XNAS:WWIN Quarterly Report 10-Q Filing - 6/30/2012

Effective Date 6/30/2012

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10−Q 

(Mark One)

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended: June 30, 2012

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ____________ to _____________ 

 

Commission File Number: 001-34484

 

WINNER MEDICAL GROUP INC.

(Exact name of Registrant as Specified in its Charter)

 

Nevada   33-0215298
(State or other jurisdiction of incorporation or organization)   (I.R.S. Employer Identification. No.)

 

Winner Industrial Park, Bulong Road
Longhua, Shenzhen City, 518109
The People’s Republic of China
(Address of principal executive offices) (Zip Code)

 

  86-(755) 28138888  
  (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 Exchange Act during the past 12 months or for such shorter period that the registrant was required to file such reports, and (2) has been subject to such filing requirements for the past 90 days.      Yes x      No ¨

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).          Yes x     No ¨

 

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 outstanding of the issuer’s class of common equity as of August 9, 2012 was 24,371,872.

 

 
 

 

TABLE OF CONTENTS

 

    Page
  PART I    
       
Item 1. Financial Statements.   4
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.   5
Item 3. Quantitative and Qualitative Disclosures About Market Risk.   22
Item 4. Controls and Procedures.   22
       
  PART II    
       
Item 1. Legal Proceedings.   23
Item 1A. Risk Factors.   23
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.   23
Item 3. Defaults Upon Senior Securities.   23
Item 4. Mine Safety Disclosures.   23
Item 5. Other Information.   23
Item 6. Exhibits.   23

 

2
 

 

Cautionary Statement

 

This Quarterly Report on Form 10-Q, including the following “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” contains forward-looking statements that are based on the beliefs of the Company’s management and involve risks and uncertainties, as well as assumptions that, if they ever materialize or prove incorrect, could cause the results of the Company to differ materially from those expressed or implied by such forward-looking statements. The words “believes,” “expects,” “anticipates,” “projects,” “targets,” “optimistic,” “intends,” “aims,” “will” or similar expressions are intended to identify forward-looking statements. All statements other than statements of historical fact are statements that could be deemed forward-looking statements, including statements regarding new and existing products, technologies and opportunities; statements regarding market and industry segment growth and demand and acceptance of new and existing products; any projections of sales, earnings, revenue, margins or other financial items; any statements of the plans, strategies and objectives of management for future operations; any statements regarding future economic conditions or performance; uncertainties related to conducting business in China; any statements of belief or intention; any of the factors mentioned in the “Risk Factors” section of the Company’s Annual Report on Form 10-K; and any statements of assumptions underlying any of the foregoing.

 

Except as otherwise indicated by the context, references in this report to “the Company,” “Winner,” “Winner Medical,” “we,” “us” or “our” are references to the combined business of Winner Medical Group Inc. and its subsidiaries. The English translation of the names of the Company’s subsidiaries which were incorporated in the People’s Republic of China (the “PRC”) is for reference only. The official names of the PRC subsidiaries are in Chinese.

 

3
 

 

PART I

FINANCIAL INFORMATION

 

ITEM 1.FINANCIAL STATEMENTS.

 

WINNER MEDICAL GROUP INC.

   

  Condensed Consolidated Financial Statements (Unaudited)

  For the three and nine months ended June 30, 2012 and 2011

 

4
 

 

WINNER MEDICAL GROUP INC.

 

INDEX TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

  Page
   
Condensed Consolidated Balance Sheets F-1
   
Condensed Consolidated Statements of Income and Comprehensive Income F-2
   
Condensed Consolidated Statements of Stockholders’ Equity F-3
   
Condensed Consolidated Statements of Cash Flows F-4
   
Notes to Condensed Consolidated Financial Statements F-5-F-20

 

 
 

 

WINNER MEDICAL GROUP INC.

 

CONDENSED CONSOLIDATED BALANCE SHEETS

(UNAUDITED)

 

   June 30,   September 30, 
   2012   2011 
   US$   US$ 
ASSETS 
Current assets:          
Cash and cash equivalents   25,225,650    21,945,105 
Restricted bank deposits   107,679    1,836,491 
Restricted broker margin account   475,106    0 
Accounts and notes receivable, less allowances for doubtful accounts of US$92,213 and US$159,485 at June 30, 2012 and September 30, 2011, respectively   23,789,096    20,982,263 
Amounts due from affiliated companies   84,550    157,779 
Inventories   25,500,169    25,408,700 
Prepaid expenses and other current assets   11,805,719    8,334,504 
Income taxes recoverable   234,400    146,408 
Deferred tax assets   345,293    376,411 
Total current assets   87,567,662    79,187,661 
Property, plant and equipment, net   69,678,053    65,461,750 
Investment in equity investees   2,573,325    2,421,915 
Intangible assets, net   148,340    126,918 
Prepaid expenses and other receivables   2,463,983    1,596,354 
Deferred tax assets   1,190,522    1,124,089 
Total assets   163,621,885    149,918,687 
           
LIABILITIES AND STOCKHOLDERS’ EQUITY 
           
Current liabilities:          
Short-term bank loans   6,324,211    6,294,356 
Accounts payable   10,137,984    7,420,580 
Accrued payroll and employee benefits   3,508,256    3,141,756 
Customer deposits   1,099,714    1,115,887 
Accrued and other liabilities   6,822,643    4,253,889 
Amounts due to affiliated companies   85,402    0 
Income taxes payable   1,437,598    1,970,710 
Total current liabilities   29,415,808    24,197,178 
Deferred tax liabilities   0    45,025 
Total liabilities   29,415,808    24,242,203 
           
Commitments and contingencies          
           
Stockholders’ equity:          
Common stock, par value $0.001 per share; authorized 247,500,000, issued and outstanding June 30, 2012 –24,371,872 shares; September 30, 2011 –24,140,247 shares   24,373    24,141 
Additional paid-in capital   43,559,598    42,490,464 
Retained earnings   65,635,028    58,984,686 
Statutory reserves   5,932,049    5,866,970 
Accumulated other comprehensive income   18,790,415    18,169,505 
Total Winner Medical Group Inc. stockholders’ equity   133,941,463    125,535,766 
           
Noncontrolling interests   264,614    140,718 
Total stockholder’s equity   134,206,077    125,676,484 
           
Total liabilities and stockholder’s equity   163,621,885    149,918,687 

 

See accompanying notes to condensed consolidated financial statements.

 

F-1
 

 

WINNER MEDICAL GROUP INC.

 

CONDENSED CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME

 

(UNAUDITED) 

 

   Three months ended
June 30,
   Nine months ended
June 30,
 
   2012   2011   2012   2011 
   US$   US$   US$   US$ 
                 
Net sales   48,191,971    41,536,465    130,827,383    108,460,785 
                     
Cost of sales   (35,960,360)   (30,227,856)   (97,591,364)   (78,318,957)
Gross profit   12,231,611    11,308,609    33,236,019    30,141,828 
                     
Other operating income/(loss), net   144,329    (2,831)   218,960    (104,786)
Government subsidies   169,784    90,407    416,274    1,304,622 
Realized gain/(loss) on commodity financial instruments   92,791    65,037    167,467    (1,694,632)
Foreign currency exchange gain/(loss)   199,642    (270,910)   (83,240)   (415,041)
Selling, general and administrative expenses   (10,576,805)   (7,293,780)   (25,538,616)   (19,151,578)
                     
Income from operations   2,261,352    3,896,532    8,416,864    10,080,413 
Interest income   109,120    59,088    279,760    105,256 
Interest expense   (125,150)   (134,793)   (228,701)   (227,978)
Equity in earnings of 50 percent or less owned persons   69,945    179,745    151,410    362,860 
Income before income taxes   2,315,267    4,000,572    8,619,333    10,320,551 
                     
Income taxes   55,227    (565,349)   (1,840,529)   (1,287,744)
Net income   2,370,494    3,435,223    6,778,804    9,032,807 
                     
Net income attributable to noncontrolling interests   (43,210)   (10,698)   (63,383)   (44,102)
Net income attributable to Winner Medical Group Inc.   2,327,284    3,424,525    6,715,421    8,988,705 
                     
Comprehensive income:                    
Net income   2,370,494    3,435,223    6,778,804    9,032,807 
Foreign currency translation difference   (600,851)   1,385,899    621,397    3,757,299 
Comprehensive income attributable to noncontrolling interests   (41,732)   (10,672)   (63,870)   (44,452)
                     
Comprehensive income attributable to Winner Medical Group Inc.   1,727,911    4,810,450    7,336,331    12,745,654 
                     
                     
Net income attributable to Winner Medical Group Inc.  per share                    
- basic   0.10    0.14    0.28    0.37 
- diluted   0.09    0.14    0.27    0.37 
                     
Weighted average common stock outstanding                    
- basic   24,371,872    24,130,247    24,365,867    24,125,593 
- diluted   25,013,418    24,601,088    24,770,079    24,621,897 

 

See accompanying notes to condensed consolidated financial statements.

 

F-2
 

 

WINNER MEDICAL GROUP INC.

 

CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY

(UNAUDITED)

 

                       Accumulated         
   Common stock   Additional           other   Non-    Total 
   Stock       paid-in   Retained   Statutory   comprehensive   controlling   Stockholders’ 
   outstanding   Amount   capital   earnings   reserves   Income   interests   equity 
       US$   US$   US$   US$   US$   US$   US$ 
                                 
Balance at September 30, 2010   23,950,740    23,951    40,154,494    48,730,034    4,585,731    12,302,762    100,199    105,897,171 
                                         
Restricted stock units granted   0    0    618,129    0    0    0    0    618,129 
Stockholder’s contribution   0    0    1,718,031    0    0    0    0    1,718,031 
Issuance of restricted stock units   189,507    190    (190)   0    0    0    0    0 
                                         
Net income   0    0    0    11,535,891    0    0    39,772    11,575,663 
                                         
Foreign currency translation adjustments   0    0    0    0    0    5,866,743    747    5,867,490 
Transfer to statutory reserves   0    0    0    (1,281,239)   1,281,239    0    0    0 
Balance at September 30, 2011   24,140,247    24,141    42,490,464    58,984,686    5,866,970    18,169,505    140,718    125,676,484 
Restricted stock units and stock options granted   0    0    1,129,392    0    0    0    0    1,129,392 
Issuance of restricted stock units   231,625    232    (232)   0    0    0    0    0 
                                         
Net income   0    0    0    6,715,421    0    0    63,383    6,778,804 
                                         
Transfer from Statutory reserves   0    0    0    (65,079)   65,079    0    0    0 
Foreign currency translation adjustments   0    0    0    0    0    620,910    487    621,397 
Contribution from noncontrolling interests   0    0    0    0    0    0    474,593    474,593 
Purchase of noncontrolling interests   0    0    (60,026)   0    0    0    (414,567)   (474,593)
                                         
Balance at June 30, 2012   24,371,872    24,373    43,559,598    65,635,028    5,932,049    18,790,415    264,614    134,206,077 

 

See accompanying notes to condensed consolidated financial statements.

 

F-3
 

 

WINNER MEDICAL GROUP INC.

 

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

 

   Nine months ended
June 30,
 
   2012   2011 
   US$   US$ 
Cash flows from operating activities          
Net income   6,778,804    9,032,807 
Adjustments to reconcile net income to net cash from operating activities:          
Depreciation and amortization of property, plant and equipment   4,594,318    4,030,486 
Amortization of intangible assets   26,267    20,789 
Loss on disposal of property, plant and equipment   129,211    246,097 
Impairment of property, plant and equipment   1,464,403    0 
Change in fair value of financial instruments, net   (3,028)   (71,071)
Equity in earnings of 50 percent or less owned persons   (151,410)   (362,860)
Investment income from held-to-maturity investments   (197,441)   (55,835)
Stock-based compensation expenses   1,129,392    644,726 
Gain on realized commodity financial instruments   (74,496)   0 
Deferred tax   (73,436)   (589,145)
Changes in operating assets and liabilities:          
Restricted bank deposits   1,575,114    193,677 
Restricted broker margin account   (400,610)   (1,293,173)
Accounts receivable   (2,707,311)   (4,254,544)
Amounts due from affiliated companies   73,977    (7,208)
Inventories   29,048    (8,676,339)
Prepaid expenses and current assets   (3,438,644)   (3,949,729)
Income taxes recoverable   (87,298)   7,061 
Accounts payable   2,682,207    2,582,464 
Accrued payroll and employee benefits   351,598    458,738 
Customer deposits   (21,467)   11,332 
Accrued and other liabilities   1,978,259    309,727 
Amounts due to affiliated companies   85,402    653 
Income taxes payable   (537,882)   84,838 
Net cash provided by/ (used in)  operating activities   13,204,977    (1,636,509)
           
Cash flows from investing activities          
Purchase of property, plant and equipment   (7,733,003)   (5,070,594)
Purchase of intangible assets   (47,031)   (23,904)
Proceeds from disposal of property, plant and equipment   40,585    39,139 
Deposits paid for property, plant and equipment   (2,244,371)   (1,589,928)
Redemption of held-to-maturity investments   36,480,515    31,229,055 
Purchase of held-to-maturity investments   (36,283,074)   (29,647,424)
Net cash used in investing activities   (9,786,379)   (5,063,656)
           
Cash flows from financing activities          
Proceeds from bank borrowings   9,461,036    12,752,313 
Repayment of bank borrowings   (9,461,036)   (4,390,219)
Purchase of noncontrolling interests   (425,747)   (211,490)
Restricted bank deposits   157,756    0 
Net cash (used in)/provided by financing activities   (267,991)   8,150,604 
           
Effect of exchange rate changes   129,938    723,033 
           
Net increase in cash and cash equivalents   3,280,545    2,173,472 
Cash and cash equivalents, beginning of period   21,945,105    14,818,179 
Cash and cash equivalents, end of period   25,225,650    16,991,651 
           
Supplemental disclosures of cash flows information:          
Cash paid during the period for:          
Cash paid for interest, net of capitalized interest of US$183,875 and US$Nil during the nine months ended June 30, 2012 and 2011, respectively   228,701    227,978 
Income taxes   2,542,999    1,864,125 

 

See accompanying notes to condensed consolidated financial statements.

 

F-4
 

 

WINNER MEDICAL GROUP INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

 

1.Basis of Preparation of Financial Statements

 

The accompanying condensed consolidated financial statements of Winner Medical Group Inc (“Winner Medical” or the “Company”) have been prepared in accordance with generally accepted accounting principles in the United States of America for interim consolidated financial information. Accordingly, they do not include all the information and notes necessary for comprehensive consolidated financial statements.

 

In the opinion of the management of the Company, all adjustments, which are of a normal recurring nature, necessary for a fair presentation of the operating results for the three and nine months ended June 30, 2012 have been made. It is suggested that these condensed consolidated financial statements be read in conjunction with the audited financial statements and notes thereto included in the Company’s annual report on Form 10-K for the year ended September 30, 2011. The Company follows the same accounting policies in preparation of interim reports.

 

Results for the interim periods presented are not necessarily indicative of the results that might be expected for the entire fiscal year.

 

2.Description of Business

 

The principal activities of the Company and its subsidiaries consist of research and development, manufacturing and trading of medical dressings, medical disposables and PurCotton® products. Activities of the Company are principally conducted by subsidiaries operating in the People’s Republic of China (the “PRC”).

 

3.Recently Issued Accounting Pronouncements

 

In May 2011, the FASB issued ASU No. 2011-04, Fair Value Measurement (ASC 820) Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRS. This pronouncement is an authoritative guidance to amend certain measurement and disclosure requirements related to fair value measurements to improve consistency with international reporting standards. In addition, ASU 2011-04 expanded the required disclosures around fair value measurements including (i) reporting the level in the fair value hierarchy used to value assets and liabilities which are not measured at fair value, but where fair value is disclosed, and (ii) qualitative disclosures about the sensitivity of Level 3 fair value measurements to changes in unobservable inputs used. This guidance is effective prospectively for public entities for interim and annual reporting periods beginning after December 15, 2011, with early adoption by public entities prohibited, and is applicable to the Company’s fiscal year beginning October 1, 2012. The Company is currently evaluating this guidance, but does not expect its adoption will have a material effect on its consolidated financial statements.

 

In June 2011, the FASB issued ASU No. 2011-05, Comprehensive Income (ASC 220) Presentation of Comprehensive Income (“ASU No. 2011-05”). This pronouncement is an authoritative guidance on the presentation of comprehensive income that will require a company to present components of net income and other comprehensive income in one continuous statement or in two separate, but consecutive statements. There are no changes to the components that are recognized in net income or other comprehensive income under current GAAP. This guidance is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2011, with early adoption permitted. The Company has adopted ASU No. 2011-05 for its 2012 fiscal year.

