months ended September 30, 2005, a decrease of $343,704. For the three months ended September 30, 2005, the $377,136 of interest expense was comprised of $359,189 in amortization of discount on the July Notes that was included in interest expense related to the March 2005 Private Placement and July 2005 Private Placement and $17,947 of interest expenses related to borrowings. In February 2006, upon conversion of the July Notes to common stock, we expensed all unamortized discounts related to the July Notes and the March Notes.
Net Loss
As a result of these factors, we reported a net loss of $(82,326) (less than $.01 per share) for the three months ended September 30, 2006, as compared to net loss of $(446,357) (less than $.01 per share) for the three months ended September 30, 2005.
Liquidity and Capital Resources
Liquidity is the ability of a company to generate funds to support its current and future operations, satisfy its obligations and otherwise operate on an ongoing basis. The following table provides certain selected balance sheet comparisons between September 30, 2006 (unaudited) and June 30, 2006:
| September 30, | June 30, | $ of | % of |
| 2006 (Unaudited) | 2006 | Change | Change |
| | | | |
Working capital | 563,485 | 558,414 | 5,071 | 0.9% |
Cash | 262,462 | 466,272 | (203,810) | -43.7% |
Accounts receivable, net | 4,762,590 | 4,938,985 | (176,395) | -3.6% |
Inventories | 2,199,301 | 3,293,846 | (1,094,545) | -33.2% |
Prepaid expenses and other | 2,707,711 | 81,164 | 2,626,547 | 3236.1% |
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Advance on purchases | 497,657 | 805,662 | (308,005) | -38.2% |
Other receivable | 381,632 | 384,916 | (3,284) | -0.9% |
Due from related parties | 9,474 | 3,498 | 5,976 | 170.8% |
Total current assets | 10,820,827 | 9,974,343 | 846,484 | 8.5% |
Cash restricted | 252,627 | 262,287 | (9,660) | -3.7% |
Property and equipment, net | 2,164,628 | 2,053,938 | 110,690 | 5.4% |
Land use rights, net | 2,539,296 | 2,524,568 | 14,728 | 0.6% |
Intangible assets, net | 373,492 | 393,928 | (20,436) | -5.2% |
Other assets | 65,972 | 78,759 | (12,787) | -16.2% |
Notes payable | 2,794,537 | 2,762,207 | 32,330 | 1.2% |
Accounts payable | 4,325,398 | 3,401,439 | 923,959 | 27.2% |
Accrued expenses | 1,948,211 | 2,042,113 | (93,902) | -4.6% |
Advances from customers | 47,720 | 68,694 | (20,974) | -30.5% |
Liability in connection with acquisition | 1,141,476 | 1,141,476 | 0 | 0.0% |
Total current liabilities | 10,257,342 | 9,415,929 | 841,413 | 8.9% |
Total liabilities | 10,257,342 | 9,415,929 | 841,413 | 8.9% |
| | | | |
At September 30, 2006, we had $262,462 in cash. At September 30, 2006, our cash position by geographic area is as follows:
| United States | $ | 4 | |
| China | 262,458 |
| | | | | |
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Our working capital position increased $5,071 to $563,485 at September 30, 2006 from $558,414 at June 30, 2006. This increase in working capital is primarily attributable to an increase of approximately $846,484 in current assets at September 30, 2006 as compared to June 30, 2006, which was offset by increases in current liabilities of approximately $841,413 at September 30, 2006 as compared to June 30, 2006. The increase in our current liabilities is primarily attributable to accounts payable which were offset by a decrease in accrued expenses and advances from customers.
At September 30, 2006, our inventories of raw materials, work in process and finished goods amounted $2,199,301, a decrease of $1,094,545, or approximately 33.2%, from June 30, 2006. The inventory decreased due to our increased sales during the three months ended September 30, 2006. The increased sales depleted our inventory levels. We expect our inventory levels to rise as we increase our overall production.
At September 30, 2006, our prepaid expenses and other amounted $2,707,711, an increase of $2,626,547, or approximately 3236.1%, from June 30, 2006. The prepaid expenses and other increased due to our increased prepaid import materials during the three months ended September 30, 2006.
