Item 2. Management's Discussion and Analysis or Plan of Operation.
This Quarterly Report on Form 10-Q contains statements that constitute "forward looking statements" within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, and Section 27A of the Securities Act of 1933, as amended. The words "may," "will," "expect," "anticipate," "continue," "estimate," "project," "intend," and similar expressions are intended to identify forward-looking statements. These statements appear in a number of places in this document and include statements regarding the intent, belief or expectation of the Company, its directors or its officers with respect to events, conditions, and financial trends that may affect the Company's future plans of operations, business strategy, operating results, and financial position. Persons reviewing this Quarterly Report on Form 10-Q are cautioned that any forward-looking statements are not guarantees of future performance and are subject to risks and uncertainties and that actual results may differ materially from those included within the forward-looking statements as a result of various factors.
While these forward-looking statements, and any assumptions upon which they are based, are made in good faith and reflect the Company's current judgment regarding the direction of its business, actual results will almost always vary, sometimes materially, from any estimates, predictions, projections, assumptions or other future performance suggested herein. The Company undertakes no responsibility or obligation to update publicly these forward-looking statements, but may do so in the future in written or oral statements. Investors should take note of any future statements made by or on behalf of the Company.
The following discussion should be read in conjunction with our unaudited condensed consolidated financial statements and the related notes that appear in the, "Financial Statements," of this Quarterly Report. Our unaudited condensed consolidated financial statements are stated in United States Dollars and are prepared in accordance with United States Generally Accepted Accounting Principles. The following discussion and analysis covers the Company's unaudited consolidated financial condition at March 31, 2008 and March 31, 2007, and its unaudited consolidated results of operation for the three and nine months periods ended March 31, 2008 and 2007.
China Dongsheng International, Inc. (formerly, PaperClip Software, Inc.) (OTCBB:
CDSG), a Delaware Corporation, was originally incorporated in New Jersey in October 1991 as PaperClip Imaging Software, Inc. and is the successor by merger as of March 1992. Paperclip Software, Inc. was and is engaged in the development and distribution of computer software for document management and transport of electronic document packages across the public Internet or a private intranet with interoperability, security and tracking capabilities.
American Sunrise International, Inc., a Delaware Corporation, ("ASI") was incorporated on May 30, 2006. Jilin Dongsheng Weiye Science & Technology Development Co., Ltd. ("DWST") was incorporated in the People's Republic of China (the "PRC" or "China") on August 16, 2002. On July 31, 2006, DWST signed an agreement with ASI, whereby ASI agreed to purchase all of the net assets of DWST for $1,250,000. Due to this change of ownership, DWST became a wholly foreign owned entity. DWST received its business license indicating its status as a wholly foreign owned entity on August 3, 2006.
On November 6, 2006, the Company, ASI, all shareholders of ASI, and DWST entered into a Stock Purchase and Share Exchange Agreement in which the Company acquired all of the issued and outstanding capital stock of ASI (the "Reverse Merger"). As a result of this Reverse Merger, the Company anticipated effecting a spin-off of its software development business. As a result of the spin-off, shareholders of record prior to the effectiveness of the Reverse Merger will receive shares in the software development subsidiary. As of December 31, 2007, the Company has not completed the spin-off process. On November 8, 2007, Paperclip filed a registration statement on Form 10-SB with the Securities and Exchange Commission which was subsequently withdrawn on January 7, 2008. On January 11, 2007, PaperClip, Inc. filed a Form 10-SB which it expects to be effective within 60 days of filing. The Company expects the spin-off to be complete by June 30, 2008.
When the spin-off transaction is effective, the Company will operate its business solely through DWST, its wholly-owned subsidiary which is engaged in the development and manufacture of nutritional supplements and personal care products domestically in China.
