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EX-32.1 - WINNER MEDICAL GROUP INCv193270_ex32-1.htm
EX-31.1 - WINNER MEDICAL GROUP INCv193270_ex31-1.htm
EX-31.2 - WINNER MEDICAL GROUP INCv193270_ex31-2.htm
EX-32.2 - WINNER MEDICAL GROUP INCv193270_ex32-2.htm
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, 2010

¨ 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
People’s Republic of China
(Address of principal executive offices)

86-(755) 28138888
   
(Registrant’s Telephone Number)
   

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  ¨     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 each of the issuer’s classes of common equity, as of August 11, 2010 is as follows:

Class of Securities
 
Shares Outstanding
 Common Stock, $0.001 par value
 
23,950,740
 

 
TABLE OF CONTENTS

       
Page
   
PART I
 
3
         
Item 1.
 
Condensed Financial Statements
 
3
Item 2.
 
Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
5
Item 3.
 
Quantitative and Qualitative Disclosures About Market Risk
 
19
Item 4.
 
Controls and Procedures
 
19
         
   
PART II
 
20
         
Item 1.
 
Legal Proceedings
 
20
Item 1A.
 
Risk Factors
 
20
Item 2.
 
Unregistered Sales of Equity Securities and Use of Proceeds
 
20
Item 3.
 
Defaults Upon Senior Securities
 
20
Item 4.
 
Reserved
 
20
Item 5.
 
Other Information
 
20
Item 6.
 
Index to Exhibits
 
20

2

PART I
FINANCIAL INFORMATION

ITEM 1. CONDENSED FINANCIAL STATEMENTS

WINNER MEDICAL GROUP INC.

Condensed Consolidated Financial Statements (Unaudited)
For the three and nine months ended June 30, 2010 and 2009
 
3

 
WINNER MEDICAL GROUP INC.

INDEX TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

   
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-15
 
4

 
WINNER MEDICAL GROUP INC.

CONDENSED CONSOLIDATED BALANCE SHEETS
 
   
June 30
   
September 30
 
   
2010
   
2009
 
   
(Unaudited)
   
(Unaudited)
 
   
US$
   
US$
 
ASSETS
           
Current assets:
           
Cash and cash equivalents
    12,736,013       9,493,026  
Restricted bank deposits
    128,550       123,868  
Accounts receivable, less allowances for doubtful
accounts of US$313,147 and US$244,401 at June 30, 2010
and September 30, 2009, respectively
      15,959,486         13,148,462  
Amount due from an affiliated company
    5,754       -  
Inventories
    17,105,048       14,932,740  
Prepaid expenses and other current assets
    7,654,839       3,614,567  
Income taxes recoverable
    33,525       30,910  
Deferred tax assets
    338,514       359,151  
Total current assets
    53,961,729       41,702,724  
Property, plant and equipment, net
    57,877,050       55,770,870  
Investment in equity investees
    2,072,935       1,923,956  
Intangible assets, net
    128,344       147,008  
Non-current restricted bank deposits
    101,029       34,917  
Prepaid expenses and other receivables
    657,073       1,104,344  
Deferred tax assets
    115,722       252,190  
Total assets
    114,913,882       100,936,009  
             
LIABILITIES AND STOCKHOLDERS’ EQUITY
           
Current liabilities:
           
Short-term bank loans
    736,279       6,589,545  
Accounts payable
    5,651,649       4,843,404  
Accrued payroll and employee benefits
    1,925,721       2,072,892  
Customer deposits
    397,688       603,824  
Other accrued liabilities
    2,704,998       2,574,736  
Amounts due to affiliated companies
    7,769       56,349  
Income taxes payable
    1,464,951       1,938,941  
Total current liabilities
    12,889,055       18,679,691  
Deferred tax liabilities
    42,134       41,899  
Total liabilities
    12,931,189       18,721,590  
                 
Commitments and contingencies
               
                 
Stockholders’ equity:
               
Common stock, par value $0.001 per share;
authorized 247,500,000, issued and
outstanding June 30, 2010 – 23,950,740 shares;
September 30, 2009 –22,363,740 shares
    23,951           22,364  
Additional paid-in capital
    40,740,622       31,166,123  
Retained earnings
    45,679,735       36,797,172  
Statutory reserves
    4,516,719       3,428,095  
Accumulated other comprehensive income
    11,009,153       10,717,850  
Total Winner Medical Group Inc.
 
 
   
 
 
stockholders’ equity
    101,970,180       82,131,604  
                 
Non-controlling interests
    12,513       82,815  
Total equity
    101,982,693       82,214,419  
                 
Total liabilities and equity
    114,913,882       100,936,009  
 
 
See accompanying notes to condensed consolidated financial statements.
 
F-1

 
WINNER MEDICAL GROUP INC.

CONDENSED CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
 
 
   
Three months ended
June 30
   
Nine months ended
June 30
 
   
2010
   
2009
   
2010
   
2009
 
   
(Unaudited)
   
(Unaudited)
   
(Unaudited)
   
(Unaudited)
 
   
US$
   
US$
   
US$
   
US$
 
                         
Net sales
    30,926,910       24,357,878       86,788,642       70,715,298  
                                 
Cost of sales
    (21,993,948 )     (17,176,129 )     (61,067,648 )     (51,128,269 )
Gross profit
    8,932,962       7,181,749       25,720,994       19,587,029  
                                 
Other operating income, net
    145,370       96,183       634,457       987,432  
Exchange difference, net
    (152,908 )     47,432       (233,089 )     (1,082,265 )
Selling, general and administrative expenses
    (5,277,382 )     (3,600,442 )     (14,741,028 )     (11,923,716 )
           
 
           
 
 