At September 30, 2006 our accounts receivable, was $4,762,590, as compared to $4,938,985 at June 30, 2006 and reflects our best estimate of probable losses. As is customary in the PRC, we extend relatively long payment terms to our customers. Our terms of sale generally require payment within six months, which is considerably longer than customary terms offered in the United States, however, we believe that our terms of sale are customary amongst our competitors for our a company our size within our industry.
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Net cash used in operating activities for the three months ended September 30, 2006 was $123,012, as compared to net cash used in operating activities of $465,756 for the three months ended September 30, 2005. For the three months ended September 30, 2006, we used cash to fund an increase in prepaid and other current assets, the reduction in accrued expenses and advances from customers. The decreases were offset by an increase in accounts payable of $923,959, a net decrease in accounts receivable of $23,983, and a decrease in inventories of $1,094,545. These items, combined with an add back of non-cash items of $334,174 were offset by our net loss.
For the three months ended September 30, 2005, we used cash to fund increases in inventories and other receivables, and decrease in accounts payable and accrued expenses. The decreases were offset by a net increase in advances on purchases of $254,729, a decrease in accounts receivables of $694,460, combined with a net add back of non-cash items of $403,564 were offset by our net loss,
Net cash used in investing activities during the three months ended September 30, 2006 was $161,377 as compared to net cash provided by investing activities of $27,014 for the three months ended September 30, 2005. During the three months ended September 30, 2006, we used cash for capital expenditures of $165,061 and advanced funds of $5,976 to JinKui. These transactions were consolidated upon the acquisition of JinKui on June 30, 2006. We decreased our restricted cash balance by $9,660 to collateralize certain debt. During the three months ended September 30, 2005, we used cash for capital expenditures of $163,819 and had a decrease in our restricted cash balance by $157,179 to collateralize certain debt and received cash of $33,654 from the acquisition of Yongxin.
Net cash provided by financing activities during the three months ended September 30, 2006 was $3,843, as compared to net cash provided by financing activities during the three months ended September 30, 2005 of $79,053. During the three months ended September 30, 2006, we received gross proceeds of $67,000 from loans payable offset by the repayment of loans payable of $63,157. During the three months ended September 30, 2005, we received gross proceeds of $503,500 from debentures payable offset by the repayment of loans payable of $376,097 and the payment of placement fees of $48,350.
From time to time, we need additional working capital for our operations. In 2006, Yonglongxin borrowed money pursuant to several lines of credit that we have established with two separate banks. We renewed pre-existing loans of $1,983,124 from the Bank of Agriculture with 6 to 12 months term from September 2006 to September 2007, with an annual interest rate ranging from 5.94% to 6.732%. We repaid loans of $62,450 from Ningbo Commercial Bank (Tianyuan Branch) during the three months ended September 30, 2006. All loans are renewable when they mature. We generate sufficient cash flow from financing and operations to meet our debt services. We do not anticipate these loans will have material impact on our liquidity. These loans are secured by our inventory, equipment and assets. We are current on all payments relating to these loans and expect to renew the loans at terms and at interest rates comparable to our current loans.
We currently have no material commitments for capital expenditures.
While we believe we have sufficient funds to conduct our business and operations as they are currently undertaken, we want to upgrade our manufacturing capacity in order to expand our production. In relation to the March 2005 Private Placement and July 2005 Private Placement, we received net proceeds of $1,736,660 ($321,750 from the March 2005 Private Placement +$1,414,910 from the July 2005 Private Placement). As of September 30, 2006 and 2005, we have applied $725,284 and $326,878 of the proceeds received from the offerings to upgrade equipment and technology, respectively.
Off Balance Sheet Arrangements
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Under SEC regulations, we are required to disclose our off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, such as changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that are material to investors. An off-balance sheet arrangement means a transaction, agreement or contractual arrangement to which any entity that is not consolidated with us is a party, under which we have:
| • | Any obligation under certain guarantee contracts; |
• Any retained or contingent interest in assets transferred to an unconsolidated entity or similar arrangement that serves as credit, liquidity or market risk support to that entity for such assets;
• Any obligation under a contract that would be accounted for as a derivative instrument, except that it is both indexed to our stock and classified in stockholder's equity in our statement of financial position; and
• Any obligation arising out of a material variable interest held by us in an unconsolidated entity that provides financing, liquidity, market risk or credit risk support to us, or engages in leasing, hedging or research and development services with us.