 

In December 2011, the FASB issued ASU No. 2011-11, Disclosures about Offsetting Assets and Liabilities (“ASU 2011-11”) to ASC 210, Balance Sheet. The update requires new disclosures about balance sheet offsetting and related arrangements. For derivatives and financial assets and liabilities, the amendments require disclosure of gross asset and liability amounts, amounts offset on the balance sheet, and amounts subject to the offsetting requirements but not offset on the balance sheet. The guidance is effective December 1, 2013 and is to be applied retrospectively. This guidance does not amend the existing guidance on when it is appropriate to offset. The Company is currently evaluating this guidance, but does not expect its adoption will have a material effect on its consolidated financial statements.

 

F-5
 

 

WINNER MEDICAL GROUP INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

 

4.Net Income Attributable to Winner Medical Group Inc. Per Share

 

Net income attributable to Winner Medical Group Inc. per share- Basic net income attributable to Winner Medical Group Inc. per share is computed by dividing net income attributable to Winner Medical Group Inc. available to common stockholders by the weighted average number of common shares outstanding during the period. Diluted net income attributable to Winner Medical Group Inc. per share gives effect to all dilutive potential ordinary shares outstanding during the period. The weighted average number of common shares outstanding is adjusted to include the number of additional common shares that would have been outstanding if the dilutive potential common shares had been issued. For the three and nine months ended June 30, 2012 and 2011, the basic and diluted net income attributable to Winner Medical Group Inc. per share calculated in accordance with ASC 260, "Earnings Per Share", are reconciled as follows:

 

   Three months ended
June 30,
 
   2012   2011 
   US$   US$ 
Basic income per share          
           
Net income attributable to Winner Medical Group Inc. for the period   2,327,284    3,424,525 
           
Weighted average common stock outstanding   24,371,872    24,130,247 
           
Net income attributable to Winner Medical Group Inc. per share   0.10    0.14 
           
Diluted income per share          
           
Net income attributable to Winner Medical Group Inc. for the period   2,327,284    3,424,525 
           
Weighted average common stock outstanding   24,371,872    24,130,247 
           
Effect of dilution          
           
Restricted stock   412,235    470,841 
Options   229,311    0 
           
Weighted average common stock outstanding   25,013,418    24,601,088 
           
Net income attributable to Winner Medical Group Inc. per share   0.09    0.14 

 

   Nine months ended
June 30,
 
   2012   2011 
   US$   US$ 
Basic income per share          
           
Net income attributable to Winner Medical Group Inc. for the period   6,715,421    8,988,705 
           
Weighted average common stock outstanding   24,365,867    24,125,593 
           
Net income attributable to Winner Medical Group Inc. per share   0.28    0.37 
           
Diluted income per share          
           
Net income attributable to Winner Medical Group Inc. for the period   6,715,421    8,988,705 
           
Weighted average common stock outstanding   24,365,867    24,125,593 
           
Effect of dilution          
           
Restricted stock   343,397    496,304 
Options   60,815    0 
           
Weighted average common stock outstanding   24,770,079    24,621,897 
           
Net income attributable to Winner Medical Group Inc. per share   0.27    0.37 

 

The number of stock options excluded from the calculation of diluted earnings per share for each of the three months ended June 30, 2012 and 2011, was nil; the number of stock options excluded from the calculation of diluted earnings per share for the nine months ended June 30, 2012 and 2011, was 350,000 and nil, respectively, because their inclusion would have been anti-dilutive. As of June 30, 2011, there were no potential dilutive common shares relating to stock options in the Company.

 

F-6
 

 

WINNER MEDICAL GROUP INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

 

5.Held-to-maturity investments

 

As of June 30, 2012 and September 30, 2011, there were no held-to-maturity investments. The Company had held-to-maturity investments during the three and nine months ended June 30, 2012 and 2011, which were money management products. Interest on these investments of US$81,455 and US$37,221 was included in interest income during the three months ended June 30, 2012 and 2011, respectively; US$197,441 and US$55,835 during the nine months ended June 30, 2012 and 2011, respectively.

 

6.Inventories

 

Inventories by major categories are summarized as follows:

 

   June 30,   September 30, 
   2012   2011 
   US$   US$ 
Raw materials   10,872,422    10,851,917 
Work-in-progress   6,341,270    7,086,688 
Finished goods   8,286,477    7,470,095 
    25,500,169    25,408,700 

 

7.Credit Facilities and Pledged Assets

 

The Company’s subsidiaries in Shenzhen and Huanggang have credit lines with Shenzhen Commercial Bank, Shenzhen Branch of the Industrial and Commercial Bank of China and Huanggang Branch of the Agricultural Development Bank of China, representing trade acceptances, loans and overdrafts.

 

As of June 30, 2012, the Company had approximately US$30.04 million bank credit facilities from three commercial banks and, after utilizing bank loans of US$6.32 million, there are $23.72 million available under bank credit facilities, consisting of approximately US$6.32 million from Shenzhen Branch of China Merchants Bank, approximately $12.65 million from Shenzhen Branch of the Industrial and Commercial Bank of China and approximately US$4.75 million from Huanggang Branch of Agricultural Development Bank of China. These facilities mature in August 2012 and October 2014. The weighted average interest rates on short-term borrowings as of June 30, 2012 and September 30, 2011, were 7.46% and 6.98% per annum, respectively. There are no significant covenants or other financial restrictions relating to the Company’s facilities except that, at June 30, 2012, buildings with net book values of US$3,752,034, plant and machinery with net book values of US$11,891,465 and, at September 30, 2011, buildings with a net book value of US$3,857,373 have been pledged as collateral for the above-mentioned facilities.

 

As of June 30, 2012 and September 30, 2011, the Company had the following short-term bank loans:

 

   June 30,   September 30, 
   2012   2011 
   US$   US$ 
         
Bank loans repayable within one year   6,324,211    6,294,356 
           
Original currency in Chinese Renminbi   40,000,000    40,000,000 

 

Bank loans as of June 30, 2012 that are secured by buildings and plant and machinery consisted of the following:

 

       June 30, 
       2012 
Loan  Loan period   US$ 
A   November 28, 2011 to September 16, 2012    3,162,105 
B   December 29, 2011 to September 16, 2012    3,162,106 
         6,324,211 

 

F-7
 

 

WINNER MEDICAL GROUP INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED) 

 

8.Prepaid Expenses and Other Current Assets

 

Prepaid expenses and other current assets consist of the following:

 

   June 30,   September 30, 
   2012   2011 
   US$   US$ 
         
Value added tax receivable   6,198,898    4,717,557 
Advance to suppliers   3,390,705    1,626,030 
Rental deposit   864,628    684,424 
Other deposit   538,131    826,325 
Deferred expenditure   317,617    130,666 
Fair value of financial instruments   0    51,141 
Others   495,740    298,361 
    11,805,719    8,334,504 

 

9.Income Taxes

 

United States

 

The Company is incorporated in Nevada in the United States of America and is subject to U.S. federal taxation. No provisions for income taxes have been made as the Company has no taxable income for the first quarter. The applicable income tax rate for the Company for each of the three and nine months ended June 30, 2012 and 2011, was 34%.

 

Cayman Islands

 

Winner Group Limited, a wholly owned subsidiary of the Company, is incorporated in the Cayman Islands and, under the current laws of the Cayman Islands, is not subject to income taxes.

 

Hong Kong

 

Winner Medical (Hong Kong) Limited (“Winner HK”), a 60% owned subsidiary of the Company, is incorporated in Hong Kong. Winner HK is subject to Hong Kong taxation on its activities conducted in Hong Kong and income arising in or derived from Hong Kong. Winner HK was incorporated in January 2008 and the applicable statutory tax rate for the subsidiary for the three and nine months ended June 30, 2012 and 2011, was 16.5%.

 

On January 25, 2011, a wholly-owned subsidiary HK PurCotton Co., Ltd., or “HK PurCotton” was established. The applicable income tax rate for HK PurCotton was 16.5% for the three and nine months ended June 30, 2012 and 2011.

 

PRC

 

Effective on January 1, 2008, the PRC Enterprise Income Tax Law, EIT Law, and Implementing Rules impose an unified enterprise income tax rate of 25% on all domestic-invested enterprises and foreign investment enterprises in the PRC, unless they qualify under certain limited exceptions.

 

The EIT Law gives existing foreign investment enterprises a five-year grandfather period, during which they can continue to enjoy their existing preferential tax treatments. For foreign investment enterprises that currently enjoy full exemption from PRC enterprise income tax for two years starting from the first profit-making year, followed by a 50% tax exemption for the next three years, the tax holidays are still valid.

 

Winner Medical (Huanggang) Co., Ltd. enjoyed its full tax exemption from January 1, 2008 and its 50% tax exemption from January 1, 2010 to December 31, 2012. Winner Medical & Textile Ltd., Chongyang enjoyed its 50% tax exemption from January 1, 2008 and was subject to an enterprise income tax rate of 25% from January 1, 2011. Shanghai Winner Medical Apparatus Co., Ltd. enjoyed its 50% tax exemption from January 1, 2009 and would be subject to an enterprise income tax of 25% from January 1, 2012. Hubei Winner Textiles Co., Ltd. was subject to an enterprise income tax rate of 25% from January 1, 2010.

 

F-8
 

 

WINNER MEDICAL GROUP INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

9.Income Taxes - Continued

 

On September 11, 2009, Winner Industries (Shenzhen) Co., Ltd., or "Winner Shenzhen", obtained a High and New Technology Enterprise Certificate from the Ministry of Science and Technology of China, the Ministry of Finance and the State Administration of Taxation. Winner Shenzhen enjoyed an applicable preferential income tax rate of 15% from January 1, 2009 to December 31, 2011. According to the State Administration of Taxation Notice [2011] No. 4, High and New Technology enterprises applying for renewal of their status can file and pay taxes at a 15% rate prior to receiving approval of renewal and within the previously approved qualifying period. Management expects that Winner Shenzhen will be certified as a High and New Technology enterprise during the calendar year ending December 31, 2012. Accordingly, the applicable enterprise income tax rate for Winner Shenzhen is 15% for the period from January 1 to June 30, 2012.

 

The Company classifies all interest and penalties related to unrecognized tax benefits, if any, as a component of income tax provisions. The Company performed a self-assessment and the Company’s liability for income taxes includes the liability for unrecognized tax benefits, interest and penalties which relate to tax years still subject to review by tax authorities. Audit periods remain open for review until the statute of limitations has passed. The completion of review or the expiration of the statute of limitations for a given audit period could result in an adjustment to the Company’s liability for income taxes. Any such adjustment could be material to the Company’s results of operations for any given quarterly or annual period based, in part, upon the results of operations for the given period. At June 30, 2012, the management considered that the Company had no uncertain tax positions affecting its consolidated financial position and results of operations or cash flows, and will continue to evaluate for uncertain positions in the future. There are no estimated interest costs and penalties provided in the Company’s consolidated financial statements for the three and nine months ended June 30, 2012 and 2011, respectively. The Company’s uncertain tax positions related to open tax years are subject to examination by the relevant tax authorities, the major one being the China Tax Authority. The open period for examination in the PRC is 5 tax years.

 

A reconciliation between the provision for income taxes computed by applying the statutory tax rate in PRC to income before income taxes and the actual provision for income taxes is as follows:

 

   Nine months ended
June 30,
 
   2012   2011 
   US$   US$ 
         
Tax calculated at domestic statutory rate (2012: 25%; 2011: 25%)   2,154,833    2,580,138 
Effect of different tax rates in various jurisdictions   293,335    96,791 
Tax effect of preferential tax treatment   (1,165,904)   (1,161,515)
Tax effect of preferential tax treatment on research and development expenses   (321,570)   0 
Tax effect of expenses not deductible for tax purpose   18,311    32,195 
Tax effect of government subsidies not subject to tax   0   (189,764)
Change in valuation allowance   907,223    (44,260)
Under/(over) provision in previous years   48,857   (70,523)
Utilization of tax loss   (77,169)   0 
Others   (17,387)   44,682 
    1,840,529    1,287,744 

 

10.Related Party Transactions

 

During the three months ended June 30, 2012 and 2011, the Company purchased goods from L+L Healthcare Hubei Co., Ltd. (“L+L”), an equity investee, for US$24,679 and US$6,861, respectively, and sold goods to it for US$315,019 and US$18,373, respectively. During the nine months ended June 30, 2012 and 2011, the Company purchased goods from L+L for US$56,408 and US$139,817, respectively, and sold goods to it for US$$824,169 and US$40,466, respectively. As of June 30, 2012 and September 30, 2011, the amounts due from L+L were US$79,525 and US$119,368, respectively. L+L Healthcare Hubei Co., Ltd declared dividends of US$Nil to the Company for each of the three months ended June 30, 2012 and 2011; US$Nil and US$200,000 to the Company for the nine months ended June 30, 2012 and 2011, respectively.

 

During the three months ended June 30, 2012 and 2011, the Company sold goods to Chengdu Winner Likang Medical Appliance Co., Ltd. (“Winner Chengdu”), an equity investee, for US$13,596 and US$7,613, respectively, and purchased goods from it for US$66,759 and US$22,305, respectively. During the nine months ended June 30, 2012 and 2011, the Company sold goods to Winner Chengdu, for US$58,564 and US$11,458, respectively, and purchased goods from it for US$237,265 and US$63,433, respectively. As of June 30, 2012 and September 30, 2011, amounts due to Winner Chengdu were US$85,402 and US$Nil, respectively. As of June 30, 2012 and September 30, 2011, amounts due from Winner Chengdu were US$5,025 and US$38,411, respectively.

 

The amounts due from/to the above affiliated companies are unsecured, interest free and payable according to the trading credit terms.

 

F-9
 

 

WINNER MEDICAL GROUP INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

10.Related Party Transactions - Continued

 

On January 1, 2011, Mr. Jianquan Li, the chief executive officer of the Company, entered into agreements with the Company in relation to commodity derivatives trading activities. In the agreements, as of September 30, 2011, the shortfall between the restricted broker margin account balance maintained for the commodity derivatives trading activities and the balance in that account on January 1, 2011, or US$2,838,000, was to be undertaken by Mr. Jianquan Li by way of cash payment from Mr. Jianquan Li to the Company on September 30, 2011. The Company accounts for this transaction between the Company and Mr. Jianquan Li in accordance with Staff Accounting Bulletin Topic 5T, under which the payment from Mr. Jianquan Li for the shortfall was recognized in additional paid-in capital as of September 30, 2011. The loss from trading in commodity financial instruments for the nine months ended June 30, 2011 of US$1,694,632 has been recognized in the consolidated statements of income and comprehensive income.

 

11.Stock-Based Compensation

 

Stock-Based Compensation - The Company has adopted ASC 718, ''Compensation-Stock Compensation'', which requires that share-based payment transactions with employees, such as share options, be measured based on the grant-date fair value of the equity instrument issued and recognized as compensation expense over the requisite service period, with a corresponding addition to equity. Under this method, compensation cost related to employee share options or similar equity instruments is measured at the grant date based on the fair value of the award and is recognized over the period during which an employee is required to provide service in exchange for the award, which is generally the vesting period. Compensation expense is recognized for those awards that are expected to vest, which the Company’s estimates based upon historical forfeitures.

 

There was no stock-based compensation cost recorded for independent directors for the three and nine months ended June 30, 2012 and 2011, respectively.

 

On October 7, 2007, the Board of Directors approved a 2008-09 Restricted Stock Unit Incentive Plan, the “2008-2009 Plan”, a stock incentive compensation program for fiscal years 2008 and 2009. This 2008-2009 Plan allows the Company to offer a variety of restricted stock unit awards to directors, senior management and key employees, where a participant will be eligible to receive one share of the Company’s common stock for each restricted stock unit that vests upon the achievement of corporate and individual objectives and such participant’s continued employment as of the applicable vesting date.

 

Under the 2008-2009 Plan, the Company granted 500,000 units out of the total 600,000 authorized restricted stock units on October 7, 2007. Entitled employees are eligible to vest the first 50% of the total number of restricted stock awarded on October 7, 2010 and the second 50% on October 7, 2011 if the target of corporate net income attributable to Winner Medical Group Inc., annual Company sales objectives, and the participant’s individual performance objectives are fulfilled. The estimated value of award as of the grant date is based on the market price of the common stock as quoted on the NASDAQ Global Market as of October 7, 2007, which was US$3.60 per share, and assumes that the individual achieves the applicable corporate and individual objectives set forth in the award.