Income from operations
    3,648,042       3,724,922       11,381,334       7,568,480  
Interest income
    13,295       19,069       41,038       42,888  
Interest expense
    (21,545 )     (70,884 )     (120,048 )     (397,940 )
Equity in earnings of 50 percent or less owned persons
    103,954       86,446       148,979       309,584  
Income before income taxes
    3,743,746       3,759,553       11,451,303       7,523,012  
                                 
Income taxes
    (347,881 )     (694,718 )     (1,549,977 )     (1,414,383 )
Net income
    3,395,865       3,064,835       9,901,326       6,108,629  
                                 
Net (income)/ loss attributable to non-controlling interests
    (21,928 )     (1,183 )     69,861       74,196  
Net income attributable to
Winner Medical Group Inc.
    3,373,937       3,063,652       9,971,187       6,182,825  
                                 
Comprehensive income:
                               
Net income
    3,395,865       3,064,835       9,901,326       6,108,629  
Foreign currency translation difference
    438,928       37,243       290,862       (87,899 )
Comprehensive (income)/ loss attributable to
non-controlling interests
    (21,648 )     (1,183 )     70,302       74,196  
                                 
Comprehensive income attributable to
Winner Medical Group Inc.
    3,813,145       3,100,895       10,262,490       6,094,926  
                                 
                                 
Net income attributable to
Winner Medical Group Inc.  per share
                               
- basic
    0.14       0.14       0.44       0.28  
- diluted
    0.14       0.14       0.43       0.28  
                                 
Weighted average common stock outstanding
                               
- basic
    23,378,040       22,363,740       22,701,840       22,363,740  
- diluted
    24,060,419       22,363,814       23,112,894       22,388,400  
 
 
See accompanying notes to condensed consolidated financial statements.
 
F-2

 
WINNER MEDICAL GROUP INC.

CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(UNAUDITED)


   
Equity attributable to Winner Medical Group Inc.
             
   
Common stock
   
Additional
               
Accumulated other
   
Non-
       
   
Stock
         
paid-in
   
Retained
   
Statutory
   
comprehensive
   
controlling
   
Total
 
   
outstanding
   
Amount
   
capital
   
earnings
   
reserves
   
income
   
interests
   
equity
 
         
US$
   
US$
   
US$
   
US$
   
US$
   
US$
   
US$
 
                                                 
Balance at September 30, 2008
    22,363,740       22,364       30,865,690       28,791,259       2,305,434       10,777,004       148,306       72,910,057  
Restricted stock units granted
    -       -       300,433       -       -       -       -       300,433  
Net income/(loss)
    -       -       -       9,128,574       -       -       (65,491 )     9,063,083  
Foreign currency translation difference
    -       -       -       -       -       (59,154 )     -       (59,154 )
Transfer to statutory reserves
    -       -       -       (1,122,661 )     1,122,661       -       -       -  
Balance at September 30, 2009
    22,363,740       22,364       31,166,123       36,797,172       3,428,095       10,717,850       82,815       82,214,419  
Issuance of  common stock
    1,587,000       1,587       8,791,876       -       -       -       -       8,793,463  
Restricted stock units granted
    -       -       782,623       -       -       -       -       782,623  
Net income/(loss)
    -       -       -       9,971,187       -       -       (69,861 )     9,901,326  
Foreign currency translation difference
    -       -       -       -       -       291,303       (441 )     290,862  
Transfer from statutory reserves
    -       -       -       (1,088,624 )     1,088,624       -       -       -  
Balance at June 30, 2010
    23,950,740       23,951       40,740,622       45,679,735       4,516,719       11,009,153       12,513       101,982,693  

Note: The common stock issued has been retroactively restated to reflect a reverse stock split of one new share of common stock for two old shares of common stock, effectively October 6, 2009. The authorized shares and the par value per share, as referred to in these condensed consolidated financial statements have been restated where applicable to give retroactive effect of the reverse stock split.
 
 
See accompanying notes to condensed consolidated financial statements.
 
F-3

 
WINNER MEDICAL GROUP INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
 
   
Nine months ended
June 30
 
   
2010
   
2009
 
   
(Unaudited)
   
(Unaudited)
 
   
US$
   
US$
 
Cash flows from operating activities
           
Net income
    9,901,326       6,108,629  
Adjustments to reconcile net income to net cash from
               
operating activities:
               
Depreciation and amortization of property, plant and equipment
    3,799,724       3,351,350  
Amortization of intangible assets
    19,435       13,891  
Loss/(Gain) on disposal of property, plant and equipment
    11,571       (116,991 )
Impairment of property, plant and equipment
    -       490,572  
Change in fair value of financial instruments, net
    (97,690 )     -  
Equity in earnings of 50 percent or less owned persons
    (148,979 )     (309,584 )
Stock based compensation expenses
    782,623       304,623  
Deferred tax
    160,534       (139,599 )
Changes in operating assets and liabilities:
               
Restricted bank deposits
    (71,646 )     (130,411 )
Accounts receivable
    (2,737,255 )     1,986,799  
Amounts due from affiliated companies
    (5,754 )     86,657  
Inventories
    (2,088,530 )     1,022,214  
Prepaid expenses and other receivables
    (3,857,471 )     (438,401 )
Income taxes recoverable
    (2,441 )     68,032  
Accounts payable
    781,071       (2,165,345 )
Accrued payroll and employee benefits
    (158,800 )     (97,481 )
Customer deposits
    (209,524 )     18,673  
Other accrued liabilities
    55,206       (455,772 )
Amounts due to affiliated companies
    (48,896 )     (116,419 )
Income taxes payable
    (479,988 )     460,580  
Net cash provided by operating activities
    5,604,516       9,942,017  
                 