As of the date of this report, we do not have any off-balance sheet arrangements that we are required to disclose pursuant to these regulations. In the ordinary course of business, we enter into operating lease commitments, purchase commitments and other contractual obligations. These transactions are recognized in our financial statements in accordance with generally accepted accounting principles in the United States
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
We have identified critical accounting policies that, as a result of judgments, uncertainties, uniqueness and complexities of the underlying accounting standards and operations involved could result in material changes to our financial position or results of operations under different conditions or using different assumptions. The most critical accounting policies and estimates are:
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates. Significant estimates in 2006 and 2005 include the allowance for doubtful accounts and the useful life of property, plant and equipment.
Inventories, consisting of raw materials and finished goods related to our products are stated at the lower of cost or market utilizing the weighted average method.
Fair value of instruments. Our financial instruments consist of accounts receivable, accounts payable and long-term debt. The fair values of financial instruments approximate their recorded values. Fair value of loans payable to stockholders and balances of bank lines of credit, in the circumstances, are not reasonably determinable.
We review the carrying value of property and equipment and land-use rights for impairment at least annually or whenever events or changes in circumstances indicate that the carrying amount of an asset
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may not be recoverable. Recoverability of long-lived assets is measured by comparison of its carrying amount to the undiscounted cash flows that the asset or asset group is expected to generate. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the property, if any, exceeds its fair market value.
Details regarding our use of these policies and the related estimates are described in the accompanying financial statements as of September 30, 2006. During the three month period ended September 30, 2006, there have been no material changes to our critical accounting policies that impacted our consolidated financial condition or results of operations.
Inflation
Although management expects that our operations will be influenced by general economic conditions we do not believe that inflation had a material effect on our results of operations during the three months ended September 30, 2006.
ITEM 3. CONTROLS AND PROCEDURES
Disclosure controls and procedures and other procedures that are designed to ensure that information required to be disclosed in our reports filed or submitted under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported, within the time period specified in the Securities and Exchange Commission's rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed in our reports filed under the Securities Exchange Act of 1934 is accumulated and communicated to management including our President as appropriate, to allow timely decisions regarding required disclosure. Our management, including our President, does not expect that our disclosure controls and procedures will prevent all error and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. The design of any system of controls is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions.
Based upon that evaluation, our company's CEO and CFO have concluded that our disclosure controls and procedures were not effective because of the significant deficiency and the material weakness described below. Measures are being taken to include documentation of management oversight and review as part of the appropriate functional procedures.
In our previous Annual Report on Form 10-KSB/A we restated our consolidated balance sheet at June 30, 2006 and the consolidated statements of stockholders’ equity for the year ended June 30, 2006 as contained in the Annual Report on Form 10-KSB for the year ended June 30, 2006 as previously filed with the Securities and Exchange Commission.
The restatement was made in part to correct a clerical error related to the classification of common stock to be issued in connection with the acquisition of Shanghai JinKui Packaging Material Co., Ltd. (JinKui”) on June 30, 2006. We initially classified 8,095,574 shares of common stock, based on the fair value of each share at $0.141 for a total of $1,141,476, as common stock issuable in the stockholders’ equity section of the initially issued balance sheet and statements of stockholders’ equity. We have reclassified
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these common shares to be issued as a liability in connection with the acquisition. We were aware of the proper classification prior to the initial filing of our Form 10-KSB, but deficiencies in financial statement reporting controls prevented this misclassification from being corrected. As a result of this clerical error, we have determined that there was a significant deficiency in our internal control over financial reporting as of June 30, 2006 related to the treatment of common stock to be issued in regards to the JinKui acquisition. We determined, however, that such significant deficiency did not rise to the level of a material weakness in our internal control over financial reporting. Because we have corrected our presentation of the common stock to be issued, we believe that we have corrected this significant deficiency.
Other than the changes discussed above, there have been no changes in our internal control over financial reporting that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
RISK FACTORS
An investment in our Common Stock is a risky investment. In addition to the other information contained in this report, prospective investors should carefully consider the following risk factors before purchasing shares of our Common Stock.
RISKSRELATEDTOOURBUSINESS
The management of our Company is located in the Peoples Republic of China (“PRC”) and we are materially dependent upon advisory services of a U.S. company. In the event this consultant fails to perform properly, or elects to discontinue its relationships with us, the results could have a negative impact on our ability to comply with the requirements of being a US public reporting company and may lead our Common Stock being de-listed from trading on the OTCBB.