 

On October 15, 2008, the Board of Directors approved the granting of the remaining 100,000 units out of the total 600,000 authorized restricted stock units under the 2008-2009 Plan. Entitled employees are eligible to vest the first 50% of the total number of restricted stock awarded on October 7, 2010 and the second 50% on October 7, 2011 if the target of corporate net income attributable to Winner Medical Group Inc., annual Company sales objectives, and the participant’s individual performance objectives are fulfilled. The estimated value of award as of grant date is based on the market price of the common stock as quoted on the NASDAQ Global Market as of October 15, 2008, which was US$0.50 per share, and assumes that the individual achieves of the applicable corporate and individual objectives set forth in the award.

 

On September 8, 2009, the Board of Directors approved the 2010-11 Restricted Stock Unit Incentive Plan, the “2010-2011 Plan”, a stock incentive compensation program for fiscal years 2010 and 2011. The 2010-2011 Plan allows the Company to offer a variety of restricted stock unit awards to directors, senior management and key employees, where a participant will be eligible to receive one share of the Company’s common stock for each restricted stock unit that vests upon the achievement of corporate and individual objectives and such participant’s continued employment as of the applicable vesting date.

 

Under the 2010-2011 Plan, the Company granted 250,000 units out of the total 300,000 authorized restricted stock units on September 8, 2009. Entitled employees are eligible to vest the first 50% of the total number of restricted stock awarded on September 8, 2012 and the second 50% on September 8, 2013 if the target of corporate net income attributable to Winner Medical Group Inc., annual Company sales objectives, and the participant’s individual performance objectives are fulfilled. The estimated value of award as of grant date is based on the market price of the common stock as quoted on the NASDAQ Global Market as of September 8, 2009, which was US$4.40 per share, and assumes that the individual achieves the applicable corporate and individual objectives set forth in the award.

 

F-10
 

 

WINNER MEDICAL GROUP INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

11.Stock-Based Compensation-Continued

 

On September 28, 2010, the Board of Directors approved the granting of the remaining 50,000 units out of the total 300,000 authorized restricted stock units under the 2010-2011 Plan. Entitled employees are eligible to vest the first 50% of the total number of restricted stock awarded on September 8, 2012 and the second 50% on September 8, 2013 if the target of corporate net income attributable to Winner Medical Group Inc., annual Company sales objectives, and the participant’s individual performance objectives are fulfilled. The estimated value of award as of grant date is based on the market price of the common stock as quoted on the NASDAQ Global Market as of September 28, 2010, which was US$4.56 per share, and assumes that the individual achieves the applicable corporate and individual objectives set forth in the award.

 

On July 27, 2009, the Company’s subsidiary in Shenzhen entered into a 5-year consulting agreement with a consulting firm for consulting services related to developing strategies for rolling out the Company’s own branded consumer products in China. Pursuant to the agreement, the Company granted 500,000 restricted stock units from the Company’s 2006 Equity Incentive Plan to the consulting firm as compensation for the services. As of September 18, 2010, both parties decided to terminate the consulting arrangement and mutually waived the share-based compensation terms of the agreement.

 

On October 6, 2010, the Board of Directors approved the 2011-2013 Restricted Stock Unit Incentive Plan, the "2011-2013 Plan", a stock incentive compensation program for fiscal years 2011 to 2013. The 2011-2013 Plan allows the Company to offer a variety of restricted stock unit awards to directors, senior management and key employees of the Company’s wholly-owned subsidiary, Shenzhen PurCotton Technology Co., Ltd. The participant will be eligible to receive one share of the Company’s common stock for each restricted stock unit that vests upon the achievement of corporate and individual objectives and such participant’s continued employment as of the applicable vesting date.

 

Under the 2011-2013 Plan, the Company granted 300,000 units out of the total 500,000 authorized restricted stock units on October 6, 2010. On each of October 6, 2012, October 6, 2013 and October 6, 2014, a participant will be eligible to vest up to 1/3 of the total number of restricted stock units underlying an award if the target of corporate net income attributable to Winner Medical Group Inc., annual Company sales objectives, and the participant’s individual performance objectives are fulfilled. The estimated value of award as of grant date is based on the market price of the common stock as quoted on the NASDAQ Global Market as of October 6, 2010, which was US$5.31 per share, and assumes that the individual achieves the applicable corporate and individual objectives set forth in the award.

 

On October 7, 2010, under the 2008-2009 Plan, the Company issued 179,507 shares of the Company’s common stock to those entitled employees, representing vesting of the first 50% of the total number of shares of restricted stock awarded.

 

Pursuant to a one-year consulting agreement signed between the Company and an investor relations consultant firm, 10,000 restricted stock units were granted to the consultant firm on the agreement date, which was May 1, 2010. After evaluating and assessing the accomplishments were achieved by the consultant firm, 10,000 restricted stock units were vested on May 2, 2011. The estimated value of the restricted stock units is based on the market price of the common stock as quoted on the NASDAQ.com as of May 2, 2011, which was US$4.99.

 

On October 7, 2011, the Company issued 231,625 shares of the Company’s common stock to those entitled employees, representing vesting of the second 50% of the total number of shares of restricted stock awarded.

 

On November 3, 2011, the Board of Directors approved the 2012-2013 Restricted Stock Unit and Options Incentive Plan, the "2012-2013 Plan", a stock incentive compensation program for fiscal years 2012 to 2013. This 2012-2013 Plan allows the Company to offer a variety of restricted stock units and/or options awards to directors, senior management and key employees, where a participant will be eligible to receive one share of the Company’s common stock for each restricted stock unit that vests upon the achievement of corporate and individual objectives and such participant’s continued employment as of the applicable vesting date.

 

Under the 2012-2013 Plan, the Company granted 530,000 restricted stock units on November 3, 2011. Entitled employees are eligible to vest the first 50% of the total number of shares of restricted stock awarded on November 3, 2014 and the second 50% on November 3, 2015 if the target of corporate net income attributable to Winner Medical Group Inc., annual Company sales objectives, and the participant’s individual performance objectives are fulfilled. The estimated value of award as of grant date is based on the market price of the common stock as quoted on the NASDAQ Global Market as of November 3, 2011, which was US$3.03 per share, and assumes that the individual achieves the applicable corporate and individual objectives set forth in the award.

 

F-11
 

 

WINNER MEDICAL GROUP INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

11.Stock-Based Compensation-Continued

 

Under the 2012-2013 Plan, the Company granted 1,350,000 and 350,000 options to purchase one share of the Company’s common stock at US$3.08 and US$3.38, respectively, on November 3, 2011. On each of November 3, 2012, November 3, 2013, November 3, 2014 and November 3, 2015, entitled employees are eligible to vest up to 1/4 of the total number of option awards. The percentage of such vesting is predetermined for each individual and tied to satisfaction of the target corporate net income and annual sales objectives, as well as attainment of each participant’s personal performance targets. Each option award that is vested will expire two years after its vesting date. The Company utilizes the lattice-binomial option-pricing model (“binomial model”) to estimate the fair value of new employee stock option grants. The Company’s determination of fair value of stock option awards on the date of grant using the binomial model is affected by the Company’s stock price as well as assumptions regarding a number of variables. These variables include, but are not limited to the Company’s expected stock price volatility over the term of the awards, interest rates, option forfeitures and employee stock option exercise behaviors. The estimated weighted average fair value of awards was US$1.07 per option.

 

A summary of stock option activity is as follows:

 

           Weighted 
       Weighted   Average 
   Number of stock   Average   Remaining 
   options   Exercise Price   Contractual Life 
       US$   Years 
Balance at September 30, 2010 and 2011   0    0    0 
Options granted   1,700,000    3.14    4.00 
Outstanding at June 30, 2012   1,700,000    3.14    4.00 
Exercisable at June 30, 2012   0    0      

 

There was no option cancelled or exercised during the three and nine months ended June 30, 2012. As at June 30, 2012, the aggregated intrinsic value of options outstanding was US$1,374,000.

 

The weighted average estimated fair value of stock options granted during the nine months ended June 30, 2012 was determined using the binomial model with the following weighted average assumptions:

 

Term structure of risk-free interest rate   0.42%~1.25% 
Expected life   4.5 years 
Term structure of volatility   44.70%~46.70% 
Dividend yield   0 
Weighted average estimated fair value per option   US$1.07 

 

The risk-free interest rate assumption for periods within the contractual life of the option is based on the U.S. Treasury yield curve in effect at the time of grant. Expected volatility is based on historical volatility and implied volatility of the Company’s stock. The Company uses historical data to estimate option exercises and employee termination within the valuation model. The dividend yield assumption is based on the Company’s history and expectation of dividend payouts. The expected life of employee stock options represents the weighted average period the stock options are expected to remain outstanding and is a derived output of the binomial model. The binomial model estimates employees’ exercise behavior based on the option’s remaining vested life and the extent to which the option is in-the-money. The binomial model estimates the probability of exercise as a function of these two variables based on the entire history of exercises and cancellations of all past option grants made by the Company.

 

The Company recorded stock-based compensation expenses included in selling, general and administrative expenses of US$384,569 and US$118,465 for the three months ended June 30, 2012 and 2011, respectively and US$1,129,392 and US$644,726 for the nine months ended June 30, 2012 and 2011, respectively.

 

Management considered that the fair value of outstanding restricted share units approximates the market value of the Company’s common stock of US$3.95 per share as at June 30, 2012.

 

As of June 30, 2012, a cumulative total of 1,051,306 non-vested restricted stock units have been cancelled and a cumulative total of 411,132 restricted stock units were vested. The total fair value of restricted stock units vested during the nine months ended June 30, 2012 and 2011, was US$697,191 and US$536,726, respectively.

 

F-12
 

 

WINNER MEDICAL GROUP INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

11.Stock-Based Compensation-Continued

 

A summary of the restricted stock units activity is as follows:

   2008-09 Plan 
Number of
 units
   2010-11 Plan 
Number of 
units
   2011-13 Plan 
Number of units
   2012-13 Plan 
Number of 
units
   Total 
Number of units
   Weighted
average
grant
date fair
value
US$
 
Nonvested units outstanding
At September 30, 2010
   478,750    287,250    0    0    766,000    3.53 
Granted   0    0    300,000    0    300,000    5.31 
Cancelled   (67,618)   (49,688)   (172,000)   0    (289,306)   4.60 
Vested   (179,507)   0    0    0    (179,507)   2.99 
Nonvested units outstanding at September 30, 2011   231,625    237,562    128,000    0    597,187    4.07 
Granted   0    0    0    530,000    530,000    3.03 
Cancelled   0    0    (128,000)   0    (128,000)   5.31 
Vested   (231,625)   0    0    0    (231,625)   3.01 
Nonvested units outstanding at June 30, 2012   0    237,562    0    530,000    767,562    3.46 

 

As of June 30, 2012, the unrecognized stock-based compensation expense for the 2010-2011 Plan, 2011-2013 Plan and 2012-2013 Plan was US$130,655, US$Nil and US$2,375,759, respectively, which totals US$2,506,414 and is expected to be amortized over the weighted average period of 1.99 years.

 

12.Commitments and Contingencies

 

Operating leases - The Company was obligated under operating leases requiring minimum rentals as follows:

   US$ 
Three months ending September 30, 2012   688,574 
Years ending September 30,     
2013   1,895,772 
2014   886,771 
2015   322,407 
2016 and after   0 
Total minimum lease payments   3,793,524 

 

Rental expenses under operating leases included in the consolidated statements of income and comprehensive income were US$909,272 and US$647,159 for the three months ended June 30, 2012 and 2011, respectively. Rental expenses under operating leases for nine months ended June 30, 2012 and 2011, included in the consolidated statement of income and comprehensive income were US$2,630,246 and US$1,664,982, respectively.

 

Purchase obligations - The Company has signed agreements with suppliers and other parties to purchase plant and machinery and computer equipment with estimated non-cancelable obligations of US$5,997,376 and US$4,233,939 as of June 30, 2012 and September 30, 2011, respectively.

 

F-13
 

 

WINNER MEDICAL GROUP INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

12.Commitments and Contingencies - continued

 

Legal proceedings - Between April 9 and April 27, 2012, three purported shareholder class actions were filed against the Company, its board of directors and its chief executive officer, Jianquan Li, in District Court, Clark County, Nevada (the “Class Actions”). The Class Actions arise from Mr. Li’s initial non-binding proposal on April 2, 2012 to acquire all outstanding shares of the Company’s common stock not owned or controlled by him or his wife in a “going private” transaction. The Class Actions allege that the Company’s board of directors have breached their fiduciary duties to the Company as a result of the proposed “going private” transaction, and the Company has aided and abetted those alleged breaches. The Company has not yet responded to the Class Actions, but believes the allegations therein are without merit. The Company intends to defend itself vigorously against the claims.

 

The Company has not yet been required to respond formally to these lawsuits. In addition, the complaints do not specify any amount of damages to be sought by plaintiffs. Because these matters are in very early stages, the Company cannot determine whether or not an adverse outcome is probable, nor can it provide a reasonable estimate of any potential losses related to these matters. While the Company believes that it has meritorious defenses to each of these actions and intends to defend them vigorously, an adverse outcome in one or more of these matters could have a material adverse effect on the Company’s business, financial condition, results of operations or liquidity.

 

Other than the above, the Company is currently not aware of any such legal proceedings or claims that it believes will have a material adverse affect on its business, financial condition or operating results. In addition, to the Company’s knowledge, no director, officer or affiliate of the Company, and no owner of record or beneficial owner of more than five percent of the Company’s securities, or any associate of any such director, officer or security holder, is a party adverse to the Company or has a material interest adverse to the Company in reference to pending litigation.

 

F-14
 

 

WINNER MEDICAL GROUP INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

13.Fair Value Measurement

 

FASB ASC 820, Fair Value Measurement, defines fair value, establishes a framework for measuring fair value in accordance with generally accepted accounting principles and requires certain disclosures about fair value measurement. FASB ASC topic 820 also establishes a fair value hierarchy that requires the use of observable market data, when available, and prioritizes the inputs to valuation techniques used to measure fair value in the following categories:

 

Level 1 – Quoted unadjusted prices for identical instruments in active markets.

 

Level 2 – Quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in market that are not active, and model-derived valuations in which all observable inputs and significant value drivers are observable in active markets.

 

Level 3 – Model-derived valuations in which one or more significant inputs or significant value drivers are unobservable, including assumptions developed by the Company.

 

The financial instruments of the Company are cash and cash equivalents, restricted bank deposits, restricted broker margin account, accounts receivable, deposits and other receivable, other current assets, bank loans, accounts payable and other current liabilities are valued at fair values due to their short-term nature. These financial assets and liabilities are classified as either Level 1 or Level 2 in the fair value hierarchy as of June 30, 2012 and September 30, 2011. Fair value of the amounts due to or from affiliates cannot be readily determined because of the nature of the related party transactions.

 

Held-to-maturity investments The Company’s held-to-maturity investments are carried at amortized cost. The fair value of held-to-maturity investments is approximated to the carrying value, based on the quoted prices for securities with similar characteristics and other observable inputs such as interest rates that are observable at commonly quoted intervals can be obtained directly from the commercial bank and such fair value measurement is considered as Level 2 in the fair value hierarchy.

 

The Company uses financial instruments to manage its exposures to movements in foreign exchange rates and commodity prices. The use of these financial instruments modifies the Company’s exposure to these risks with the goal of reducing the risk of cost to the Company. The Company does not use derivative financial instruments for speculative or trading purposes, nor does it hold or issue leveraged derivative financial instruments.

 

Foreign exchange derivatives - The Company’s operations are exposed to market risk primarily due to changes in currency exchange rates. In order to manage such risks so as to reduce volatility in earnings and cash flows, the Company enters into several foreign exchange forward contracts with a commercial bank to hedge for future trade receipts in U.S. dollars against RMB. No foreign exchange forward contracts were outstanding as of June 30, 2012. The Company’s foreign exchange forward contracts are classified as Level 2 in the fair value hierarchy under ASC 820 since the quoted prices of these foreign currency forward contracts can be obtained directly from the commercial bank.