Cash flows from investing activities
               
Purchase of property, plant and equipment
    (3,713,082 )     (2,150,846 )
Purchase of intangible assets
    -       (41,432 )
Proceeds from disposal of property, plant and equipment
    16,339       950,793  
Deposits paid for property, plant and equipment
    (1,455,096 )     -  
Proceeds from disposal of an equity investee
    -       141,753  
Investment in an equity investee
    -       (358,612 )
Repayment received from affiliated companies
    -       96,225  
Net cash used in investing activities
    (5,151,839 )     (1,362,119 )
                 
Cash flows from financing activities
               
Proceeds from bank borrowings
    -       16,487,671  
Repayment of bank borrowings
    (5,873,715 )     (23,740,311 )
Proceeds from issuance of common stock
    8,793,463       -  
Net cash provided by/(used in) financing activities
    2,919,748       (7,252,640 )
                 
Effect of exchange rate changes on cash balance
    (129,438 )     47,938  
                 
Net increase in cash and cash equivalents
    3,242,987       1,375,196  
Cash and cash equivalents, beginning of period
    9,493,026       6,462,505  
Cash and cash equivalents, end of period
    12,736,013       7,837,701  
                 
Supplemental disclosures of cash flows information:
               
Cash paid during the period for:
               
Interest
    120,048       397,316  
Income taxes
    1,872,343       1,022,119  

 
See accompanying notes to condensed consolidated financial statements.
 
F-4

 
WINNER MEDICAL GROUP INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 
 
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 nine months ended June 30, 2010, have been made. It is suggested that these condensed consolidated financial statements be read in conjunction with the financial statements and notes thereto included in the Company’s annual audited financial statements for the year ended September 30, 2009. The Company follows the same accounting policies in preparation of interim reports.

On October 6, 2009, the Company’s Board of Directors approved and authorized the Company to complete a one-for-two reverse split of the Company’s common stock, decreasing the Company’s authorized capital to 247,500,000 shares of common stock and 2,500,000 shares of preferred stock, par value $0.001 per share. Pursuant to the Nevada Revised Statues, shareholder approval of this action was not required. The authorized shares, the par value per share, earning per share, common stock outstanding and weighted average common stock outstanding as referred to in these condensed consolidated financial statements have been restated where applicable to give retroactive effect of the reverse stock split.

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 and medical disposable, as well as PurCotton® products. All 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 June 2009, the FASB issued SFAS No.167, “Amendments to FASB Interpretation No.46(R)”, which is codified as ASC 810. ASC 810 amends FASB Interpretation No.46(R), “Variable Interest Entities” for determining whether an entity is a variable interest entity (“VIE”) and requires an enterprise to perform an analysis to determine whether the enterprise’s variable interest or interests give it a controlling financial interest in a VIE. Under ASC 810, an enterprise has a controlling financial interest when it has a) the power to direct the activities of a VIE that most significantly impact the entity’s economic performance and b) the obligation to absorb losses of the entity or the right to receive benefits from the entity that could potentially be significant to the VIE. ASC 810 also requires an enterprise to assess whether it has an implicit financial responsibility to ensure that a VIE operates as designed when determining whether it has power to direct the activities of the VIE that most significantly impact the entity’s economic performance. ASC 810 also requires ongoing assessments of whether an enterprise is the primary beneficiary of a VIE, requires enhanced disclosures and eliminates the scope exclusion for qualifying special-purpose entities. ASC 810 shall be effective as of the beginning of each reporting entity’s first annual reporting period that begins after November 15, 2009, for interim periods within that first annual reporting period, and for interim and annual reporting periods thereafter. Earlier application is prohibited. ASC 810 is effective for the Company in the first quarter of fiscal 2011. The Company is currently evaluating the effect of ASC 810 on its financial statements and results of operation and is currently not yet in a position to determine such effects.

In December 2009, the FASB issued ASU No. 2009-17, “Improvements to Financial Reporting by Enterprises Involved with Variable Interest Entities (“ASU 2009-17”)”. ASU 2009-17 amends the variable-interest entity guidance in FASB ASC 810-10-05-8 to clarify the accounting treatment for legal entities in which equity investors do not have sufficient equity at risk for the entity to finance its activities without financial support. ASU 2009-17 shall be effective as of the beginning of each reporting entity’s first annual reporting period that begins after November 15, 2009. ASU 2009-17 is effective for the Company in the first quarter of fiscal 2011. The Company is currently evaluating the effect of ASU 2009-17 on its financial statements and results of operation and is currently not yet in a position to determine such effects.

In January 2010, the FASB issued ASU 2010-06, Improving Disclosures about Fair Value Measurements. ASU 2010-06 amends ASC Topic 820 to require additional disclosures regarding fair value measurements. One of the areas concerned is related to the inclusion of information about purchases, sales, issuances and settlements of recurring Level 3 measurements. Such disclosure requirements will be effective for annual reporting periods beginning after December 15, 2010.  The Company is currently evaluating the effect of ASC 2010-06 on its financial statements and results of operation and is currently not yet in a position to determine such effects.