None of the current members of our management have any experience in U.S. public companies and these individuals are not fluent in English, except our President. We have engaged China Direct Investments, Inc. to provide us with various advisory and consulting services, including U.S. business methods and compliance with SEC disclosure requirements. We selected China Direct Investments, Inc. to provide these services to us in part because its staff includes Chinese-speaking individuals with experience in the operation and regulatory framework applicable to U.S. public companies. Until such time as we are able to expand our board of directors to include English-speaking individuals who have experience with the operation and regulatory framework applicable to U.S. public companies, we are materially dependent upon our relationship with China Direct Investments, Inc. Our contract with that company expires in June 2006. If for any reason China Direct Investments, Inc. should fail to provide the contracted services at the anticipated levels or fails to extend its services and we have not added members to our board of directors with the requisite experience, the abilities of our board of directors to do business as a U.S. public company could be materially and adversely affected. In such instances, we may be unable to prepare and file reports as required by the Securities Exchange Act of 1934 on a timely basis that could lead to our Common Stock being de-listed from trading on the OTCBB.
Certain agreements to which we are a party and which are material to our operations lack various legal protections that are customarily contained in similar contracts prepared in the United States. This could result in adverse consequences to our business operations in the future.
Our operations are based in the People’s Republic of China (“China” or “PRC”), our operating subsidiaries are Chinese companies and all of our business and operations are conducted in China. We
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are a party to certain material contracts, including supply contracts, purchase contracts and the lease for our principal offices and manufacturing facility. While these contracts contain the basic business terms of the agreements between the parties, these contracts do not contain certain provisions which are customarily contained in similar contracts prepared in the U.S., such as representations and warranties of the parties, confidentiality and non-compete clauses, provisions outlining events of defaults, and termination and jurisdictional clauses. Because our material contracts omit these types of clauses, notwithstanding the differences in Chinese and U.S. laws, we may not have the same legal protections as we would if the contracts contained these additional provisions. We anticipate that contracts we enter into in the future will likewise omit these types of legal protections. While we have not been subject to any adverse consequences as a result of the omission of these types of clauses, and we consider the contracts to which we are a party to contain all the material terms of our business arrangements with the other party, we cannot provide assurances that future events will not occur which could have been avoided if the contracts were prepared in conformity with U.S. standards, or what the impact, if any, of these hypothetical future events could have on our Company.
We are materially reliant on revenues from our operations in the PRC. There are significant risks associated with doing business in the PRC that may cause you to lose your entire investment in our Company.
While our goal is to both expand our operations to countries outside the PRC, in the foreseeable future our growth and success will remain tied to our existing operations in the PRC. Therefore, a downturn or stagnation in the economic environment of the PRC could have a material adverse effect on our financial condition that could result in a significant loss of revenues and liquidity in future periods.
We cannot assure you that the current Chinese policies of economic reform will continue. Because of this uncertainty, there are significant economic risks associated with doing business in China.
Although the majority of productive assets in China are owned by the Chinese government, in the past several years the government has implemented economic reform measures that emphasize decentralization and encourage private economic activity. In keeping with these economic reform policies, the PRC has been openly promoting business development in order to bring more business into the PRC. Because these economic reform measures may be inconsistent or ineffectual, there are no assurances that:
| • | the Chinese government will continue its pursuit of economic reform policies; |
| • | the economic policies, even if pursued, will be successful; |
| • | economic policies will not be significantly altered from time to time; and |
| • | business operations in China will not become subject to the risk of nationalization. |
Even if the Chinese government continues its policies of economic reform, we may be unable to take advantage of these opportunities in a fashion that will provide financial benefit to our Company. Our inability to sustain our operations in China at current levels could result in a significant reduction in our revenues that would result in escalating losses and liquidity concerns
China's economy has experienced significant growth in the past decade, but such growth has been uneven across geographic and economic sectors and has recently been slowing. There can be no assurance that such growth will not continue to decrease or that any slow down will not have a negative effect on our business. The Chinese economy is also experiencing deflation which may continue in the future. We cannot assure you that we will be able to capitalize on these economic reforms, assuming the reforms continue. Given our material reliance on our operations in the PRC, any failure on our part to continue to
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take advance of the growth in the Chinese economy will have a material adverse effect on our results of operations and liquidity in future periods.