 

F-15
 

 

WINNER MEDICAL GROUP INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

13.Fair Value Measurement -Continued

 

The following table summarizes the Company’s fair value of derivatives:

 

  Condensed Consolidated   June 30,   September 30, 
  Balance Sheet Presentation   2012   2011 
     US$   US$ 
Derivatives not designated as hedging instruments               
Fair value of foreign exchange forward  contracts   Prepaid expenses and other current assets    0    51,141 
                
Fair value of foreign exchange forward  contracts   Accrued and other liabilities    0    16,482 

 

The impact on earnings from foreign exchange derivatives activity, including changes in the fair value of derivatives for the three and nine months ended June 30, 2012 and 2011 are as follows:

 

 

     Three months ended 
  Presentation of gain or loss   June 30, 
  recognized on derivatives   2012   2011 
     US$   US$ 
Derivatives not designated as hedging instruments               
Foreign exchange forward contracts   Unrealized exchange gain    0    39,611 
   Unrealized exchange loss    0    (4,946)
               
   Other operating income, net    0    34,665 

 

     Nine months ended 
  Presentation of gain or loss   June 30, 
  recognized on derivatives   2012   2011 
     US$   US$ 
Derivatives not designated as hedging instruments               
Foreign exchange forward contracts   Unrealized exchange gain    0    79,560 
   Unrealized exchange loss    0    (8,489)
               
   Other operating income, net    0    71,071 

 

The realized gain on foreign exchange forward contracts included in other operating income, net was US$Nil in each of the three months ended June 30, 2012 and 2011, respectively. The realized loss on foreign exchange forward contracts included in other operating income was US$20,484 and realized gain was US$169,040 for the nine months ended June 30, 2012 and 2011, respectively.

 

Commodity derivatives - Cotton is the primary raw material used to manufacture many of the Company’s products and is purchased at market prices. Starting from October 2010, the Company uses commodity financial instruments to manage the risk of cotton purchase cost. Although the commodity financial instruments are economic hedges of specified risks, they are not designated or accounted for as hedging instruments. The commodity financial instruments are valued at fair value. The commodity derivatives require collateral, referred to as margin, in the form of cash. As of June 30, 2012, the Company’s restricted broker margin account was US$475,106, net of unrealized gain of US$Nil. As of June 30, 2012 and 2011, the fair value of commodity financial instruments decreased by US$Nil and US$73,738, respectively, which were recorded in other operating income. The total outstanding cotton futures contracts amounted to US$Nil as of June 30, 2012. The Company’s commodity financial instruments are classified as Level 1 in the fair value hierarchy under ASC Topic 820 since the quoted unadjusted prices of these commodity financial instruments are available in active markets.

 

The realized gain for the three months ended June 30, 2012 and 2011 on commodity financial instruments was US$92,791 and US$65,037, respectively. The realized gain for the nine months ended June 30, 2012 was US$167,467 and the realized loss for the nine months ended June 30, 2011 was US$1,694,632.

 

F-16
 

 

 

WINNER MEDICAL GROUP INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

14.Operating Risk

 

Concentrations of credit risk, major customers and suppliers - A substantial percentage of the Company’s sales are made to one customer, Sakai Shoten Co., Ltd, and are typically sold on an open account basis. The sales to Sakai Shoten Co., Ltd. accounted for 9.93% and 11.39% of the total net sales for the three months ended June 30, 2012 and 2011, respectively, and 9.09% and 12.07% of the total net sales for the nine months ended June 30, 2012 and 2011, respectively.

 

A substantial percentage of the Company’s accounts receivable are from three customers with balances that represented the following percentages of total accounts receivable at June 30, 2012 and September 30, 2011, respectively: Heng’an Group Ltd, 14.14% and 8.40%; Molnlycke Health Care AB, 9.98% and 15.14%; and Tyco Healthcare Co., Ltd, 9.95% and 10.05%. The Company has not experienced any significant difficulty in collecting its accounts receivable in the past and is not aware of any financial difficulties being experienced by its major customers.

 

Interest rate risk - The interest rates and terms of repayment of bank and other borrowings ranged from 6.36% to 7.87%. Other financial assets and liabilities do not have material interest rate risk.

 

Credit risk - In order to reduce the risk of inability to collect accounts receivable, the Company entered into an insurance policy with China Export & Credit Insurance Corporation effective on January 1, 2012. This insurance policy will expire on December 31, 2012 and is automatically renewable subject to a one month written notice given by either party. The maximum insurance coverage from China Export & Credit Insurance Corporation is US$2.5 million.

 

Foreign currency risk - The value of the Renminbi, the main currency used in the PRC, fluctuates and is affected by, among other things, changes in China's political and economic conditions. In addition, the Renminbi is not readily convertible into US dollars or other foreign currencies. All foreign exchange transactions continue to take place either through the Bank of China or other banks authorized to buy and sell foreign currencies at the exchange rate quoted by the People’s Bank of China. The conversion of Renminbi into foreign currencies such as the US dollar has been generally based on rates set by the People's Bank of China, which are set daily based on the previous day's interbank foreign exchange market rates and current exchange rates on the world financial markets. On June 30, 2012 and September 30, 2011, the exchange rates of RMB against the US dollar were 6.3249 and 6.3549, respectively; the appreciation of RMB against the US dollar was 0.47%. On June 30, 2012 and September 30, 2011, the exchange rates of RMB against Euro were 7.8710 and 8.6328 respectively. This floating exchange rate, and any appreciation of the Renminbi that may result from such rate, could have a material adverse effect on the Company’s business and financial results.

 

F-17
 

 

WINNER MEDICAL GROUP INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

15.Geographical Information

 

The business of the Company is manufacturing and trading of medical dressings and medical disposable products. The Company's sales by geographic destination are analyzed as follows:

 

   Three months ended   Nine months ended 
   June 30,   June 30, 
   2012   2011   2012   2011 
   US$   US$   US$   US$ 
                 
Europe   16,410,903    16,071,074    43,073,676    35,684,291 
PRC   15,923,947    9,020,041    40,175,200    25,724,476 
North and South America   7,298,178    8,556,687    22,998,629    24,794,963 
Japan   5,426,130    6,201,565    16,779,429    16,834,536 
Others   3,132,813    1,687,098    7,800,449    5,422,519 
Total net sales   48,191,971    41,536,465    130,827,383    108,460,785 

 

Sales to countries which were in excess of 10% of total sales for the three and nine months ended June 30, 2012 and 2011, are as follows:

 

   Three months ended   Nine months ended 
   June 30,   June 30, 
   2012   2011   2012   2011 
   US$   US$   US$   US$ 
                 
PRC   15,923,947    9,020,041    40,175,200    25,724,476 
Japan   5,426,130    6,201,565    16,779,429    16,834,536 
United States of America   5,804,907    4,920,077    16,217,395    18,447,279 
Britain   2,848,530    4,369,665    7,841,422    9,573,037 

 

F-18
 

 

WINNER MEDICAL GROUP INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

16.Segment Information

 

The Company has two reportable segments: medical products (Medical Care, Wound Care, and Home Care) and PurCotton® products. The Company’s reportable segments are strategic business units that offer different products and services. They are managed separately because each business requires different technology and marketing strategies.

 

Contributions of the major activities and profitability information of the Company’s reportable segments for the three and nine months ended June 30, 2012 and 2011, are as follows:

 

   Three months ended 
   June 30, 
   2012   2011 
  US$   US$ 
Net sales:        
Segment:        
Medical products   38,980,265    36,177,197 
PurCotton®  products   9,211,706    5,359,268 
Consolidated total   48,191,971    41,536,465 
           
Gross profits:          
Segment:          
Medical products   8,711,490    9,641,393 
PurCotton®  products   3,520,121    1,667,216 
Consolidated total   12,231,611    11,308,609 
           
Income before income taxes:          
Segment:          
Medical products   2,681,628    5,103,391 
PurCotton®  products   (366,361)   (1,102,819)
Consolidated total   2,315,267    4,000,572 
           
Net income attributable to Winner Medical Group Inc.:          
Segment:          
Medical products   2,379,861    4,315,020 
PurCotton®  products   (52,577)   (890,495)
Consolidated total   2,327,284    3,424,525 
           
Depreciation and amortization:          
Segment:          
Medical products   855,939    817,117 
PurCotton® products   687,716    579,499 
Consolidated total   1,543,655    1,396,616 

 

F-19
 

 

WINNER MEDICAL GROUP INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

16.Segment Information-Continued

 

   Nine months ended 
   June 30, 
   2012   2011 
  US$   US$ 
 Net sales:        
Segment:        
Medical products   107,187,537    94,548,622 
PurCotton®  products   23,639,846    13,912,163 
Consolidated total   130,827,383    108,460,785 
           
Gross profits:          
Segment:          
Medical products   25,391,656    25,554,717 
PurCotton®  products   7,844,363    4,587,111 
Consolidated total   33,236,019    30,141,828 
           
Income before income taxes:          
Segment:          
Medical products   9,681,607    12,247,619 
PurCotton®  products   (1,062,274)   (1,927,068)
Consolidated total   8,619,333    10,320,551 
           
Net income attributable to Winner Medical Group Inc.:          
Segment:          
Medical products   8,003,299    10,387,235 
PurCotton®  products   (1,287,878)   (1,398,530)
Consolidated total   6,715,421    8,988,705 
           
Depreciation and amortization:          
Segment:          
Medical products   2,583,065    2,465,766 
PurCotton® products   2,037,520    1,585,509 
Consolidated total   4,620,585    4,051,275 

 

    June 30,    September 30, 
    2012    2011 
   

US$ 

    

US$ 

 
 Total assets:          
Segment:          
Medical products   123,003,275    109,317,729 
PurCotton® products   50,674,985    45,578,410 
Segment total   173,678,260    154,896,139 
Reconciliation to consolidated totals:          
Elimination of other receivable from inter-segments   (10,056,375)   (4,977,452)
Consolidated total   163,621,885    149,918,687 

 

F-20
 

 

ITEM 2.MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

 

The following management’s discussion and analysis should be read in conjunction with the Company’s financial statements and the notes thereto and the other financial information appearing elsewhere in this Report. In addition to historical information, the following discussion contains certain forward-looking information. See “Cautionary Statement” above for certain information concerning those forward-looking statements. The Company’s financial statements are prepared in U.S. dollars and in accordance with U.S. GAAP.

 

Overview

 

Winner Medical’s business operations consist of the manufacturing, marketing, researching and development of cotton-based medical dressings and medical disposables, as well as consumer products. The Company has fifteen wholly-owned operating subsidiaries and three joint ventures, all located in the PRC and Hong Kong. The Company has established several integrated manufacturing and processing lines for its core products. The Company’s product offerings include cotton-based medical dressings and medical disposables, which consist of medical care and wound care, as well as PurCotton® products, which are produced from a spunlace, natural cotton nonwoven material. The Company manufactures its products in China and sells its medical dressings and medical disposables both in China and abroad, with Europe, China, the United States and Japan serving as the top four markets. The Company also sells its PurCotton® jumbo rolls in both China and abroad, and PurCotton® finished consumer products (the PurCotton retail business) mainly in China.

 

Winner Medical was originally incorporated in the State of Nevada in August 1986. The Company’s common stock is quoted under the symbol “WWIN” on Nasdaq Global Market. The CUSIP number is 97476P204.

 

Business Operations

 

Winner Medical’s present business operations commenced February 1991, and it conducts its manufacturing and marketing through its operating subsidiaries located in the PRC. The Company generates revenue through domestic (China) and international sales of a variety of medical dressings and medical disposables, which include medical care, wound care and home care products, such as gauze, wound dressings, disposable drapes, surgical gowns, face masks and cotton balls and PurCotton® jumbo rolls and finished consumer products, which are 100% natural cotton non-woven fabric made products, such as dry and wet tissues, facial puffs, baby wears and cleansing wipes.

 

The Company has integrated manufacturing lines that provide its clients with the ability to procure certain products from a single supplier. In the developed countries where it sells its products, the Company provides its customers with its specialized design, manufacturing and packaging services. When the Company works on this basis, its clients are able to select the design, size, type and scale of the products the Company manufactures for them. The Company sells its own “Winner” medical brand products in developing countries and regions including China, the Middle East, South America and Southeast Asia, with distribution channels consisting of local distributors, chain drugstores and direct sales to hospitals, particularly in the China market. During the nine months ended June 30, 2012, the medical business was approximately 81.93% of total sales. The Company believes that the overseas medical business provides stable cash flow for the Company, but that its Chinese medical business will be a driving force in the growth of its business portfolio in the future.

 

In August 2009, the Company started selling PurCotton® jumbo rolls to large consumer-products manufacturers in the PRC and Japan, and launched the PurCotton retail business in China in December 2009. During the nine months ended June 30, 2012, the overall PurCotton business accounted for approximately18.07% of the Company’s sales revenue. Moreover, revenue from the PurCotton retail business reached approximately 5.40% of total sales in the nine months ended June 30, 2012.

 

The Company believes that the PurCotton business, as a percentage of its total sales in China, will be a driver of future growth in its business portfolio. The Company believes that, as living standards improve and environmental protection awareness grows in the PRC and abroad, products that are healthy, trusted, soft, comfortable and have less carbon emission will be favored by consumers. The Company believes that its material and manufacturing processes have produced PurCotton® products that are healthy, soft, comfortable and environmentally friendly. The Company believes that PurCotton® products, which are produced in a quality-controlled, medical manufacturing environment, are particularly geared to target preferred customers, such as younger women and new mothers.

 

In order to better promote the “PurCotton” brand, the Company established a wholly owned subsidiary, Shenzhen PurCotton Technology Co., Ltd., “Shenzhen PurCotton,” in 2009 to monitor and centralize brand building, marketing, product development and design, packaging and purchasing for the retail business in the PRC and Hong Kong. The Company’s PurCotton retail distribution channel now includes chain stores, online sales and distributors (such as hypermarkets, supermarkets, department stores, convenience stores). As of August 9, 2012, the Company has forty-seven chain stores in first and second-tier cities in the PRC, which are mainly located in shopping malls. In addition, the Company started using distributors as a channel for marketing its retail products in November 2011. The Company established Shenzhen PurCotton E-Commerce Co., Ltd. to oversee the operation of its two online platforms (http://purcotton.mall.taobao.com and www.purcotton.com). Going forward, the Company believes it can continue to nurture online sales and distributors in order to produce sales growth, while selectively selling in chain stores to build brand awareness and expose potential customers to the Company’s products.

 

5
 

 

Industry Wide Trends that are Relevant to the Company’s Business

 

The cotton-based medical dressings and medical disposables manufacturing markets are continually evolving due to technological advances and new demands in the healthcare industry. The Company believes trends in the industry towards improving medical care and higher quality patient conditions, changes in patient treatment approaches and technological advances will impact favorably on the demand for its products. The Company anticipates that these factors will result in a growth in sales of medical dressings and medical disposables and increase revenue for the Company.

 

The cotton-based medical dressings and medical disposables market is subject to consumption patterns and trends. One such trend or consumption pattern relates to the age demographics of the end users of the Company’s products. On average, the worldwide population is aging and life spans are generally increasing. As the general population begins to include a larger percentage of older people, the Company anticipates that more medical care will be required, and that will result in increased sales of the Company’s products.

 

Another industry trend or consumption pattern in the Company’s industry is that hospitals are continuously looking to reduce costs. Hospitals reduce costs by seeking alternative products that increase efficiency or reduce labor costs. For example, disposable catheters reduce the need for frequent changes of diapers and bed sheets. Other popular disposables used by hospitals to reduce operating costs include Eustachian tubes and needles, disposable clothing and accessories. The Company believes the demand for cost-effective products and healthcare solutions and an increasing emphasis on health worldwide will bring an increase in the demand for medical instruments and medical dressings and medical disposables.

 

For global medical dressings and medical disposables, the Company believes that there is a geographical shift in product manufacturing from countries with high labor and manufacturing costs to countries where labor and manufacturing costs are generally lower. As a result of the relatively low cost structure and high level of infrastructure development in the PRC, some foreign multinational companies are entering the China market to seek suppliers to produce their goods. The Company believes that having more large multinational healthcare companies seeking suppliers to produce their products in China will benefit the Company. In addition, the Company is negotiating with several large healthcare companies in developed countries which intend to outsource some of their production lines.