F-5

 
WINNER MEDICAL GROUP INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 
 
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.  At June 30, 2010 and 2009, the basic and diluted net income attributable to Winner Medical Group Inc. per share calculated in accordance with SFAS No. 128, "Earnings Per Share", which is codified as ASC 260, are reconciled as follows:

   
Three months ended
June 30
 
   
2010
   
2009
 
   
(Unaudited)
   
(Unaudited)
 
   
US$
   
US$
 
Basic income per share
           
             
Net income attributable to Winner Medical Group Inc. for the period
    3,373,937       3,063,652  
                 
Weighted average common stock outstanding
    23,378,040       22,363,740  
                 
Net income attributable to Winner Medical Group Inc. per share
    0.14       0.14  
                 
Diluted income per share
               
                 
Net income attributable to Winner Medical Group Inc. for the period
    3,373,937       3,063,652  
                 
Weighted average common stock outstanding
    23,378,040       22,363,740  
                 
Effect of dilution
               
                 
Restricted stock awards
    682,379       74  
Options
    -       -  
                 
Weighted average common stock outstanding
    24,060,419       22,363,814  
                 
Net income attributable to Winner Medical Group Inc. per share
    0.14       0.14  

   
Nine months ended
 June 30
 
   
2010
   
2009
 
   
(Unaudited)
   
(Unaudited)
 
   
US$
   
US$
 
Basic income per share
           
             
Net income attributable to Winner Medical Group Inc. for the period
    9,971,187       6,182,825  
                 
Weighted average common stock outstanding
    22,701,840       22,363,740  
                 
Net income attributable to Winner Medical Group Inc. per share
    0.44       0.28  
                 
Diluted income per share
               
                 
Net income attributable to Winner Medical Group Inc. for the period
    9,971,187       6,182,825  
                 
Weighted average common stock outstanding
    22,701,840       22,363,740  
                 
Effect of dilution
               
                 
Restricted stock awards
    411,054       24,660  
Options
    -       -  
                 
Weighted average common stock outstanding
    23,112,894       22,388,400  
                 
Net income attributable to Winner Medical Group Inc. per share
    0.43       0.28  

On May 7, 2009, 4,167 potential common shares expired. On February 5, 2010, 10,000 potential common shares expired. As of June 30, 2010, there was no potential common share relating to options in the Company.

F-6

 
WINNER MEDICAL GROUP INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 
 
5.  Inventories

Inventories by major categories are summarized as follows:
 
   
June 30
   
September 30
 
   
2010
   
2009
 
   
(Unaudited)
   
(Unaudited)
 
   
US$
   
US$
 
Raw materials
    6,811,662       7,083,409  
Work in progress
    4,927,667       3,768,446  
Finished goods
    5,365,719       4,080,885  
      17,105,048       14,932,740  

6.  Income Taxes

United States

The Company is incorporated in the United States of America and is subject to United States federal taxation. No provisions for income taxes have been made as the Company has no taxable income for the first three quarters. There are no current taxes due to Internal Revenue Service of United States as of June 30, 2010. The applicable income tax rate for the Company for the nine months ended June 30, 2010 and 2009 is 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 nine months ended June 30, 2010 and 2009 is 16.5%.

 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 PRC, unless they qualify under certain limited exceptions. As such, starting from January 1, 2008, three of the Company’s subsidiaries in PRC, including Winner Medical & Textile Ltd., Jingmen, Winner Medical & Textile Ltd., Jiayu, and Winner Medical & Textile Ltd., Yichang, are subject to an enterprise income tax rate of 25%.

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. Four of the Company’s PRC subsidiaries, Winner Medical (Huanggang) Co., Ltd., Winner Medical & Textile Ltd., Chongyang, Hubei Winner Textiles Co., Ltd., and Shanghai Winner Medical Apparatus Co., Ltd. are each entitled to a two-year exemption from enterprise income tax and a reduced enterprise income tax rate for the three years following its second profitable year.

Winner Medical (Huanggang) Co., Ltd. enjoys its full tax exemption from January 1, 2008, and the 50% tax exemption from January 1, 2010. The preferential tax incentives will expire on December 31, 2012. Winner Medical & Textile Ltd., Chongyang enjoys the 50% tax exemption from January 1, 2008, and from January 1, 2011, Winner Medical & Textile Ltd., Chongyang will be subject to an enterprise income tax rate of 25%. Shanghai Winner Medical Apparatus Co., Ltd. enjoys the 50% tax exemption from January 1, 2009 and will be expired on December 31, 2011.
 
F-7

 
WINNER MEDICAL GROUP INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 
 
6.  Income Taxes-Continued

In October 2006, for the purpose of improving operation efficiency, Hubei Winner Textiles Co., Ltd., “Winner Hubei”, merged with Winner Medical & Textile Ltd., Tianmen, “Winner Tianmen”. Income from Winner Hubei and Winner Tianmen were separately reported to the local tax office to reflect the different tax incentive status enjoyed by both entities. The applicable income tax rates for Winner Hubei and Winner Tianmen was 12.5% and 25% respectively for calendar years 2008 and 2009 and was 25% for both entities starting from January 1, 2010.

On September 11, 2009, Winner Industries (Shenzhen) Co., Ltd., or "Winner Shenzhen", obtained the High and New Technology Enterprise Certificate granted by the Ministry of Science and Technology of China, the Ministry of Finance and the State Administration of Taxation. Winner Shenzhen enjoyed an applicable corporate income tax rate of 15% from January 1, 2009 to the year end of 2011. The applicable income tax rates for Winner Shenzhen was 15% and 18% for the three months ended December 31, 2009 and 2008, respectively and was 15% for the six months ended June 30, 2010 and 2009.

On December 7, 2009, a wholly-owned subsidiary Shenzhen PurCotton Technology Co., Ltd., or “Shenzhen PurCotton” was established.  The applicable income tax rate for Shenzhen PurCotton was 25% for the nine months ended June 30, 2010.

On October 1, 2007, the Company adopted FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes- an interpretation of FASB Statement No. 109, which is codified as ASC 740. The Company’s policy classifies all interest and penalties related to unrecognized tax benefits, if any, as a component of income tax provisions. The Company performed 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 taxing 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. Until June 30, 2010, 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 the uncertain position in future. There are no estimated interest costs and penalties provided in the Company’s consolidated financial statements for the nine months ended June 30, 2010 and 2009, respectively. The Company’s uncertain tax positions are related to tax years that remain subject to examination by the relevant tax authorities and the major one is the China Tax Authority. The open tax year for examination in PRC is 5 years.