Results of Operations
Nine-Month Ended Three-Month Ended
March 31, March 31, March 31, March 31,
2008 2007 2008 2007
(Unaudited) (Unaudited) (Unaudited) (Unaudited)
Sales $ 22,932,944 $ 23,280,402 $ 4,543,223 $ 4,544,019
Cost of Sales 5,200,332 9,402,668 751,571 1,774,086
Gross Profit 17,732,612 13,877,734 3,791,652 2,769,933
Selling, general and administrative 3,656,533 1,330,034 837,993 560,801
Operating income 14,076,079 12,547,700 2,953,659 2,209,132
Other Income and Expenses
Interest income 7,297 3,441 1,501 4,349
Other income (expense) - 700,522 (13) 34,549
Total Other Income 7,297 703,963 1,488 38,898
Income Before Income Taxes 14,083,376 13,251,663 2,955,147 2,248,030
(Benefit) provision for Income Taxes
Income tax benefit (19,392,018 ) - - -
Provision for income taxes 4,324,850 4,248,314 774,665 730,540
Total (benefit) provision for income taxes (15,067,168 ) 4,248,314 774,665 730,540
Net Income 29,150,544 9,003,349 2,180,482 1,517,490
Three Months Ended March 31, 2008 Compared to the Three Months Ended March 31, 2007
Sales Revenues. The Company generated $4,543,223 in net sales for the three months ended March 31, 2008 compared to $4,544,019 for the same period ended march 31, 2007. The Company's Dongsheng subsidiary ("Dongsheng") accounted for $4,047,774 while the Company's Paperclip software subsidiary ("Paperclip") accounted for $495,449.
Dongsheng's net sales remain stable with no significant change for the three months ended March 31, 2008, however, the sales volume increased. In the previous quarter we purchased finished products from outside venders and resold them to wholesalers. As a result of making the shift of manufacturing our own branded products in house, we are able to reduce the cost of our products and in turn sell them to wholesalers at a lower price. Therefore despite the net sales revenue remaining stable, the volume of sale actually increased due to the lowered price of our products. We expect that the lower price of our products will provide added incentive for the wholesalers to promote our products due to higher profit margin for them.
Cost of Goods Sold. Cost of goods sold was $751,571 for the three months ended March 31, 2008. Dongsheng accounted for all the cost of goods sold during the quarter.
Compared to the corresponding period in 2007, cost of goods sold decreased by $1,022,515, or 58% for the three months ended March 31, 2008. The decrease is due in the lowered raw material purchase expenses. Dongsheng began manufacturing its own branded products and was able to drastically reduce the cost of the raw materials by negotiating more favorable terms with suppliers. This planned shift in production has considerably reduced our cost of goods sold and generated the improved gross margin.
Gross Profit Margin. Gross profit margin increased to 83.5% for the three months ended March 31, 2008, compared to the three months ended March 31, 2007 of 61%. Dongsheng accounted for all the improvement. This increase is primarily due to the lower cost of goods sold which resulted from our in house manufacturing capabilities as well as the improved revenue mix.
Operating Expenses. Operating expenses were $837,993 for the quarter ended March 31, 2008. Dongsheng accounted for $380,640 while Paperclip accounted for $457,353 compared to $560,801 for the quarter ended March 31, 2007.
Operating expenses increased by $277,192 for the quarter ended March 31, 2008. This increase is mainly attributable to the increasing depreciation and amortization expenses in the amount of RMB 1.4 Million (approximately $277,192) from the purchase of land use rights and construction of new facilities.
Net Income. Net income increased 44% to $2,180,482 for the three months ended March 31, 2008 compared to $1,517,490 of the corresponding period in 2007 primarily reflecting our transition to in-house manufacturing and our focus on our higher margin branded products.
Nine Months Ended March 31, 2008 Compared to the Nine Months Ended March 31, 2007
Sales Revenues. Sales Revenues of the Company during the nine months period ended March 31, 2008 was 22,932,944. Dongsheng accounted for $21,388,094 while Paperclip accounted for $1,544,850.
Compared to the corresponding period in 2007, sales revenues in 2008 decreased $347,458, or 1.5%. The Company's sales revenues remained relatively unchanged as a result of our shift to our higher margined branded products beginning in the second quarter of 2007.