 

The Company believes that China’s local market demand for medical dressings and medical disposables will continue to grow along with corresponding increases in per capita income as more affluent people demand higher-quality medical services and products. This presents a significant opportunity for the Company, since the Company believes that it provides relatively higher-quality products than its peers. However, the Company’s competitors compete with reduced prices and significant relationship with hospitals, as the Company’s entrance into the Chinese medical dressings market has been more recent than its competitors. In order to increase market share, the Company is developing a distribution network to capture opportunities in China, mainly through local distributors, over-the-counter drugstore chains and direct sales to hospitals in Hong Kong and hospitals in parts of Guangdong province. Specifically, certain employees have been placed in charge of communicating with local distributors in some major cities, such as Guangzhou, Fuzhou, Chengdu, Chongqing, Wuhan, Shanghai, Beijing and Shenyang.

 

Also affecting the Company’s industry is the growing sensitivity towards protecting the environment and increased health concerns, as consumers are becoming increasingly concerned about the environmental impact of the products they buy. Nonwoven medical dressings, medical instruments and medical disposables usually contain materials like rubber and polyester, which may result in restrictions on the purchase of these products under environmental protection regulations. At the same time, such materials are not biodegradable and are composed of petroleum, a non-renewable energy resource. In recent years, cases of melamine-tainted milk, recycled edible oil and contaminated vegetables have significantly raised consumers’ awareness about the environment they live in, the food they eat, and the products they use. The Company believes this trend will strengthen one of its competitive advantages because its new PurCotton® products are primarily made of natural cotton and manufactured in an environmentally-friendly fashion. The Company believes its PurCotton® products will be a medium to long-term growth contributor to its revenue, because they can be applied to consumer products as well as to the medical industry.

 

At the same time, competition among retail brands for women’s and baby care products is intense in China. Many larger foreign and domestic brands have increased their market shares by marketing their product portfolios through various channels. The Company may not attract a large amount of new customers from its competitors in the near term, while it has to expend start-up costs in building sales channels and raising brand awareness among consumers.

 

Recent Developments

 

PurCotton Retail Business Updates

 

The Company’s main distribution channels for expanding PurCotton retail business include self-operated chain stores, online sales and distributors. As of August 9, 2012, the Company operates 48 retail chain stores, with 18 in Guangdong province, 10 in Beijing, 8 in Shanghai, 2 in Hong Kong and 10 in PRC second-tier cities, such as Changsha, Wuhan, Xiamen, Shenyang, Tianjin and Chengdu, after having recently opened 1 new store in each of Wuhan, Chendu and Shenyang and 3 stores in Beijing. From May 10, 2012 to the date of the filing of this Quarterly Report, 1 store in Hong Kong and 1 in Shanghai were closed due to low traffic or expiration of lease agreements, with both stores having been opened in the initial stage of operating the retail business.

 

6
 

 

Since launching the customer loyalty membership program in the Company’s chain stores in November 2010, approximately 65,000 members have been recorded as of August 9, 2012, compared with approximately 50,000 members as of May 10, 2012. The repurchase rate by members is approximately 70%. A customer loyalty program membership requires filling out an application form and paying a one-time membership fee of RMB30, which allows members to enjoy an 8% discount when purchasing PurCotton® products.

 

The Company established Shenzhen PurCotton E-Commerce Co., Ltd. ("PurCotton E-Commerce") in November 2011 with two non-affiliated individuals who are experts in ecommerce in order to oversee the operation of its online sales. At the time of establishment, the Company owned 70% of the equity interests in this operating company, with the other 30% being owned by the two individuals. However, in April 2012, the three parties mutually agreed to cease the partnership in PurCotton E-Commerce. The two individuals withdrew their initial capital by April 2012. The Company is in the process of changing the business registration with the government and expects to complete this process in the fourth quarter 2012.

 

In addition, the Company has launched its PurCotton retail products into new distribution channels (such as hypermarkets, supermarkets, department stores and convenience stores). As of the filing date, the Company sells eight separate stock keeping units (or “SKUs”) of PurCotton sanitary napkin to a network of more than 1,000 stores, which includes Jusco, Guangzhou Grandbuy, RT-MART and other local stores in more than 12 cities (including Shenzhen, Guangzhou, Beijing, Shanghai and Qingdao). It is expected that a total of 12 SKUs of sanitary napkin and 8 SKUs of PurCotton baby diapers will be launched in the fourth quarter of 2012. The Company believes that these distribution channels will increase sales. However, this form of sales has a high level of start-up costs, including new product sales fees in each network for each SKU.

 

Manufacturing Lines

 

The Company purchased two PurCotton baby diaper manufacturing lines in 2011, which it expected to start trial production in February 2012. However, after producing samples and market testing them, the Company found that the manufacturing lines needed minor adjustments to better meet management’s expectations. These lines started the trial production in July 2012 and the Company estimates that normal production will begin in August 2012. In addition, in July, 2012, the Company started to install two new PurCotton jumbo roll manufacturing lines, which were purchased in December 2011. The Company estimates that these lines will enter into normal production by the first quarter of fiscal 2013.

 

As part of the expansion of its production capacity for its medical products, and considering the high cost of labor in Shenzhen, the Company’s base of operations, the Company plans to relocate some of its manufacturing operations to inland cities in the PRC, where the cost of labor is relatively lower. The Company’s wholly owned subsidiary, Winner Medical & Textile Ltd. Chongyang (“Winner Chongyang”), is currently building two workshops, an administrative office, a canteen and a dormitory in Chongyang, Hubei province, to facilitate the production expansion and relocation. The Company expects that these buildings will be completed by the end of December 2012, and enter production in early 2013.

 

Going-private Transaction

 

As noted in the Company’s Current Report on Form 8-K, as filed with the Securities and Exchange Commission (the “SEC”) on July 25, 2012 (the “Form 8-K”), the Company has entered into an Agreement and Plan of Merger (the “Merger Agreement”) with Winner Holding Limited (“Parent”), a Cayman Islands exempted company with limited liability and indirectly wholly owned by Mr. Jianquan Li, and Winner Acquisition, Inc., a Nevada corporation and a wholly owned, direct subsidiary of Parent (“Merger Sub”). Subject to satisfaction of the Merger Agreement’s terms and conditions, upon consummation of the merger, Merger Sub will merge with and into the Company, with the Company continuing as the surviving corporation and a wholly owned subsidiary of Parent (the “Merger”). The transaction is subject to the approval of the Merger Agreement by an affirmative vote of stockholders of both (i) a majority of the outstanding shares of the Company’s common stock and (ii) a majority of the outstanding shares of the Company’s common stock not owned by Parent, Merger Sub, Mr. Jianquan Li or Ms. Ping Tse (Mr. Li’s wife), voting in person or by proxy at a special meeting of stockholders of the Company. For more information on the Merger, please see the Form 8-K or other relevant filings of the Company with the SEC (as they become available) on the SEC’s website (http://www.sec.gov).

 

The language in this “Going-private Transaction” section of Item 2 of Part 1, Management’s Discussion and Analysis of Financial Condition and Results of Operations, of this Report is neither a solicitation of a proxy nor an offer to purchase nor a solicitation of an offer to sell any securities. Such language is also not a substitute for any proxy statement or other filings that may be made with the SEC should the proposed Merger go forward.

 

7
 

 

RESULTS OF OPERATIONS

 

Comparison for the Three Months Ended June 30, 2012 and 2011

 

The following sets forth the Company’s statement of income information for the three months ended June 30, 2012 and 2011.

 

Comparison of the Three Months Ended June 30, 2012 and 2011

(All amounts, other than percentages, in thousands of U.S. Dollars)

 

   THREE MONTHS   THREE MONTHS         
   ENDED 6/30/2012   ENDED 6/30/2011         
   In   As a   In   As a   Amount     
Item  Thousands   Percentage   Thousands   Percentage   Change   %Change 
Net sales  $48,192    100.00%  $41,536    100.00%  $6,656    16.02%
Cost of sales  $35,960    74.62%  $30,228    72.77%  $5,732    18.96%
Gross profit  $12,232    25.38%  $11,309    27.23%  $923    8.16%
Other operating income/(loss), net  $143    0.30%  $-3    -0.01%  $146    4,866.67%
Government subsidies  $170    0.35%  $90    0.22%  $80    88.89%
Gain on commodity financial instruments  $93    0.19%  $65    0.16%  $28    43.08%
Foreign currency exchange gains/(losses), net  $200    0.42%  $-271    -0.65%  $471    173.80%
Selling, general and administrative expenses  $10,577    21.95%  $7,294    17.56%  $3,283    45.01%
Income from operations  $2,261    4.69%  $3,897    9.38%  $-1,636    -41.98%
Interest income  $109    0.23%  $59    0.14%  $50    84.75%
Interest expense  $125    0.26%  $135    0.32%  $-10    -7.41%
Equity in earnings of 50 percent or less owned persons  $70    0.15%  $180    0.43%  $-110    -61.11%
Income taxes credit/(expenses)  $55    0.11%  $-565    -1.36%  $620    109.73%
Non-controlling interests  $43    0.09%  $11    0.03%  $32    290.91%
Net income attributable to Winner Medical Group Inc.  $2,327    4.83%  $3,425    8.24%  $-1,098    -32.06%

 

Sales by Product

 

Winner Medical is a diversified manufacturer and marketer of cotton-based medical dressings and medical disposables, as well as PurCotton® products. The Company’s operations are conducted in two operating segments by products. The Company’s operation, on-site management, internal reporting and performance assessments are conducted within each of the following two identified product segments:

 

·Medical Products (Medical Care and Wound Care)
·PurCotton® Products (Jumbo Roll Supplies and Personal Products)

 

The following table illustrates the operating results for each product type for the three months ended June 30, 2012 and 2011.

 

Comparison by Operating Results for Each Product Type for the Three Months Ended June 30, 2012 and 2011

(All amounts, other than percentages, in thousands of U.S. dollars)

 

   Medical Products   PurCotton® Products 1   Consolidated 
   Three   Three   Three   Three   Three   Three 
   Months   Months   Months   Months   Months   Months 
   Ended   Ended   Ended   Ended   Ended   Ended 
Item  6/30/2012   6/30/2011   6/30/2012   6/30/2011   6/30/2012   6/30/2011 
Net sales  $38,980    36,177   $9,212    5,359   $48,192    41,536 
Gross profit  $8,712    9,642   $3,520    1,667   $12,232    11,309 
Gross margin   22.35%   26.65%   38.21%   31.11%   25.38%   27.23%
Income/(loss) before income taxes  $2,682    5,104   $-366    -1,103   $2,316    4,001 
Net income/(loss) attributable to Winner Medical Group Inc.  $2,380    4,315   $-53    -890   $2,327    3,425 
Profit margin   6.11%   11.93%   -0.58%   -16.61%   4.83%   8.25%

 

1. – PurCotton® products consist of sales from jumbo roll supplies and retail business.

 

8
 

 

Sales by Region

 

The following table illustrates the sales revenues by regions from major geographic areas for the three months ended June 30, 2012 and 2011. The table also provides the percentage of total revenues represented by each listed region.

 

Comparison of Sales by Region for the Three Months Ended June 30, 2012 and 2011

(All amounts, other than percentages, in thousands of U.S. dollars)

 

   Three       Three             
   Months   As a   Months   As a         
   Ended   Percentage of   Ended   Percentage of   Amount   As a 
   6/30/2012 in   Total   6/30/2011 in   Total   Change in   Percentage 
   Thousands   Revenue   Thousands   Revenue   Thousands   Change 
Europe   16,411    34.05%   16,071    38.69%   340    2.12%
Britain   2,849    5.91%   4,370    10.52%   -1,521    -34.81%
Sweden   2,491    5.17%   2,762    6.65%   -271    -9.81%
Others   11,071    22.97%   8,939    21.52%   2,132    23.85%
North and South America   7,298    15.14%   8,556    20.60%   -1,258    -14.70%
U.S.A.   5,805    12.05%   4,920    11.85%   885    17.99%
Brazil   1,084    2.25%   2,919    7.03%   -1,835    -62.86%
Others   409    0.85%   717    1.73%   -308    -42.96%
China 1   15,924    33.04%   9,020    21.72%   6,904    76.54%
Japan   5,426    11.26%   6,202    14,93%   -776    -12.51%
Others   3,133    6.50%   1,687    4.06%   1,446    85.71%
Total   48,192    100%   41,536    100%   6,656    16.02%

 

1 – Sales to the China market include medical sales to hospitals, chain drug stores and local distributors, PurCotton® jumbo roll supplies and PurCotton® retail business.

 

Net Sales

 

Net sales increased by approximately US$6,656,000, or 16.02%, to approximately US$48,192,000 for the three months ended June 30, 2012 from approximately US$41,536,000 for the three months ended June 30, 2011. The increase in net sales was mainly attributable to the robust expansion of medical and PurCotton® products sales in China, offsetting sluggish or declining export sales as the market for exports from the PRC deteriorated during the three months ended June 30, 2012.

 

Net sales generated from Europe increased slightly by 2.12% during the three months ended June 30, 2012 to US$16,411,000 from US$16,071,000 during the three months ended June 30, 2011. As in previous quarters, against a general background of debt crisis and relatively low raw cotton prices, customers in Europe are trying to lower purchasing costs while maintain product quality. In order to retain existing customers and add new ones in European countries, the Company continued to offer a lower selling price for certain products, which resulted in more orders from those customers. Of note, sales generated from the Britain decreased approximately US$1,521,000, or 34.81%, due to (1) one customer’s restructuring of its supply chain, which resulted in reduced inventory stock levels, and (2) lower selling prices. Sales generated from Sweden decreased US$271,000, or 9.81%, for the three months ended June 30, 2012, as a result of lower selling prices.

 

Net sales from North and South America decreased by 14.70% for the three months ended June 30, 2012 to US$7,298,000 from US$8,556,000 for the three months ended June 30, 2011. Of note, sales generated from the United States increased US$885,000, or 17.99%, during the three months ended June 30, 2012, as the Company enhanced its sales efforts in this country, despite one of its major customers decreasing its orders due to an adjustment of its procurement plans for certain medical dressing products during the three months ended June 30, 2012. However, this increase was partly offset by a decrease in orders from Brazil. The Company believes that this was mainly due to customers in Brazil not making consistent orders each month, resulting in a decrease in orders during the three months ended June 30, 2012 as compared to the same period last year.

 

Net sales generated from Japan also saw a decline of 12.51%, to US$5,426,000, for the three months ended June 30, 2012 from US$6,202,000 for the three months ended June 30, 2011. This decrease in sales was caused by a number of Japanese customers reducing orders because of overstocked inventory that they had accumulated through excess purchasing made following Japan’s Tohoku earthquake of March 11, 2011.

 

Net sales for medical and PurCotton® products in the China market increased significantly by approximately US$6,904,000, or 76.54%, to approximately US$15,924,000 for the three months ended June 30, 2012 from approximately US$9,020,000 for the three months ended June 30, 2011. This increase was primarily composed of:

 

9
 

 

(1)net sales from medical products to the China market reached US$6,712,000, from US$3,661,000 for the three months ended June 30, 2011, an increase of approximately US$3,051,000, or 83.34%, as compared to the same period last year, due to the Company’s continuing efforts to expand its sales channels, including increasing the number of local distributors covering more hospitals and penetrating deeper into existing hospitals, chain drug stores and other channels;

 

(2)net sales attributable to the PurCotton® jumbo roll-supply business increased to US$6,361,000 for the three months ended June 30, 2012 from US$3,985,000 in the same period last year, an increase of US$2,376,000, or 59.62%. This significant increase was due to increased demand from China-based customers who use it as a material in hygienic products and the versatile use of jumbo rolls in areas such as home care and disposable products. With the increasing demand from these customers, PurCotton® jumbo roll sales have been steadily growing; and

 

(3)net sales attributable to the PurCotton® retail business (which consists of online and offline businesses and includes 44 PurCotton retail stores and two online sales platforms and sales to distributors) increased approximately US$1,477,000 to US$2,851,000 for the three months ended June 30, 2012, as compared to US$1,374,000 in the same period last year (when the Company had only 37 PurCotton® retail stores and its online business was in the initial stage of development, as well as almost no mass distribution yet to supermarkets and department stores). PurCotton® consumer products have been receiving positive customer feedback and gaining brand recognition, as evidenced by increasing sales and membership in the Company’s customer loyalty program.

 

Net sales generated from other regions increased 85.71% during the three months ended June 30, 2012 to US$3,133,000 from US$1,687,000 during the three months ended June 30, 2011. This increase in sales was due to the Company’s enhanced sales efforts in the Middle East and Africa markets.