We are subject to risks associated with the conversion of Chinese RMB into U.S. dollars.
We generate revenue and incur expenses and liabilities in both Chinese Renminbi (RMB) and U.S. dollars. Since 1994, the official exchange rate for the conversion of Chinese RMB to U.S. dollars has generally been stable and the Chinese RMB has appreciated slightly against the U.S. dollar. We have not entered into agreements or purchased instruments to hedge our exchange rate risks, although we may do so in the future. Our results of operations and financial condition may be affected by changes in the value of Chinese RMB and other currencies in which our earnings and obligations are denominated. Recently, the Chinese government raised 2% of Chinese RBM against US dollar by floating Chinese RMB with a basket of foreign currencies. The Company can not guarantee that the current exchange rate will remain steady, therefore there is a possibility that the Company could post the same amount of profit for two comparable periods and because of a fluctuating exchange rate actually post higher or lower profit depending on exchange rate of Chinese RMB converted to US dollars on that date. The exchange rate could fluctuate depending on changes in the political and economic environments without notice.
We may not have sufficient protection of certain of our intellectual property.
We utilize certain technologies in the production of certain packaging paper that are used in our products that are proprietary in nature. To protect our proprietary rights, we rely generally on confidentiality agreements with employees and third parties, and agreements with consultants, vendors and customers, although we have not signed such agreements in every case. Despite such protections, a third party could, without authorization, utilize our propriety technologies without our consent. The unauthorized use of this proprietary information by third parties could adversely affect our business and operations as well as any competitive advantage we may have in our market segment. We can give no assurance that our agreements with employees, consultants and others who participate in the production of our products will not be breached, or that we will have adequate remedies for any breach, or that our proprietary technologies will not otherwise become known or independently developed by competitors.
We have not voluntarily implemented various corporate governance measures, in the absence of which, stockholders may have reduced protections against interested director transactions, conflicts of interest and other matters.
We are not subject to any law, rule or regulation requiring that we adopt any of the corporate governance measures that are required by the rules of national securities exchanges or Nasdaq such as independent directors and audit committees. It is possible that if we were to adopt some or all of the corporate governance measures, stockholders would benefit from somewhat greater assurances that internal corporate decisions were being made by disinterested directors and that policies had been implemented to define responsible conduct. Prospective investors should bear in mind our current lack of corporate governance measures in formulating their investment decisions.
We may be exposed to potential risks relating to our internal controls over financial reporting and our ability to have those controls attested to by our independent auditors.
As directed by Section 404 of the Sarbanes-Oxley Act of 2002 (“SOX 404”), the Securities and Exchange Commission adopted rules requiring public companies to include a report of management on the company’s internal controls over financial reporting in their annual reports, including Form 10-KSB. In addition, the independent registered public accounting firm auditing a company’s financial statements must also attest to and report on management’s assessment of the effectiveness of the company’s internal
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controls over financial reporting as well as the operating effectiveness of the company’s internal controls. We were not subject to these requirements for the fiscal year ended June 30, 2005. We are evaluating our internal control systems in order to allow our management to report on, and our independent auditors attest to, our internal controls, as a required part of our annual report on Form 10-KSB beginning with our reports for the fiscal year ended June 30, 2007.
While we expect to expend significant resources in developing the necessary documentation and testing procedures required by SOX 404, there is a risk that we will not comply with all of the requirements imposed thereby. At present, there is no precedent available with which to measure compliance adequacy. Accordingly, there can be no positive assurance that we will receive a positive attestation from our independent auditors.
In the event we identify significant deficiencies or material weaknesses in our internal controls that we cannot remediate in a timely manner or we are unable to receive a positive attestation from our independent auditors with respect to our internal controls, investors and others may lose confidence in the reliability of our financial statements and our ability to obtain equity or debt financing could suffer.
We will need to raise additional capital to expand our operations in future periods. If we cannot raise sufficient capital, our ability to implement our business strategies and continue to expand will be at risk.