7.  Related Party Transactions

During the nine months ended June 30, 2010 and 2009, the Company purchased goods from L+L Healthcare Hubei Co., Ltd., an equity investee, for US$61,715, and US$27,446 and sold goods to it for US$462 and US$Nil, respectively. The Company purchased a set of machinery from the equity investee for US$Nil and US$36,593 during the nine months ended June 30, 2010 and 2009, respectively. As of June 30, 2010 and September 30, 2009, amount due to L+L Healthcare Hubei Co., Ltd. ware US$1,714 and US$56,349, respectively.

During the nine months ended June 30, 2010 and 2009, the Company sold goods to Chengdu Winner Likang Medical Appliance Co., Ltd. (“Winner Chengdu”), an equity investee, for US$27,710 and US$Nil and purchased goods from it for US$66,271 and US$Nil, respectively. As of June 30, 2010 and September 30, 2009, amount due to Winner Chengdu were US$6,055 and US$Nil, respectively; and amount due from Winner Chengdu were US$5,754 and US$Nil, respectively.

The amounts due from/to the above affiliated companies are unsecured, interest free and payable according to the trading credit terms.
 
F-8

 
WINNER MEDICAL GROUP INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 
 
8.  Stock-Based Compensation

Stock-Based Compensation - The Company has adopted Statement of Financial Accounting Standard ("SFAS") No. 123 (revised 2004) ("SFAS No. 123(R)"), ''Share-based Payment'', which is codified as 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.

The Company uses the Black-Scholes option-pricing model, which was developed for use in estimating the fair value of traded options that have no restrictions, are fully transferable and negotiable in a free trading market, to value its options under the independent director’s contract.  Use of an option valuation model, as required by SFAS No. 123(R), “Accounting for Stock-Based Compensation”, which is codified as ASC 718, ''Compensation-Stock Compensation'', includes highly subjective assumptions based on long-term prediction, including the expected stock price volatility and average life of each option grant.

In a contract signed on May 8, 2006, the Company agreed to grant to two of its independent directors each year non-qualified options for purchasing up to 10,000 shares of the common stock of the Company, which options shall be exercisable within three years from the grant date and have an exercise price equal to the fair market value on the grant date.  On May 8, 2006, a total of 4,167 non-qualified options was granted and expired on May 7, 2009. On February 6, 2007, a total of 10,000 non-qualified options was granted. On October 1, 2007, the Company and two of its independent directors agreed to increase the cash compensation to them of US$5,000 each, and in order to substitute the option compensation terms agreed in the previous contracts.  The options granted on February 6, 2007 according to the previous contracts are still valid.  On February 5, 2010, 10,000 non-qualified options was expired. There was no stock-based compensation cost recorded for the nine months ended June 30, 2010 and 2009, respectively. Instead, the total cash compensation costs for independent directors for the nine months ended June 30, 2010 and 2009 are US$76,250 and US$56,250, respectively.

A summary of option activity under the Plan as of June 30, 2010, and changes during the period then ended is presented below:

   
 
Options
   
Weighted Average Exercise Price
   
Weighted Average Remaining Contractual Term
 
   
(Unaudited)
   
(Unaudited)
   
(Unaudited)
 
         
US$
   
Years
 
                   
Outstanding at September 30, 2008
    14,167       12.15       1.13  
Granted (from October 1, 2008 to September 30, 2009)
    -       -       -  
Exercised (from October 1, 2008 to September 30, 2009)
    -       -       -  
Forfeited or expired
    (4,167 )     -       -  
Outstanding at September 30, 2009
    10,000       9.50       0.35  
Granted (from October 1, 2009 to June 30, 2010)
    -       -       -  
Exercised (from October 1, 2009 to June 30, 2010)
    -       -       -  
Forfeited or expired
    (10,000 )     -       -  
Outstanding at June 30, 2010
    -       -       -  

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.

Following this incentive 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 sales objectives, and the participant’s individual performance objectives are fulfilled. Estimated value of award as of grant date is based on the market price of the common stock as quoted on the NASDAQ.com as of October 7, 2007, which was $3.60 per share, and assumes that the individual achieves of the applicable corporate and individual objectives set forth in the award.
 
F-9

 
WINNER MEDICAL GROUP INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 
 
8.  Stock-Based Compensation-Continued

On October 15, 2008, the Company’s Board of Directors approved to grant the remaining 100,000 units out of the total 600,000 authorized restricted stock units. 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 sales objectives, and the participant’s individual performance objectives are fulfilled. Estimated value of award as of grant date is based on the market price of the common stock as quoted on the NASDAQ.com 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 a 2010-2011 Restricted Stock Unit Incentive Plan, the “2010-2011 Plan”, a stock incentive compensation program for fiscal years 2010 and 2011. This 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.

Following this incentive 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 7, 2012 and the second 50% on September 7, 2013 if the target of corporate net income attributable to Winner Medical Group Inc., annual sales objectives, and the participant’s individual performance objectives are fulfilled. Estimated value of award as of grant date is based on the market price of the common stock as quoted on the NASDAQ.com as of September 8, 2009, which was $4.40 per share, and assumes that the individual achieves of 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 receiving services of developing marketing, brand building and promotion planning of the Company’s own branded consumer products in China. Pursuant to the agreement, the Company is committed to pay the consulting firm a cash compensation of US$146,548 each year in the following five years with a total of US$732,740. The Company has also granted 500,000 restricted stock units from the Company’s 2006 Equity Incentive Plan to the consulting firm for the 5-year services. Vesting condition of these restricted stock units depends upon the achievement of the agreed marketing objectives by the consulting firm, subject to the approval of the Company. The service contract explicitly stated that if the consulting firm withdraws from the contract, the consulting firm has to pay a compensation of US$1,350,000 to the Company.