 

Cost of Sales

 

The Company’s cost of sales increased by approximately US$5,732,000, to approximately US$35,960,000, for the three months ended June 30, 2012, from approximately US$30,228,000 for the three months ended June 30, 2011. The cost of sales as a percentage of net sales was 74.62% and 72.77% for the three months ended June 30, 2012 and 2011, respectively. The increase in cost of sales was mainly attributable to: (1) an approximate 15% salary cost increase (which includes welfare and social insurance for employees); and (2) an increase of approximately US$818,000 for depreciation and impairment costs related to a factory workshop owned by Hubei Winner Textile Co., Ltd. and painting equipment owned by Winner Medical (Huanggang) Co., Ltd..

 

Gross Profit

 

The Company’s gross profit increased by approximately US$923,000 to approximately US$12,232,000 for the three months ended June 30, 2012, from approximately US$11,309,000 for the three months ended June 30, 2011. Gross profit as a percentage of net revenues was 25.38% for the three months ended June 30, 2012, compared with 27.23% for the three months ended June 30, 2011. The decrease in gross margin was mainly due to: (1) lower selling price to customers in Europe and the United States. Challenging global economic conditions, especially in Europe and North America, have forced governments in those areas to tighten public expenditures, leading to more stringent budgets for medical products. In order to maintain long-term cooperation with customers in those areas, the Company offered certain products with lower selling prices than before to maintain and attract orders during the current economic climate. The Company expects that ongoing adjustments of selling prices might continue, subject to global economic conditions and customer demands; (2) an increase of approximately US$818,000 in depreciation and impairment costs related to a factory workshop owned by Hubei Winner Textile Co., Ltd. and painting equipment owned by Winner Medical (Huanggang) Co., Ltd.; and (3) an approximate 15% salary increase (which includes welfare and social insurance for employees).

 

Other Operating Income/(Loss), Net

 

The Company’s other operating income, net, for the three months ended June 30, 2012 was US$144,000, as compared with a loss of US$3,000 for the three months ended June 30, 2011. Other operating income, net, in the three months ended June 30, 2012 mainly consisted of disposals of property, plant and equipment and obsolete materials and small amounts of processed cotton.

 

Government Subsidies

 

The Company’s government subsidies increased US$80,000 to US$170,000 for the three months ended June 30, 2012, from US$90,000 for the three months ended June 30, 2011. The increase was mainly driven by increased receipt of financial incentives from the Shenzhen government as compared to the same period last year.

 

Gain on Commodity Financial Instruments

 

Gain on commodity financial instruments for the three months ended June 30, 2012 from transactions in cotton futures products was approximately US$93,000, as compared with US$65,000 for the same period last year. This modest increase in gain resulted from implementation of more stringent trading policies and process controls since the establishment of the Company’s commodity trading center in July 2011.

 

10
 

 

Cotton is the Company’s primary raw material used in its manufacturing process. In the past, cotton prices have experienced periods of rapid increases and fluctuations. In such a situation, the Company cannot secure stable price quotes from cotton suppliers, resulting in inconsistency in the prices quoted to its customers. Therefore, the Company engages in cotton futures transactions in order to manage the impact of volatility in cotton prices on production.

 

Foreign Currency Exchange Gains (Losses), Net

 

The Company’s exchange gains for the three months ended June 30, 2012 increased US$471,000 to US$200,000, from a loss of US$271,000 for the three months ended June 30, 2011. On June 30, 2012 and April 1, 2012, the exchange rates of the RMB against the U.S. Dollar were 6.3249 and 6.3035, respectively, indicating a deprecation of the RMB by 0.34% against the U.S. Dollar, as compared to an appreciation of the RMB by 1.29% against the U.S. Dollar for the three months ended June 30, 2011.

 

In order to minimize the currency exchange rate risk, the Company has been (1) reinforcing and expanding its businesses in the China market and (2) inserting clauses into contracts stipulating that the selling price is subject to the fluctuation of currency and the price of raw materials.

 

Selling, General and Administrative Expenses

 

The Company’s selling, general and administrative expenses increased US$3,283,000 to approximately US$10,577,000 for the three months ended June 30, 2012, from approximately US$7,294,000 for the three months ended June 30, 2011. The selling, general and administrative expenses as a percentage of net sales was 21.95% and 17.56% for the three months ended June 30, 2012 and 2011, respectively. The increase in selling, general and administrative expenses resulted from increases in expenses related to the Company’s going-private transaction, salary, leasing expenses, domestic transportation expenses, advertising fees , as well as new product sales fees (such as slotting allowance and bar code expenses to stores) for PurCotton retail products. These changes are:

 

(1)“expenses related to the Company’s going private” transaction (i.e., legal and consultant fees) of approximately US$1,063,000, as compared to US$nil in the same period last year;

 

(2)salary (including wages, welfare, social insurance and stock incentives) increases of approximately US$988,000, or 43.23%, during the three months ended June 30, 2012, as compared to the same period last year. The increase was primarily due to increases in wages and welfare for new and existing staff, as well as increases in stock incentives to key employees;

 

(3)increases in transportation expenses of approximately US$612,000, as compared with the same period last year, due to higher maritime transport costs from an increase in quantity sold as well as increased logistics costs related to the PurCotton retail business and medical products as the Company broadened its distribution channels;

 

(4)slotting allowance and bar code expenses to stores such as supermarkets and department stores, for the PurCotton retail business increases of US$404,000 during the three months ended June 30, 2012, as compared with the same period last year. This increase was due to the Company launching its products into more supermarkets and department stores which resulted in the payment of new product sales fees expenses; and

 

(5)leasing expense increases of approximately US$253,000 during the three months ended June 30, 2012, as compared with the same period last year. The increase was mainly attributable to the rent paid for existing and newly established PurCotton self-operated chain stores. The number of PurCotton retail stores increased to 44 as of June 30, 2012 from 37 as of June 30, 2011.

 

Interest Income

 

Interest income was approximately US$109,000 for the three months ended June 30, 2012, as compared to interest income of approximately US$59,000 for the same period last year, a change of approximately US$50,000. The increase in interest income was mainly to the increase in held-to-maturity investments owned by the Company for the three months ended June 30, 2012.

 

Interest Expense

 

Interest expense was approximately US$125,000 for the three months ended June 30, 2012, as compared to interest expense of approximately US$135,000 for the same period last year, a change of approximately US$10,000. The difference in interest expense was driven by the changes in the level of short-term bank loans. The Company’s bank loans are primarily used as a supplement to working capital for daily operations.

 

11
 

 

Income Taxes

 

The Company’s income tax credit for the three months ended June 30, 2012 was US$55,000, as compared to income tax provision of US$565,000 for the three months ended June 30, 2011. Income tax credit as a percentage of income before income taxes was 2.39% for the three months ended June 30, 2012, as compared with income tax expenses as a percentage of income before income taxes was of 14.13% for the same period last year. The different effective tax rates for the three-month period ended June 30, 2012 and 2011, were mainly due to: (1) the recognition of 150% tax-deductible preferential policy on research and development expenses of US$322,000, which was confirmed by the tax authority during this quarter; and (2) the recognition of a deferred tax asset for Shenzhen PurCotton Technology Co., Ltd. and Hubei Winner Textile Co., Ltd. for the three months ended June 30, 2012, as the Company expects that the losses from PurCotton retail business can be utilized before such expiration period.

 

The tax rates applicable to the Company’s PRC wholly owned subsidiaries are as follows:

 

   Calendar                 
   Year Ended                 
   December 31,   Calendar Year Ending December 31, 
   2011   2012   2013   2014   2015 
Winner Medical & Textile Ltd., Jingmen   25%   25%   25%   25%   25%
Winner Medical & Textile Ltd. Jiayu   25%   25%   25%   25%   25%
Winner Medical & Textile Ltd. Yichang   25%   25%   25%   25%   25%
Winner Medical (Huanggang) Co., Ltd.   12.5%   12.5%   25%   25%   25%
Winner Medical & Textile Ltd. Chongyang   25%   25%   25%   25%   25%
Hubei Winner Textile Co., Ltd.   25%   25%   25%   25%   25%
Shanghai Winner Medical Apparatus Co., Ltd.   12.5%   25%   25%   25%   25%
Winner Industries (Shenzhen) Co., Ltd. 1   15%   15%   15%   15%   25%
Shenzhen PurCotton Technology Co., Ltd.   25%   25%   25%   25%   25%
Winner (Huanggang) Cotton Processing Co., Ltd.   25%   25%   25%   25%   25%
Shenzhen PurCotton E-Commerce Co., Ltd.   25%   25%   25%   25%   25%
Beijing PurCotton Co., Ltd.   25%   25%   25%   25%   25%
Guangzhou PurCotton Co., Ltd.   25%   25%   25%   25%   25%
Shanghai PurCotton Co., Ltd.   25%   25%   25%   25%   25%

 

1 – For the years 2012, 2013 and 2014, the preferential tax rate of 15% is subject to whether Winner Shenzhen can successfully renew its High and New Technology Enterprise Certificate, which was originally awarded in 2009. The Company is applying for a renewal at this time, and management considers that the renewal will be received in September 2012.

 

Winner Medical (Hong Kong) Limited and HK PurCotton Co. Ltd were subject to Hong Kong taxation on their activities conducted in Hong Kong and income arising in or derived from Hong Kong. The applicable statutory tax rate for each of the three months ended June 30, 2012 and 2011, was 16.5%.

 

No provision for U.S. tax was made as the Company had no assessable income in the United States for the three months ended June 30, 2012 and 2011. The enterprise income tax rate in the U.S. was 34%.

 

Net Income Attributable to Non-controlling Interests

 

The Company’s financial statements reflect an adjustment to its consolidated group net income of income attributable to non-controlling interests of US$43,000 and US$11,000 for the three months ended June 30, 2012 and 2011, respectively. The third party non-controlling interests reflected a 40% interest in Winner Medical (Hong Kong) Limited for the three months ended June 30, 2012 and 2011.

 

Net Income Attributable to Winner Medical Group Inc.

 

The net income attributable to Winner Medical Group Inc. was approximately US$2,327,000 for the three months ended June 30, 2012, as compared to approximately US$3,425,000 for the three months ended June 30, 2011, a decrease of approximately US$1,098,000, or 32.06%. Net income as a percentage of net sales was 4.83% for the three months ended June 30, 2012, as compared with 8.24% for the same period last year.

 

This decrease in net income and net profit margin was primarily due to: (1) lower selling prices to customers in Europe and the United States due to the economic downturn; (2) an increase in depreciation and impairment expenses of US$818,000 relating to the Company’s factory workshops and facilities; (3) an increase of advertising fees, slotting allowances and bar code expenses paid to stores for PurCotton retail business; and (4) an increase in expenses related to the Company’s going private transaction. The Company’s PurCotton retail business experienced an after-tax losses of US$984,000 and US$852,000 for the three months ended June 30, 2012 and 2011, respectively. The Company regards these losses as strategic losses that reflect initial expenses by the Company for brand-building and expansion of online and offline distribution channels.

 

12
 

 

Comparison for the Nine Months Ended June 30, 2012 and 2011

 

The following sets forth the Company’s statement of income information for the nine months ended June 30, 2012 and 2011.

 

Comparison of the Nine Months Ended June 30, 2012 and 2011

(All amounts, other than percentages, in thousands of U.S. Dollars)

 

   NINE MONTHS   NINE MONTHS         
   ENDED 6/30/2012   ENDED 6/30/2011         
   In   As a   In   As a   Amount     
Item  Thousands   Percentage   Thousands   Percentage   Change   %Change 
Net sales  $130,827    100.00%  $108,461    100.00%  $22,366    20.62%
Cost of sales  $97,591    74.60%  $78,319    72.21%  $19,272    24.61%
Gross profit  $33,236    25.40%  $30,142    27.79%  $3,094    10.26%
Other operating income/(loss), net  $220    0.17%  $-105    -0.10%  $325    309.52%
Government subsidies  $416    0.32%  $1,305    1.20%  $-889    -68.12%
Gain/(loss) on commodity financial instruments  $167    0.13%  $-1,695    -1.56%  $1,862    109.85%
Foreign currency exchange losses, net  $-83    -0.06%  $-415    -0.38%  $332    80.00%
Selling, general and administrative expenses  $25,539    19.52%  $19,152    17.66%  $6,387    33.35%
Income from operations  $8,417    6.43%  $10,080    9.29%  $-1,663    -16.50%
Interest income  $280    0.21%  $105    0.10%  $175    166.67%
Interest expense  $229    0.18%  $228    0.21%  $1    0.44%
Equity in earnings of 50 percent or less owned persons  $151    0.12%  $363    0.33%  $-212    -58.40%
Income taxes  $1,841    1.41%  $1,288    1.19%  $553    42.93%
Non-controlling interests  $63    0.05%  $44    0.04%  $19    43.18%
Net income attributable to Winner Medical Group Inc.  $6,715    5.13%  $8,989    8.29%  $-2,274    -25.30%

 

Sales by Product

 

The following table illustrates the operating results for each product type for the nine months ended June 30, 2012 and 2011.

 

Comparison by Operating Results for Each Product Type for the Nine Months Ended June 30, 2012 and 2011

(All amounts, other than percentages, in thousands of U.S. dollars)

 

   Medical Products   PurCotton® Products 1   Consolidated 
   Nine   Nine   Nine   Nine   Nine   Nine 
   Months   Months   Months   Months   Months   Months 
   Ended   Ended   Ended   Ended   Ended   Ended 
Item  6/30/2012   6/30/2011   6/30/2012   6/30/2011   6/30/2012   6/30/2011 
Net sales  $107,187    94,549   $23,640    13,912   $130,827    108,461 
Gross profit  $25,392    25,555   $7,844    4,587   $33,236    30,142 
Gross margin   23.69%   27.03%   33.18%   32.97%   25.40%   27.79%
Income/(loss) before income taxes  $9,681    12,248   $-1,062    -1,927   $8,619    10,321 
Net income/(loss) attributable to Winner Medical Group Inc.  $8,003    10,387   $-1,288    -1,398   $6,715    8,989 
Profit margin   7.47%   10.99%   -5.45%   -10.05%   5.13%   8.29%

 

1. – PurCotton® products consist of sales from jumbo roll supplies and retail business.

 

Sales by Region

 

The following table illustrates the sales revenues by regions from major geographic areas for the nine months ended June 30, 2012 and 2011. The table also provides the percentage of total revenues represented by each listed region.

 

13
 

 

Comparison of Sales by Region for the Nine Months Ended June 30, 2012 and 2011

(All amounts, other than percentages, in thousands of U.S. dollars)

 

   Nine       Nine             
   Months   As a   Months   As a         
   Ended   Percentage of   Ended   Percentage of   Amount   As a 
   6/30/2012 in   Total   6/30/2011 in   Total   Change in   Percentage 
   Thousands   Revenue   Thousands   Revenue   Thousands   Change 
Europe   43,074    32.92%   35,684    32.90%   7,390    20.71%
Britain   7,841    5.99%   9,573    8.83%   -1,732    -18.09%
Sweden   7,060    5.40%   6,015    5.55%   1,045    17.37%
Others   28,173    21.53%   20,096    18.53%   8,077    40.19%
North and South America   22,999    17.58%   24,795    22.86%   -1,796    -7.24%
U.S.A.   16,217    12.40%   18,447    17.01%   -2,230    -12.09%
Brazil   4,743    3.63%   4,842    4.46%   -99    -2.04%
Others   2,039    1.56%   1,505    1.39%   534    35.48%
China 1   40,175    30.71%   25,724    23.72%   14,451    56.18%
Japan   16,779    12.83%   16,835    15.52%   -56    -0.33%
Others   7,800    5.96%   5,423    5.00%   2,377    43.83%
Total   130,827    100%   108,461    100%   22,366    20.62%

 

1 – Sales to the China market include medical sales to hospitals, chain drug stores and local distributors, PurCotton® jumbo roll supplies and PurCotton® retail business.

 

Net Sales

 

Net sales increased by approximately US$22,366,000, or 20.62%, to approximately US$130,827,000 for the nine months ended June 30, 2012 from approximately US$108,461,000 for the nine months ended June 30, 2011. The increase in net sales was mainly attributable to significant continuing demand from existing and new customers in Europe (despite decreased orders from customers in Britain during the second and third quarters) and the robust expansion in sales of medical products and PurCotton® products in China for the nine months ended June 30, 2012.