We want to build an additional manufacturing line and upgrade our manufacturing facilities and technologies in order to expand our business. Based upon our preliminary estimates this will require capital and other expenditures of approximately USD $1 million to $2 million. We do not presently have sufficient working capital to fund the additional acquisitions and upgrade our manufacturing facilities and technologies, and we will need to raise additional working capital to accomplish these objectives. We do not presently have any external sources of capital and will in all likelihood raise the capital in a debt or equity offering. If we raise the necessary capital through the issuance of debt, this will result in increased interest expense. If we raise additional funds through the issuance of equity or convertible debt securities, the percentage ownership of our Company held by existing stockholders will be reduced and those stockholders may experience significant dilution. In addition, new securities may contain certain rights, preferences or privileges that are senior to those of our Common Stock. There can be no assurance that acceptable financing to fund this project can be obtained on suitable terms, if at all. Our ability to continue to implement our growth strategy could suffer if we are unable to raise the additional funds on acceptable terms that will have the effect of adversely affecting our ongoing operations and limiting our ability to increase our revenues in the future.
We do not have significant financial reporting experience, which may lead to delays in filing required reports with the Securities and Exchange Commission and suspension of quotation of our securities on the OTCBB, which will make it more difficult for you to sell your securities.
The OTCBB limits quotations to securities of issuers that are current in their reports filed with the Securities and Exchange Commission. These limitations may be impediments to our quotation on the OTCBB. Because we do not have significant financial reporting experience, we may experience delays in filing required reports with the Securities and Exchange Commission. Because issuers whose securities are qualified for quotation on the OTCBB are required to file these reports with the Securities and Exchange Commission in a timely manner, the failure to do so may result in a suspension of trading or delisting from the OTCBB.
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There are no automated systems for negotiating trades on the OTCBB and it is possible for the price of a stock to go up or down significantly during a lapse of time between placing a market order and its execution, which may affect your trades in our securities.
Because there are no automated systems for negotiating trades on the OTCBB, they are conducted via telephone. In times of heavy market volume, the limitations of this process may result in a significant increase in the time it takes to execute investor orders. Therefore, when investors place market orders, an order to buy or sell a specific number of shares at the current market price, it is possible for the price of a stock to go up or down significantly during the lapse of time between placing a market order and its execution.
Because our stock currently trades below $5.00 per share, and is quoted on the OTCBB, our stock is considered a "penny stock" which can adversely affect its liquidity.
As the trading price of our Common Stock is less than $5.00 per share, our Common Stock is considered a "penny stock," and trading in our Common Stock is subject to the requirements of Rule 15g-9 under the Securities Exchange Act of 1934. Under this rule, broker/dealers who recommend low-priced securities to persons other than established customers and accredited investors must satisfy special sales practice requirements. The broker/dealer must make an individualized written suitability determination for the purchaser and receive the purchaser's written consent prior to the transaction.
SEC regulations also require additional disclosure in connection with any trades involving a "penny stock," including the delivery, prior to any penny stock transaction, of a disclosure schedule explaining the penny stock market and its associated risks. These requirements severely limit the liquidity of securities in the secondary market because few broker or dealers are likely to undertake these compliance activities. In addition to the applicability of the penny stock rules, other risks associated with trading in penny stocks could also be price fluctuations and the lack of a liquid market.
“Penny Stock” rules may make buying or selling our Securities difficult.
Trading in our Securities will be subject to the “penny stock” rules for the foreseeable future. The Securities and Exchange Commission has adopted regulations that generally define a penny stock to be any equity security that has a market price of less than $5.00 per share, subject to certain exceptions. These rules require that any broker-dealer who recommends our securities to persons other than prior customers and accredited investors must, prior to the sale, make a special written suitability determination for the purchaser and receive the purchaser’s written agreement to execute the transaction. Unless an exception is available, the regulations require the delivery, prior to any transaction involving a penny stock, of a disclosure schedule explaining the penny stock market and the risks associated with trading in the penny stock market. In addition, broker-dealers must disclose commissions payable to both the broker-dealer and the registered representative and current quotations for the securities they offer. The additional burdens imposed upon broker-dealers by such requirements may discourage broker-dealers from recommending transactions in our securities, which could severely limit the liquidity of our securities and consequently adversely affect the market price for our securities.
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We do not anticipate payment of dividends, and investors will be wholly dependent upon the market for the Common Stock to realize economic benefit from their investment.