On April 15, 2010, the Company signed an agreement with Mr. Zihan Wu, the general manager of Shenzhen PurCotton Technology Co., Ltd. Pursuant to the agreement, Mr. Zihan Wu is awarded by the Company’s board of director a maximum of 500,000 Restricted Stock Units in 4 years upon the achievement of agreed volume of sales. The agreement also mentioned that the relevant performance in relation to achieve the agreed volume of sales started from October 2010. As the expansion of PurCotton consumer business is fairly new for the Company, the current business operation, model, strategy and targets are different from the premier prospective. In this case, the Company and Mr. Zihan Wu agreed to terminate this stock incentive compensation program as the Company needed to redefine its business direction. Since the relevant performance had not yet started as of June 30, 2010, there was no share-based compensation expense regarding this incentive plan for the nine months ended June 30, 2010.

On June 10, 2010, due to a change of the Company's marketing and development plan, after a negotiation between the Company’s subsidiary in Shenzhen and the consulting firm, both parties agreed to set up a three months cooling-off period starting from June 19, 2010. This three months cooling-off period allowed both parties to consider whether to continue the co-operation relationship or to modify the terms of existing incentive plan. All rights and obligations stated in the consulting agreement signed on July 27, 2009 were temporary suspended. In addition, in order to reflect no service was available from the consulting firm during the cooling-off period, the first year cash compensation was adjusted to US$132,159 from US$146,548 previously agreed. As of June 30, 2010, the Company did not make final decision on whether to continue the co-operation relationship or to modify the terms of existing incentive plan.

The total share-based compensation expense for the nine months ended June 30, 2010 was US$782,623, representing an amount of US$577,545 share-based compensation expense for the employee incentive plan and an amount of US$205,078 share-based compensation expense for the marketing service to the consulting firm respectively.
 
F-10


WINNER MEDICAL GROUP INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 
 
8.  Stock-Based Compensation-Continued

Management considered that the fair value of outstanding restricted share units is approximate to the market value of the Company’s common stock, as of June 30, 2010, the market value of the Company’s common stock is US$5.26.

As of June 30, 2010, a total of 102,000 units were cancelled due to the resignation of employees.

A summary of the restricted stock units activity is as follows:
 
   
Incentive plan on marketing service
   
2008-09 plan
   
2010-11 plan
   
Total
 
   
Number of units
   
Number of units
   
Number of units
   
Number of units
 
   
(Unaudited)
   
(Unaudited)
   
(Unaudited)
   
(Unaudited)
 
                         
Units outstanding at October 1, 2007
    -       -       -       -  
Granted
    -       500,000       -       500,000  
Cancelled
    -       (44,250 )     -       (44,250 )
Units outstanding at September 30, 2008
    -       455,750       -       455,750  
Granted
    500,000       100,000       250,000       850,000  
Cancelled
    -       (31,250 )     -       (31,250 )
Units outstanding at September 30, 2009
    500,000       524,500       250,000       1,274,500  
Granted
    -       -       -       -  
Cancelled
    -       (26,500 )     -       (26,500 )
Units outstanding at June 30, 2010
    500,000       498,000       250,000       1,248,000  

9.  Commitments and Contingencies

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

       
   
(Unaudited)
 
   
US$
 
Three months ending September 30, 2010     245,850  
Years ending September 30
       
2011
    898,457  
2012
    602,375  
2013
    309,125  
2014
    227,200  
On and after 2015
    92,034  
Total minimum lease payments
    2,375,041  

Rental expenses under operating leases included in the statement of income were US$509,288 and US$279,715 for the nine months ended June 30, 2010 and 2009, respectively.

Purchase obligations: The Company has signed agreements with suppliers and other parties to purchase plant and machinery, and computer equipment with estimated non-cancellable obligations of US$3,635,573 and US$576,651 as of June 30, 2010 and 2009, respectively.

10.  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.

F-11

 
WINNER MEDICAL GROUP INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 
 
10.  Fair Value Measurement-Continued

The financial instruments of the Company are cash and cash equivalents, restricted bank deposits, accounts receivable, deposits and other receivable, other current assets, bank loans, accounts payable, other current liabilities and other liabilities are reasonable estimates of their fair values. These financial assets and liabilities are classified either Level 1 or Level 2 in the fair value hierarchy as of June 30, 2010. Fair value of the amounts due to or from affiliates cannot be readily determined because of the nature of the related party transactions.

11.  Financial Instruments and Derivatives

The Company does not use derivative financial instruments for speculative or 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 total outstanding foreign currency forward contracts were amounted to US$86,000,000 as of June 30, 2010. The Company’s foreign currency forward contracts are classified as Level 2 in the fair value hierarchy under ASC topic 820 since the quote prices of these foreign currency forward contracts can be obtained directly from commercial bank. The following table summarizes the Company’s fair value of outstanding derivatives:

 
Condensed Consolidated
   
June 30
   
September 30
 
 
Balance Sheet Presentation
   
2010
   
2009
 
       
(Unaudited)
   
(Unaudited)
 
       
US$
   
US$
 
Derivatives not designated as hedging instruments
               
                 
Fair value of foreign currency forward exchange contracts
Other current assets
      158,300       -  
                     
 
Other liabilities
      60,610       -  

The impact on earnings from derivatives activity, including changes in the fair value of derivatives for the three and nine months ended June 30, 2010 and 2009 are as follows:
 
 
Presentation of gain or loss
   
Three months ended
 June 30
   
Nine months ended
June 30
 
 
recognized on derivatives
   
2010
   
2009
   
2010
   
2009
 
       
(Unaudited)
   
(Unaudited)
   
(Unaudited)
   
(Unaudited)
 
       
US$
   
US$
   
US$
   
US$
 
Derivatives not designated as hedging instruments                          
Foreign currency
Unrealised exchange gain
      93,274       -       158,300       -  
forward exchange
                                 
contracts
Unrealised exchange loss
      -       -       60,610       -  
                                     
 
Other operating income, net
      93,274       -       97,690       -  
 
F-12

 
WINNER MEDICAL GROUP INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 
 
12. 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 12% and 15% of the total net sales for the nine months ended June 30, 2010 and 2009, respectively.