Cost of Goods Sold. Cost of goods sold was $5,200,332 for the nine months ended March 31, 2008. Dongsheng accounted for all the cost of goods sold during this period.
Compared to the corresponding period in 2007, cost of goods sold decreased by $4,202,336, or 44.7% for the nine months ended March 31, 2008. The decrease is primarily due to lowered expenses in raw material and the shift from selling products from outside vendor to selling products manufactured in house.
Gross Profit Margin. Gross profit margin increased to 77% for the nine months ended March 31, 2008, compared to 60% for the nine months ended March 31, 2007. Dongsheng accounted for all the increase during this period. The increase was mainly due to a decrease of $4,202,336 of our cost of sale for the corresponding period.
Operating Expenses. Operating expenses was $3,656,533. Dongsheng accounted for $2,272,664 while Paperclip accounted for $1,383,869.
Selling, general and administrative expenses increased by $2,326,499, or 175% for the nine months ended March 31, 2008. The increase was primarily due to bonuses paid to our employees in December 2007 in the total amount of approximately $1,500,000 and depreciation and amortization expenses due to increase of property and equipment.
Income taxes. The benefit for income taxes increased to $15,072,050 for the nine months ended March 31, 2008. Dongsheng accounted for $15,112,256 while Paperclip accounted for a $45,088 provision.
This increase was mainly due to a one time tax benefit of $19,392,018. Dongsheng, received this tax clearance notice from the Local Tax Bureau in China stating that as of September 23, 2007, all tax liabilities have been cleared. The amount has been included in the statements of Income for the nine months ended March 31, 2008 as income tax benefit.
On March 16, 2007, the National People's Congress of China approved the Corporate Income Tax Law of the People's Republic of China (the "New CIT Law"), which is effective from January 1, 2008. Under the new CIT law, the corporate income tax rate applicable to all Companies, including both domestic companies or foreign-invested companies, will be 25%, replacing the current applicable tax rate of 33%.
In light of the recent changes in the Corporate Income Tax Law, the local tax authority has called off new approvals on all new applications for the old two-year tax exemption and three-year 50% tax reduction for all new foreign-invested enterprises. Therefore, Dongsheng will still be liable for the income taxes on any net income generated in the third and fourth quarter of 2007 at the current tax rate of 33% until the new rate of 25% applies in 2008.
The total taxes payable of $8,404,844 accrued as of March 31, 2008 includes $3,233,327 in income taxes, $3,163,018 in value-added taxes for the Company's operating subsidiary Dongsheng, individual income tax payable in $1,549,492, other tax payable $10,925, and $84,082 accrued income taxes for the parent company, Paperclip Software, Inc.
Liquidity and Capital Resources
Net cash flows provided by operating activities for the nine months ended March 31, 2008, was $10,057,371 as compared with $21,033,934 provided by operating activities for the nine months ended March 31, 2007, for a decrease of $10,976,563 or 52%. This decrease was primarily due to an increase in inventory by approximately $6.7 Million and advances made to certain vendor's inventory purchases and purchase of construction equipment in the amount of $2,424,070. This large increase in inventory was because of the purchase of ginseng crop of the same amount. The ginseng crop is estimated to be ready for harvest and used as raw material for our products in 2012.
Net cash flows used in investing activities for the nine months ended March 31, 2008, was $10,483,144 as compared to $20,733,272 for the nine months ended March 31, 2007 a decrease of 49%. The significant change in investing activity was primarily due to our substantial spending on construction of our manufacturing facilities during the nine months ended March 31, 2007. These investment spendings are part of our strategic plan to become more vertically integrated by producing our own branded products in-house and securing high quality raw materials.
Net cash flows provided by financing activities for the nine months ended March 31, 2008, was $382,470 compared to $104,368 used by financing activities for the nine months ended March 31, 2007. The increase of 466% in net cash flows provided in financing activity is a result of an increase of proceeds from notes payable and $50,000 in proceeds received upon recapitalization compared with zero last year.
Off-Balance Sheet Arrangements