As holders of our Securities, you will only be entitled to receive those dividends that are declared by our board of directors out of surplus. We do not expect to have surplus available for declaration of dividends in the foreseeable future. Indeed, there is no assurance that such surplus will ever materialize to permit payment of dividends to you as holders of the Securities. The board of directors will determine future dividend policy based upon our results of operations, financial condition, capital requirements, reserve needs and other circumstances.
RISKSRELATEDTOOURINDUSTRY
Our business is strongly conjunct with the cigarette industry and in the exposure of risks derived from the fluctuation of the cigarette industry.
A majority of our clientele is involved in various aspects of the cigarette manufacturing industry in China, which is facing significant governmental actions aimed at reducing the consumption of cigarettes. As one of the largest cigarette consumption markets in the world, the Chinese government is following the world trends to enforce more regulations on the cigarette industry. Management does not think the Chinese cigarette industry will have a regression in the near future, but we cannot ignore the risks deriving from the fluctuation of the cigarette industry.
Intense competition from existing and new entities may adversely affect our revenues and profitability.
We face intense competition. The packaging products and paperboard industries are highly competitive, and no single company dominates either industry. Our competitors include large, vertically integrated packaging products and paperboard companies and numerous smaller companies.
Because all of our businesses operate in highly competitive industry segments, we regularly bid for sales opportunities to customers for new business or for renewal of existing business. The loss of business or the award of new business from our larger customers may have a significant impact on our results of operations.
The primary competitive factors in the packaging products and paperboard industries are price, design, product innovation, quality and service, with varying emphasis on these factors depending on the product line and customer preferences. We believe that we compete effectively with respect to each of these factors. However, to the extent that any of our competitors becomes more successful with respect to any key competitive factor, our business could be materially adversely affected.
Provisions of our Articles of Incorporation and Bylaws may delay or prevent a take-over that may not be in the best interests of our stockholders.
Provisions of our Articles of Incorporation and Bylaws may be deemed to have anti-takeover effects, which include when and by whom special meetings of our stockholders may be called, and may delay, defer or prevent a takeover attempt. In addition, certain provisions of the Nevada Revised Statutes also may be deemed to have certain anti-takeover effects which include that control of shares acquired in excess of certain specified thresholds will not possess any voting rights unless these voting rights are approved by a majority of a corporation's disinterested stockholders.
In addition, our Articles of Incorporation authorize the issuance of up to 25,000,000 shares of Preferred Stock with such rights and preferences as may be determined from time to time by our Board of
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Directors. No shares are currently outstanding. Our Board of Directors may, without stockholder approval, issue Preferred Stock with dividends, liquidation, conversion, voting or other rights that could adversely affect the voting power or other rights of the holders of our Common Stock.
Our executive officers, directors and 5% or greater shareholders have the ability to significantly influence matters requiring a shareholder vote and other shareholders may not have the ability to influence corporate transactions.
Currently, our existing officers, directors and 5% or greater shareholders in the aggregate beneficially own approximately 45.8% of our outstanding stock. As a result, such persons, acting together, will have the ability to significantly influence the vote on all matters requiring approval of our shareholders, including the election of directors and approval of significant corporate transactions.
We cannot predict whether we will successfully effectuate our current business plan. Each prospective investor is encouraged to carefully analyze the risks and merits of an investment in our Common Stock and should take into consideration when making such analysis, among others, the Risk Factors discussed above.
Part II - OTHER INFORMATION
None
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
We did not issue any shares of our common stock during the three month period ended September 30, 2006.
Item 3. Defaults Upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders
None
Item 5. Other Information
None
Item 6. Exhibits
Exhibit
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Number | Description | |
----------- | ---------------- | |
31.1 | Rule 13a – 14(a)/15d-14(a) Certification of the Chief Executive Officer * | |
31.2 | Rule 13a – 14(a)/15d-14(a) Certification of the Chief Financial Officer * | |
32.1 | Certification of Chief Executive Officer Certification under Section 906 * | |
32.2 | Certification of Principal Financial and Accounting Officer Certification under Section 906 * |
| | | | | | | |
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SIGNATURES
In accordance with Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, in Ningbo, China on November 14, 2006.
DRAGON INTERNATIONAL GROUP CORP.
By: /s/ David Wu
David Wu,
CEO, Principal Executive Officer
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