 

Net sales generated from Europe increased 20.71% during the nine months ended June 30, 2012 to US$43,074,000, from US$35,684,000 during the nine months ended June 30, 2011. Generally, customers in Europe are trying to lower purchasing cost while maintain product quality. In order to retain existing customers and add new ones in European countries, the Company continued a low selling price of certain products, which resulted in more orders from those customers. Of note, sales generated from Sweden increased US$1,045,000, or 17.37%, during the nine months ended June 30, 2012 as the Company established relationships with customers in Sweden, which resulted in receiving more orders in the first and second quarters of fiscal 2012. However, sales generated from customers in Britain decreased approximately US$1,732,000, or 18.09%, due to one customer’s integration of its supply chain, resulting in reduced inventory stock levels and lower selling prices since the second quarter of fiscal 2012.

 

Net sales from North and South America decreased by 7.24% for the nine months ended June 30, 2012, to US$22,999,000 from US$24,795,000 for the nine months ended June 30, 2011. This decrease was mainly due to one of our major customers in the United States decreasing its orders due to an adjustment of its procurement plans for certain medical dressing products since the first quarter of fiscal 2012.

 

Net sales to Japan slightly decreased by 0.33% to US$16,779,000 for the nine months ended June 30, 2012 from US$16,835,000 for the nine months ended June 30, 2011. Lack of significant movement for sales in Japan was due to our major customers reducing orders because of overstocked inventory that they had accumulated through excess purchasing made following Japan’s Tohoku earthquake of March 11, 2011.

 

Net sales for medical products and PurCotton® products in the China market increased by approximately US$14,451,000, or 56.18%, to approximately US$40,175,000 for the nine months ended June 30, 2012 from approximately US$25,724,000 for the nine months ended June 30, 2011. This increase was primarily composed of:

 

(1)net sales from medical products in China reached US$16,535,000, from US$11,812,000 for the nine months ended June 30, 2012, an increase of approximately US$4,723,000, or 39.98%, as compared to the same period last year, due to the Company’s continuing efforts to expand its sales channels, including increasing the number of local distributors covering more hospitals and penetrating deeper into existing hospitals, chain drug stores and other channels;

 

(2)net sales attributable to the PurCotton® jumbo roll-supply business increased to US$16,571,000 for the nine months ended June 30, 2012 from US$10,731,000 in the same period last year, an increase of US$5,840,000, or 54.42%. This significant increase was due to increased demand from China-based customers who used it as a material in hygiene products and the versatile use of jumbo-rolls in areas such as home care and disposable products. With the increasing demand from these customers, PurCotton® jumbo roll sales have been steadily growing; and

 

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(3)net sales attributable to the PurCotton® retail business (which consists of online and offline businesses with 44 PurCotton retail stores and two online sales platforms and sales to distributors) which increased approximately US$3,888,000 to US$7,069,000 for the nine months ended June 30, 2012, as compared to US$3,181,000 in the same period last year (when the Company had only 37 PurCotton® retail stores and its online business was in the initial stage of development, as well as almost no mass distribution channels to supermarkets and department stores). The PurCotton® consumer products have been receiving positive customer feedback and gaining brand recognition, as evidenced by increasing sales and membership in the Company’s customer loyalty program.

 

Net sales generated from other regions increased 43.83% during the nine months ended June 30, 2012 to US$7,800,000 from US$5,423,000 during the nine months ended June 30, 2011. This increase in sales was due to the Company’s enhanced sales efforts in the Middle East and Africa markets.

 

Cost of Sales

 

The Company’s cost of sales increased by approximately US$19,272,000, to approximately US$97,591,000, for the nine months ended June 30, 2012, from approximately US$78,319,000 for the nine months ended June 30, 2011. The cost in sales as a percentage of net sales was 74.60% and 72.21% for the nine months ended June 30, 2012 and 2011, respectively. The increase in cost of sales was mainly attributable to: (1) an approximate 15% salary increase (which including welfare and social insurance for employees); (2) an increase of approximately US$1,464,000 for depreciation and impairment costs related to a factory workshop owned by Hubei Winner Textile Co., Ltd and painting equipment owned by Winner Medical (Huanggang) Co., Ltd.; and (3) the use of cotton with a higher average purchase price, as compared with the same period last year.

 

Gross Profit

 

The Company’s gross profit increased by approximately US$3,094,000 to approximately US$33,236,000 for the nine months ended June 30, 2012, from approximately US$30,142,000 for the nine months ended June 30, 2011. Gross profit as a percentage of net revenues was 25.40% for the nine months ended June 30, 2012, compared with 27.79% for the nine months ended June 30, 2011. The decrease in gross margin was mainly due to: (1) the challenging global economic conditions, especially in Europe and the North America, which forced governments in those areas to tighten public expenditures leading to more stringent budgets for medical products. In order to maintain long-term cooperation with customers in those areas, the Company offered certain products with lower selling prices than before to maintain and attract orders during the current economic climate. The Company expects that its adjustment of selling prices will be subject to global economic conditions and customer demands; (2) an increase of approximately US$1,464,000 in depreciation and impairment costs related to a factory workshop owned by Hubei Winner Textile Co., Ltd and painting equipment owned by Winner Medical (Huanggang) Co., Ltd.; and (3) an approximate 15% salary increase (which includes welfare and social insurance for employees).

 

Other Operating Income/(Loss), Net

 

The Company’s other operating income, net, for the nine months ended June 30, 2012 was US$220,000, as compared with a loss of US$105,000 for the nine months ended June 30, 2011. Other operating income, net, mainly consists of disposals of leftover and obsolete materials and small amounts of processed cotton.

 

Government Subsidies

 

The Company’s government subsidies decreased US$889,000 to US$416,000 for the nine months ended June 30, 2012, from US$1,305,000 for the nine months ended June 30, 2011. The decrease was mainly driven by the reduced receipt of financial incentives from PRC government authorities (especially from the Shenzhen government) because public expenses for holding certain local events resulted in less money for financial incentives to local companies, as compared to the same period last year.

 

Gain/(loss) on Commodity Financial Instruments

 

Gain on commodity financial instruments for the nine months ended June 30, 2012 was primarily composed of a gain of approximately US$167,000 on trading cotton futures, compared to a loss of approximately US$1,695,000 in the same period last year. The gain resulted from implementation of more stringent trading policies and process controls since the establishment of the Company’s commodity trading center in July 2011.

 

Cotton is the Company’s primary raw material used in its manufacturing process. In the past, cotton prices have experienced periods of rapid increases and fluctuations. In such a situation, the Company cannot secure stable price quotes from cotton suppliers, resulting in inconsistency in the prices quoted to its customers. Therefore, the Company engages in cotton futures transactions in order to manage the impact of volatility in cotton prices on production.

 

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Foreign Currency Exchange Losses, Net

 

The Company’s exchange difference, net, for the nine months ended June 30, 2012 decreased US$332,000 to a loss of US$83,000, from a loss of US$415,000 for the nine months ended June 30, 2011. On June 30, 2012 and September 30, 2011, the exchange rates of the RMB against the U.S. Dollar were 6.3249 and 6.3549, respectively, indicating an appreciation of the RMB by 0.47% against the U.S. Dollar, as compared to an appreciation of the RMB by 3.42% against the U.S. Dollar for the nine months ended June 30, 2011.

 

In order to minimize the currency exchange rate risk, the Company has been (1) reinforcing and expanding its businesses in the China market and (2) inserting clauses into contracts stipulating that the selling price is subject to the fluctuation of currency and the price of raw materials.

 

Selling, General and Administrative Expenses

 

The Company’s selling, general and administrative expenses increased US$6,387,000 to approximately US$25,539,000 for the nine months ended June 30, 2012, from approximately US$19,152,000 for the nine months ended June 30, 2011. The selling, general and administrative expenses as a percentage of net sales was 19.52% and 17.66% for the nine months ended June 30, 2012 and 2011, respectively. The increase in selling, general and administrative expenses resulted from increases in expenses related to the Company’s going-private transaction, salary, leasing expenses, domestic transportation expenses and advertising fees, as well as new product sales fees (such as slotting allowance and bar code expenses to stores) for PurCotton retail products. These changes are:

 

(1)salary (including wages, welfare, social insurance and stock incentives) increases of approximately US$2,920,000, or 44.90%, during the nine months ended June 30, 2012, as compared to the same period last year. The increase was primarily due to increases in wages and welfare for new and existing staff, as well as an increase in stock incentives to key employees;

 

(2)increases in transportation expenses of approximately US$1,097,000, as compared with the same period last year, due to an increase in sales and increases in the cost of logistics related to the PurCotton retail business and medical products as broader distribution channels were built;

 

(3)expenses related to the Company’s going-private transaction (i.e., legal and consultant fees) of approximately US$1,063,000, as compared to US$nil in the same period last year;

 

(4)leasing expense increases of approximately US$939,000 during the nine months ended June 30, 2012, as compared with the same period last year. The increase was mainly attributable to the rent paid for existing and newly-established PurCotton self-operated chain stores. The number of PurCotton retail stores increased to 44, as of June 30, 2012, from 37, as of June 30, 2011; and

 

(5)slotting allowance and bar code expense increases of US$583,000 to stores (such as supermarkets and department stores) for the PurCotton retail business during the nine months ended June 30, 2012, as compared with the same period last year. This increase was due to the Company launching its products into supermarkets and department stores, which resulted in the payment of new product sales fees expenses.

 

Interest Income

 

Interest income was approximately US$280,000 for the nine months ended June 30, 2012, as compared to interest income of approximately US$105,000 for the same period last year, a change of approximately US$175,000. The increase in interest income was mainly due to the increase in held-to-maturity investments owned by the Company.

 

Interest Expense

 

Interest expense was approximately US$229,000 for the nine months ended June 30, 2012, as compared to approximately US$228,000, for the same period last year, an increase of 0.44%. The Company has maintained a stable level of short-term bank loans over past year, which has translated into the Company’s interest expense remaining relatively the same. The Company’s bank loans are primarily used as a supplement to working capital for daily operations.

 

Income Taxes

 

The Company’s income tax provision for the nine months ended June 30, 2012 was US$1,841,000, as compared to US$1,288,000 for the nine months ended June 30, 2011, an increase of US$553,000. Income tax as a percentage of income before income taxes was 21.35% for the nine months ended June 30, 2012, as compared with 12.48% for the same period last year.

 

According to PRC tax laws, a company’s pretax income in the current year cannot offset a loss that occurred more than five years ago. As the Company expects that the pretax income of PurCotton retail business may not be sufficient to utilize the unused tax losses before such expiration period, the Company recognized an approximate US$907,000 valuation allowance for unused tax losses arising from the calendar years 2010 and 2011 for its retail business during the nine months ended June 30, 2012, which was offset by the recognition of a 150% tax-deductible preferential policy on research and development expenses of US$322,000, which was confirmed by the tax authority during this quarter. This resulted in a comparatively higher effective tax rate for the nine-month period ended June 30, 2012 as compared to the same period last year.

 

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The tax rates applicable to the Company’s PRC wholly owned subsidiaries are as follows:

 

   Calendar Year Ending December 31, 
   2012   2013   2014   2015 
Winner Medical & Textile Ltd., Jingmen   25%   25%   25%   25%
Winner Medical & Textile Ltd. Jiayu   25%   25%   25%   25%
Winner Medical & Textile Ltd. Yichang   25%   25%   25%   25%
Winner Medical (Huanggang) Co., Ltd.   12.5%   25%   25%   25%
Winner Medical & Textile Ltd. Chongyang   25%   25%   25%   25%
Hubei Winner Textile Co., Ltd.   25%   25%   25%   25%
Shanghai Winner Medical Apparatus Co., Ltd.   25%   25%   25%   25%
Winner Industries (Shenzhen) Co., Ltd. 1   15%   15%   15%   25%
Shenzhen PurCotton Technology Co., Ltd.   25%   25%   25%   25%
Winner (Huanggang) Cotton Processing Co., Ltd.   25%   25%   25%   25%
Shenzhen PurCotton E-Commerce Co., Ltd.   25%   25%   25%   25%
Beijing PurCotton Co., Ltd.   25%   25%   25%   25%
Guangzhou PurCotton Co., Ltd.   25%   25%   25%   25%
Shanghai PurCotton Co., Ltd.   25%   25%   25%   25%

 

1 – For the years 2012, 2013 and 2014, the preferential tax rate of 15% is subject to whether Winner Shenzhen can successfully renew its High and New Technology Enterprise Certificate, which was originally awarded in 2009. The Company is applying for a renewal at this time, and management considers that the renewal will be received in September 2012.

 

Winner Medical (Hong Kong) Limited and HK PurCotton Co. Ltd were subject to Hong Kong taxation on their activities conducted in Hong Kong and income arising in or derived from Hong Kong. The applicable statutory tax rate for each of the nine months ended June 30, 2012 and 2011, was 16.5%.

 

No provision for U.S. tax was made as the Company had no assessable income in the United States for the nine months ended June 30, 2012 and 2011. The enterprise income tax rate in the United States was 34%.

 

Net Income Attributable to Non-controlling Interests

 

The Company’s financial statements reflect an adjustment to its consolidated group net income of income attributable to non-controlling interests of US$63,000 and US$44,000 for the nine months ended June 30, 2012 and 2011, respectively. The third party non-controlling interests reflected a 40% interest in Winner Medical (Hong Kong) Limited and a 30% interest in Shenzhen PurCotton E-commerce Co. Ltd. for the nine months ended June 30, 2012. The third party non-controlling interests reflected a 40% interest in Winner Medical (Hong Kong) Limited for the nine months ended June 30, 2011.

 

Net Income Attributable to Winner Medical Group Inc.

 

The net income attributable to Winner Medical Group Inc. was approximately US$6,715,000 for the nine months ended June 30, 2012, as compared to approximately US$8,989,000 for the nine months ended June 30, 2011, a decrease of approximately US$2,274,000, or 25.30%. Net income as a percentage of net sales was 5.13% for the nine months ended June 30, 2012, as compared with 8.29% for the same period last year.

 

This decrease in net income and net profit margin was primarily due to: (1) lower selling prices to customers in Europe and the United States due to the economic downturn; (2) an increase in depreciation and impairment expenses of US$1,464,000 relating to the Company’s factory workshops and facilities; (3) an increase of advertising fees, slotting allowances and bar code expenses paid to stores for PurCotton retail business; and (4) an increase in expenses relating to the Company’s going-private transaction. The Company’s PurCotton retail business experienced after-tax losses of US$3,644,000 and US$1,698,000 for the nine months ended June 30, 2012 and 2011, respectively. The Company regards these losses as strategic losses that reflect initial expenses by the Company for brand-building and expansion of online and offline distribution channels.

 

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Inventory turnover

 

The Company’s inventory increased to approximately US$25,500,000 as of June 30, 2012, as compared with approximately US$25,409,000 as of September 30, 2011, an increase of US$91,000, or 0.36%. Raw materials, work in process and finished goods accounted for approximately 42.64%, 24.87% and 32.50% of inventories as of June 30, 2012. The Company’s inventory turnover was 75 and 76 days for the nine months ended June 30, 2012 and the year ended September 30, 2011, respectively. The slightly increased inventories during the nine months ended June 30, 2012 was driven by the higher level of materials usage driven by increased net sales. However, the inventories decreased approximately US$684,000 as compared with approximately US$26,184,000 as of March 31, 2012. The decrease was mainly driven by the Company’s strong management of inventory turnover and the lower level of purchases of seed cotton by Winner (Huanggang) Cotton Processing Co, Ltd. due to the seasonal availability of cotton.

 

Accounts and notes receivable collection period

 

Accounts and notes receivable increased to approximately US$23,789,000 as of June 30, 2012, as compared to approximately US$20,982,000 as of September 30, 2011, an increase of approximately US$2,807,000 or 13.38%. The Company’s average accounts receivable collection period was 45 days and 44 days for the nine months ended June 30, 2012 and the fiscal year ended September 30, 2011, respectively. The stable accounts receivable collection period was due to the Company’s strong management of accounts receivable turnover.

 

In order to reduce the risk of inability to collect accounts receivable, the Company entered into an insurance policy with China Export & Credit Insurance Corporation effective on January 1, 2012. This insurance policy will expire on December 31, 2012 and is automatically renewable subject to a one month written notice given by either party. The maximum insurance coverage from China Export & Credit Insurance Corporation is US$2.5 million.

 

The accounts and notes receivable collection age as of June 30, 2012 is illustrated as follows:

 

(All amounts, other than percentages, in thousands of U.S. Dollars)

 

   Amount   As a 
Periods  In Thousands   Percentage 
Less than or equal to 3 months  $23,733    99.76%
3 to 6 months  $39    0.16%
6 to 12 months  $17    0.07%
More than 12 months  $0    0%
Total  $23,789    100.00%

 

Liquidity and Capital Resources

 

As of June 30, 2012, the Company had cash and cash equivalents of approximately US$25,226,000.