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. Bad debt expense was US$67,920 and US$100,828 during the nine months ended June 30, 2010 and 2009, respectively.

Interest rate risk - The interest rates and terms of repayment of bank and other borrowings was 5.31%. Other financial assets and liabilities do not have material interest rate risk.

Credit risk - In order to reduce the risk of inability to collect the accounts receivable, the Company entered into a one-year insurance policy with China Export & Credit Insurance Corporation effective on April 15, 2010 and 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 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, 2010 and 2009, the exchange rates of RMB against US dollar were 6.7909 and 6.8319 respectively; the appreciation of RMB against US dollar was 0.6%. The exchange rates of RMB against Euro were 8.2710 and 9.6408 respectively. This floating exchange rate, and any appreciation of the Renminbi that may result from such rate, could have various adverse effects on the Company’s business.

The Company’s currency exchange rate risks come primarily from the sales of products to international customers. If the RMB appreciates against foreign currencies, it will make the Company’s sale prices more expensive, thus its sales may decline. The Company believes that the exchange rate of RMB against US dollar will remain relatively stable in the short run.

13.  Geographical Information

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

   
Three months ended
June 30
 
   
2010
   
2009
 
   
(Unaudited)
   
(Unaudited)
 
   
US$
   
US$
 
             
Europe
    12,405,888       9,752,937  
PRC
    5,932,889       5,022,645  
North and South America
    7,203,259       4,557,277  
Japan
    4,216,607       3,821,324  
Others
    1,168,267       1,203,695  
Total net sales
    30,926,910       24,357,878  

   
Nine months ended
June 30
 
   
2010
   
2009
 
   
(Unaudited)
   
(Unaudited)
 
   
US$
   
US$
 
             
Europe
    31,427,425       29,306,740  
PRC
    19,348,818       11,499,951  
North and South America
    18,110,887       13,547,078  
Japan
    13,645,080       12,337,802  
Others
    4,256,432       4,023,727  
Total net sales
    86,788,642       70,715,298  
 
F-13

 
WINNER MEDICAL GROUP INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 
 
14.  Segment Information

The Company has two reportable segments: traditional products (Medical Care, Wound Care and Home Care) and new style 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, 2010 and 2009 are as follows:

   
Three months ended
 June 30
 
   
2010
   
2009
 
   
(Unaudited)
   
(Unaudited)
 
Net Sales:
 
US$
   
US$
 
Segment:
           
Traditional products
    28,343,421       23,150,458  
PurCotton®  products
    2,583,489       1,207,420  
Consolidated total
    30,926,910       24,357,878  
                 
Gross Profits:
               
Segment:
               
Traditional products
    8,125,371       6,837,570  
PurCotton® products
    807,591       344,179  
Consolidated total
    8,932,962       7,181,749  
                 
Income from operations before taxes:
               
Segment:
               
Traditional products
    3,754,887       3,762,701  
PurCotton® products
    (11,141 )     (3,148 )
Consolidated total
    3,743,746       3,759,553  
                 
Net Income attributable to Winner Medical Group Inc.:
               
Segment:
               
Traditional products
    3,386,589       3,068,199  
PurCotton® products
    (12,652 )     (4,547 )
Consolidated total
    3,373,937       3,063,652  
 
F-14

 
WINNER MEDICAL GROUP INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 
 
14.  Segment Information-Continued

   
Nine months ended
 June 30
 
   
2010
   
2009
 
   
(Unaudited)
   
(Unaudited)
 
Net Sales:
 
US$
   
US$
 
Segment:
           
Traditional products
    79,788,820       67,557,256  
PurCotton®  products
    6,999,822       3,158,042  
Consolidated total
    86,788,642       70,715,298  
                 
Gross Profits:
               
Segment:
               
Traditional products
    23,342,177       18,822,718  
PurCotton® products
    2,378,817       764,311  
Consolidated total
    25,720,994       19,587,029  
                 
Income from operations before taxes:
               
Segment:
               
Traditional products
    10,745,965       7,842,236  
PurCotton® products
    705,338       (319,224 )
Consolidated total
    11,451,303       7,523,012  
                 
Net Income attributable to Winner Medical Group Inc.:
               
Segment:
               
Traditional products
    9,358,815       6,502,049  
PurCotton® products
    612,372       (319,224 )
Consolidated total
    9,971,187       6,182,825  
 
15.  Subsequent events

The Company has evaluated transactions, events and circumstances for consideration of recognition or disclosed those items within the condensed consolidated financial statements as deemed appropriate.

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

Special Note Regarding Forward Looking Statements

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 “believe”, “expect”, “anticipate”, “project”, “targets”, “optimistic”, “intend”, “aim”, “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 registration statement on Form S-3 and 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.

Overview

Winner Medical’s business operations consist of the manufacturing and marketing, researching and developing of medical dressings and medical disposables, as well as natural cotton consumer products. The Company has eight wholly-owned operating subsidiaries and four joint venture companies. The Company has established several integrated manufacturing and processing lines for its core products. The Company’s product offerings include medical dressings and medical disposables, which consist of medical care, wound care and home care products, as well as PurCotton® products, a non-woven fabric made from 100% natural cotton. The Company manufactures its products in China and sells its medical dressings and medical disposables both in China and abroad, such as Japan, Germany, Italy, the Netherlands, the United Kingdom, Australia, France, South America, Africa, the Middle East and the United States, and sells its PurCotton® finished consumer products mainly in China.