 

Cash Flows for the Nine Months Ended June 30, 2012 and 2011

(All amounts in thousands of U.S. dollars)

 

   Nine Months Ended 
   June 30, 
   2012   2011 
Net cash provided by/(used in) operating activities   13,205    (1,637)
Net cash used in investing activities   (9,786)   (5,064)
Net cash (used in)/provided by financing activities   (268)   8,151 
Effect of exchange rate changes   130    723 
Net increase in cash and cash equivalents   3,281    2,173 
Cash and cash equivalents at the beginning of period   21,945    14,818 
Cash and cash equivalents at the end of period   25,226    16,992 

 

Operating Activities

 

Net cash provided by operating activities was US$13,205,000 for the nine months ended June 30, 2012, an increase of US$14,842,000 from US$1,637,000 of net cash used in operating activities for the same period last year. Overall, this increase was mainly due to:

 

(1)cash flows provided by inventories of approximately US$29,000 during the nine months ended June 30, 2012, as compared with cash flows used in of approximately US$8,676,000 for the nine months ended June 30, 2011, a change of approximately US$8,705,000. This change in cash flows used in inventories was driven by the Company’s stronger management of inventory turnover;

 

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(2)cash flows provided by accrued and other liabilities of approximately US$1,978,000 during the nine months ended June 30, 2012, as compared with approximately US$310,000 for the nine months ended June 30, 2011, an increase of approximately US$1,668,000. This increase was mainly due to: (a) increased new product sales fees such as slotting allowances and bar code expenses paid to stores; (b) expenses incurred during the reporting period in 2012 relating to the Company’s going-private transaction; and (c) construction expenses for Winner Medical & Textile Ltd., Chongyang;

 

(3)cash flows used in accounts receivable of approximately US$2,707,000 during the nine months ended June 30, 2012, as compared with approximately US$4,255,000 for the nine months ended June 30, 2011, a decrease of approximately US$1,548,000. This change in cash flows used in accounts receivable was due to the Company’s strong management of account receivable turnover; and

 

(4)cash flows provided by restricted bank deposits of approximately US$1,575,000 during the nine months ended June 30, 2012, as compared with restricted cash of approximately US$194,000 for the nine months ended June 30, 2011, an increase of approximately US$1,381,000. This change in restricted bank deposits was mainly driven by the withdrawal of approximately US$1,587,000 registered capital for Shenzhen PurCotton E-Commerce Co., Ltd., which was deposited during the same period of last year.

 

Investing Activities

 

Net cash used in investing activities for the nine months ended June 30, 2012 was US$9,786,000, an increase of US$4,725,000 from US$5,064,000 for the nine months ended June 30, 2011. During the nine months ended June 30, 2012, the increased cash used in investing activities was primarily for: (1) an approximately US$1,370,000 initial investment by Winner Medical & Textile Ltd. Chongyang in the construction of buildings for expanding and relocating production lines; and (2) an approximately US$3,255,000 investment in the installation of manufacturing lines for PurCotton baby diapers and two additional PurCotton manufacturing lines.

 

Financing Activities

 

The Company’s net cash used in financing activities was primarily for the purchase of noncontrolling interest for the nine months ended June 30, 2012. Net cash used in financing activities for the nine months ended June 30, 2012 totaled US$268,000, a decrease of US$8,418,000 from net cash provided by US$8,151,000 for the nine months ended June 30, 2011, which is mainly due to the repayment of bank borrowings of US$9,461,000, compared with US$4,390,000 in the same period of the previous fiscal year.

 

The Company’s debt to asset ratio was approximately 17.98% as of June 30, 2012. The Company plans to maintain its debt to asset ratio below 40% in order to provide adequate space for new bank loans, if needed. The Company believes that it currently maintains a good business relationship with each of the banks with which it has loans. As of June 30, 2012, the Company had approximately US$30.04 million in bank credit facilities from three commercial banks and, after utilizing bank loans of US$6.32 million, there is US$23.72 million available under bank credit facilities. These facilities consist of approximately: (i) US$6.32 million from Shenzhen Branch of China Merchants Bank; (ii) US$12.65 million from Shenzhen Branch of the Industrial and Commercial Bank of China; and (iii) US$4.75 million from Huanggang Branch of Agricultural Development Bank of China. The weighted average interest rate on short-term borrowings for the nine months ended June 30, 2012 and September 30, 2011, was 7.46% and 6.98% per annum, respectively.

 

The Company’s subsidiaries in Shenzhen and Huanggang have credit lines with the Shenzhen Branch of China Merchants Bank, the Shenzhen Branch of the Industrial and Commercial Bank of China and Huanggang Branch of Agricultural Bank of China, representing trade acceptances, loans and overdrafts.

 

Bank loans as of June 30, 2012

 

            Balance as of  
            June 30, 2012  
Item   Bank   Loan period   US$  
A   Shenzhen Branch of China Merchants Bank   11-28-2011 to
09-16-2012
    3,162,000  
B   Shenzhen Branch of China Merchants Bank   12-29-2011 to
09-16-2012
    3,162,000  
         Total     6,324,000  

 

These loan facilities are all secured by the Company’s buildings, plant and machinery. These revolving lines of credit allow the Company to renew short-term loans when due, and the banks reevaluate the Company’s credit line annually. These bank facilities enable the Company to utilize the short-term loans and enjoy a lower interest expense compared with long-term loans.

 

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Critical Accounting Policies

 

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires the Company’s management to make assumptions, estimates and judgments that affect the amounts reported in the financial statements, including the notes thereto, and related disclosures of commitments and contingencies, if any. The Company considers its critical accounting policies to be those that require the more significant judgments and estimates in the preparation of financial statements, including the following:

 

·Revenue Recognition –The Company derives its revenue primarily from the sales of disposable medical dressings and PurCotton® products. Sales of goods are recognized when goods are shipped, title of goods sold has passed to the purchaser, the price is fixed or determinable as stated on the sales contract, and its collectability is reasonably assured. Customers do not have a general right of return on products shipped. Product returns to the Company were insignificant.

 

·Inventory –Inventories are stated at the lower of cost or market, determined by the weighted average method. Work-in-progress and finished goods inventories consist of raw materials, direct labor and overhead associated with the manufacturing process.

 

·Trade accounts receivable –Trade accounts receivable are stated at the amount management expects to collect from balances outstanding at reporting period-end. Based on management's assessment of the credit history with customers having outstanding balances and current relationships with them, it has concluded that realization losses on balances outstanding at reporting period-end will be immaterial.

 

·Property, plant and equipment –Property, plant and equipment are stated at cost including the cost of improvements. Maintenance and repairs are charged to expenses as incurred. Assets under construction are not depreciated until construction is completed and the assets are ready for their intended use. Depreciation and amortization are provided on the straight-line method based on the estimated useful lives of the assets as follows:

 

Leasehold land Over the lease term
   
Buildings 10 - 30 years
   
Plant and machinery 10 - 12 years
   
Furniture, fixtures and equipment 5 - 8 years
   
Motor vehicles 5 - 8 years
   
Leasehold improvements Over the lease term

 

·Impairment of long-lived assets – The Company evaluates all of its long-lived assets for impairment in accordance with the provisions of ASC 360, “Accounting for the Impairment or Disposal of Long-Lived Assets.” The Company assesses the impairment of fixed assets on an annual basis or whenever events or changes in circumstances indicate that the fair value or future discounted cash flows of these assets is less than the carrying value. Should events indicate that any of the Company’s long-lived assets are impaired, the amount of such impairment will be measured as the difference between the carrying value and the fair value, or the difference between the carrying value and future discounted cash flows of the impaired assets, and recorded in earnings during the period of such impairment.

 

·Financial Instruments and Derivatives – The Company does not use derivative financial instruments for speculative trading purpose, nor does it hold or issue leveraged derivative financial instruments. However, the Company’s operations are exposed to market risk primarily due to changes in currency exchange rates. In order to manage such risks so as to reduce volatility on earnings and cash flows, the Company enters into several foreign-currency forward contracts with a commercial bank to hedge for future trade receipts in U.S. dollars against RMB. The Company’s foreign currency forward contracts are classified as Level 2 in the fair value hierarchy under ASC 820 since the quote prices of these foreign currency forward contracts can be obtained directly from commercial banks. The Company uses commodity financial instruments to manage the risk of cotton purchase cost. Although the commodity financial instruments are economic hedges of specified risks, the Company has not designated or accounted for them as hedging instruments. The Company’s commodity financial instruments are classified as Level 1 in the fair value hierarchy under ASC 820 since the quoted unadjusted prices of these commodity financial instruments are available in active markets.

 

·Stock-Based Compensation – The Company has adopted ASC 718, ''Compensation-Stock Compensation,'' which requires that share-based payment transactions with employees, such as share options, be measured based on the grant-date fair value of the equity instrument issued and recognized as compensation expense over the requisite service period, with a corresponding addition to equity. Under this method, compensation cost related to employee share options or similar equity instruments is measured at the grant date based on the fair value of the award and is recognized over the period during which an employee is required to provide service in exchange for the award, which is generally the vesting period. Compensation expense is recognized for those awards that are expected to vest, which the Company estimates based upon historical forfeitures.

 

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·Income taxes –Income taxes are provided on an asset and liability approach for financial accounting and reporting of income taxes. Any tax paid by subsidiaries during the year is recorded. Current tax is based on the profit or loss from ordinary activities adjusted for items that are non-assessable or disallowable for income tax purpose and is calculated using tax rates that have been enacted or substantively enacted at the balance sheet date. Deferred income tax liabilities or assets are recorded to reflect the tax consequences in future years of differences between the tax basis of assets and liabilities and the financial reporting amounts at each year end. A valuation allowance is recognized if it is more likely than not that some portion, or all, of a deferred tax asset will not be realized.

 

Recent Accounting Pronouncements

 

In May 2011, the FASB issued ASU No. 2011-04, Fair Value Measurement (ASC 820) Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRS. This pronouncement is an authoritative guidance to amend certain measurement and disclosure requirements related to fair value measurements to improve consistency with international reporting standards. In addition, ASU 2011-04 expanded the required disclosures around fair value measurements including (i) reporting the level in the fair value hierarchy used to value assets and liabilities which are not measured at fair value, but where fair value is disclosed, and (ii) qualitative disclosures about the sensitivity of Level 3 fair value measurements to changes in unobservable inputs used. This guidance is effective prospectively for public entities for interim and annual reporting periods beginning after December 15, 2011, with early adoption by public entities prohibited, and is applicable to the Company’s fiscal year beginning October 1, 2012. The Company is currently evaluating this guidance, but does not expect its adoption will have a material effect on its consolidated financial statements.

 

In June 2011, the FASB issued ASU No. 2011-05, Comprehensive Income (ASC 220) Presentation of Comprehensive Income (“ASU No. 2011-05”). This pronouncement is an authoritative guidance on the presentation of comprehensive income that will require a company to present components of net income and other comprehensive income in one continuous statement or in two separate, but consecutive statements. There are no changes to the components that are recognized in net income or other comprehensive income under current GAAP. This guidance is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2011, with early adoption permitted. The Company has adopted ASU No. 2011-05 for its fiscal 2012 year.

 

In December 2011, the FASB issued ASU No. 2011-11, Disclosures about Offsetting Assets and Liabilities (“ASU 2011-11”) to ASC 210, Balance Sheet. The update requires new disclosures about balance sheet offsetting and related arrangements. For derivatives and financial assets and liabilities, the amendments require disclosure of gross asset and liability amounts, amounts offset on the balance sheet, and amounts subject to the offsetting requirements but not offset on the balance sheet. The guidance is effective December 1, 2013 and is to be applied retrospectively. This guidance does not amend the existing guidance on when it is appropriate to offset. The Company is currently evaluating this guidance, but does not expect its adoption will have a material effect on its consolidated financial statements.

 

Off-Balance Sheet Arrangements

 

The Company has no off-balance sheet arrangements.

 

Seasonality

 

The Company’s operating results and operating cash flows historically have not been subject to seasonal variations. This pattern may change, however, as a result of new market opportunities or new product introductions.

 

21
 

 

ITEM 3.QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

 

Not applicable.

 

ITEM 4.CONTROLS AND PROCEDURES.

 

A.Disclosure controls and procedures.

 

The Company’s management, under the supervision and with the participation of its chief executive officer and chief financial officer, Messrs. Jianquan Li and Xiuyaun Fang, respectively, evaluated the effectiveness of the Company’s disclosure controls and procedures as of June 30, 2012, the end of the period covered by this Report. The term “disclosure controls and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended, or the Exchange Act, means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports, such as this Form 10-Q, that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure.

 

Based on that evaluation, Messrs. Li and Fang concluded that the Company’s disclosure controls and procedures were effective as of June 30, 2012.

 

The Company’s disclosure controls and procedures are designed to provide reasonable, not absolute, assurance that the objectives of its disclosure control system are met. Because of inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues, if any, within a company have been detected.

 

B.Changes in internal control over financial reporting.

 

There were no changes in the Company’s internal control over financial reporting during the three months ended June 30, 2012 that materially affected or were reasonably likely to materially affect the Company’s internal control over financial reporting.

 

22
 

 

PART II

OTHER INFORMATION

 

ITEM 1.LEGAL PROCEEDINGS.

 

Please see Note 12, Commitments and Contingences, of the condensed consolidated financial statements (unaudited) in this Report and the Company’s Quarterly Report on Form 10-Q for the three-month period ended March 31, 2012 for a discussion of class action litigation related to the Company’s going-private transaction.

 

Other than the above, the Company is currently not aware of any such legal proceedings or claims that it believes it will have a material adverse affect on its business, financial condition or operating results. In addition, to the Company’s knowledge, no director, officer or affiliate of the Company, and no owner of record or beneficial owner of more than five percent of the Company’s securities, or any associate of any such director, officer or security holder, is a party adverse to the Company or has a material interest adverse to the Company in reference to pending litigation.

 

ITEM 1A.RISK FACTORS.

 

Not applicable.

 

ITEM 2.UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.

 

None.

 

ITEM 3.DEFAULTS UPON SENIOR SECURITIES.

 

None.

 

ITEM 4.MINE SAFETY DISCLOSURES.

 

Not applicable.

 

ITEM 5.OTHER INFORMATION.

 

None.

 

ITEM 6.EXHIBITS.

 

The list of exhibits required to be filed as exhibits to this Report is listed under the “Exhibit Index,” which is incorporated herein by reference.

 

23
 

 

SIGNATURES

 

Pursuant to the requirements of the Exchange Act, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

DATED: August 9, 2012

 

WINNER MEDICAL GROUP INC.  
   
By: / s/ Jianquan Li  
Jianquan Li  
Chief Executive Officer and Chairman  
(Principal Executive Officer)  
   
By: /s/ Xiuyuan Fang  
Xiuyuan Fang  
Chief Financial Officer and Treasurer  
(Principal Financial Officer)  

 

24
 

 

EXHIBIT INDEX

 

31.1Certification of Principal Executive Officer filed pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.*

 

31.2Certification of Principal Financial Officer filed pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.*

 

32.1Certification of Principal Executive Officer furnished pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.*

 

32.2Certification of Principal Financial Officer furnished pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.*

 

The following materials from the Winner Medical Group Inc. Quarterly Report on Form 10-Q for the quarter ended June 30, 2012 filed on August 9, 2012 formatted in Extensible Business Reporting Language (XBRL):

(i)Condensed Consolidated Balance Sheets (Unaudited),
(ii)Condensed Consolidated Statements of Income and Comprehensive Income (Unaudited),
(iii)Condensed Consolidated Statements of Stockholders’ Equity (Unaudited),
(iv)Condensed Consolidated Statements of Cash Flows (Unaudited), and
(v)Notes to Condensed Consolidated Financial Statements (Unaudited)

 

*filed herewith

 

+XBRL information is furnished and not filed or a part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, as amended, is deemed not filed for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, and otherwise is not subject to liability under these sections.

 

25

XNAS:WWIN Quarterly Report 10-Q Filling

XNAS:WWIN Stock - Get Quarterly Report SEC Filing of XNAS:WWIN stocks, including company profile, shares outstanding, strategy, business segments, operations, officers, consolidated financial statements, financial notes and ownership information.

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XNAS:WWIN Quarterly Report 10-Q Filing - 6/30/2012
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