The following analysis discusses changes in the financial condition and results of operations at and for the three and nine months ended June 30, 2010 and 2009, and should be read in conjunction with the Company’s unaudited consolidated financial statements and the notes thereto included elsewhere in this Report.

The Company’s History

Winner Medical Group Inc., formerly known as Birch Enterprises, Inc., HDH Industries, Inc. and Las Vegas Resorts Corporation, was originally incorporated in the State of Nevada in August 1986.

On December 16, 2005, Winner Medical Group Inc. and Winner Group Limited entered into a share exchange agreement pursuant to which the stockholders of Winner Group Limited were issued 42,280,840 shares of Winner Medical Group Inc. common stock in exchange for all 1,143,000 shares of Winner Group Limited that were issued and outstanding as of December 16, 2005. In connection with the acquisition transaction, Winner Group Limited became the Company’s wholly-owned subsidiary. On October 6, 2009, the Company’s board of directors approved a 1-for -2 reverse stock split of its issued and outstanding common shares and authorized shares, meaning that 42,280,840 shares had been restated to 21,140,420 shares in the Company’s financial statements. Upon effectiveness of the reverse stock split, the outstanding and issued shares were approximately 22,363,740 shares, after rounding up fractional shares. On April 30 and May 19, 2010, the Company completed a public offering of 1,587,000 shares of common stock at a price of $6.10 per share. In connection with this public offering, the total outstanding and issued shares were approximately 23,950,740 shares.

Effective October 8, 2009, the Company migrated from the OTC Bulletin Board or OTCBB to the New York Stock Exchange AMEX, changing its symbol from “WMDG.OB.” to “WWIN”. Effective April 6, 2010, the Company migrated from the New York Stock Exchange AMEX to NASDAQ Global Market, under the same symbol of “WWIN”.

Winner Medical Group Inc. presently conducts its business operations through its operating subsidiaries located in China.
 
5


The Company’s Business Operations

Winner Medical’s present business operations commenced February 1991 and involve the manufacture and marketing of its products primarily out of its facilities in China. The Company generates revenue through domestic (China) and foreign 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, cotton balls, etc. and a non-woven fabric made from 100% natural cotton products, that is, PurCotton® products, which consist of dry and wet tissues, beauty pads, baby wears, cleansing wipes, etc.

The Company has integrated manufacturing lines that provides its clients with the ability to procure certain products from a single supplier. The Company sells its own medical brand products in developing countries and regions including China, the Middle East, South America, Africa, and Southeast Asia. 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 builds its PurCotton® finished products by its own marketing and sales efforts in the Chinese marketplace. Each store contains four types of PurCotton® branded personal products and healthcare supplies, which include PurCotton® baby personal products, feminine personal products, daily home care products and medical care products. The main distribution channels are chain stores (PurCotton® stores), on-line sales, supermarkets and wholesale to large customers.

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

The medical dressings and medical disposables manufacturing market are continually evolving due to technological advances and new demands in the healthcare industry. The Company believes the trends in the industry towards improving medical care and 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 increased revenue for the Company.

The export of medical dressings and medical disposables from China has grown rapidly over the last few years. The Company believes that its sales over the next five years will grow in correlation to the growth of medical dressings and medical disposables export volume from China.

The 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 trend or consumption pattern in the Company’s industry is that hospitals are increasingly seeking to reduce their costs. Hospitals reduce costs by seeking alternative products that increase efficiency or reduce labor costs. For example, disposable catheters may 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 in the United States and European Union will bring an increase in the demand for medical instruments, medical dressings and medical disposables.

The Company believes that there is a trend in its industry that is resulting in the 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 rapid development of the Chinese economy, some foreign multinational companies are entering the Chinese market to seek suppliers to produce their goods. The Company believes that having large multinational companies seeking suppliers to produce their products in China will benefit the Company. In addition, the Company is negotiating with several large companies in the industry in developed countries which intend to outsource some of their production lines.

The Company estimates that China’s local market demand for medical dressings and medical disposables will continue to grow. This presents a significant opportunity for the Company. 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.

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 composed of petroleum, a non-renewable energy resource. In recent years, cases about 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 be a competitive advantage because its new PurCotton® products are primarily made of natural cotton and manufactured in an environmentally-friendly fashion. The Company believes PurCotton® products are medium- to long-term growth contributor to its revenue, because they can be applied to consumer products as well as to the medical industry.  
 
6

 
Competition

The Company competes based upon manufacturing capacity, product quality, product cost, ability to produce a diverse range of products and logistical capabilities.

The Company encounters significant competition within China and throughout the world. Some of the Company’s competitors have greater financial resources, additional human resources, and more established market recognition in both domestic and international markets. The Company believes that its China-based competitors have lower labor costs, but their products often lack diversity. With respect to the Company’s competitors located outside China, it believes competitors in India generally utilize older equipment to manufacture their products, resulting in lower product quality. The Company’s competition in Europe and North and South America may have a geographic advantage in the European Union and U.S. markets, however, the Company believes they are generally manufacturing on a smaller scale, have less product diversity and higher production costs.

The Company’s competitive advantages

The Company’s customers in the medical industry employ high quality standards, since product quality and safety are their primary consideration.  They perform strict factory and production system verification and product quality testing on their target suppliers. Once a supplier passes these tests, it is costly to switch to another.  Compared with the Company’s competitors, its competitive advantages include the following:

- Sound quality management system and certificates obtained. The Company has already established three quality management systems, ISO9001:2000 quality management system, ISO13485:2003 medical devices quality control system, and 21CFR Part 820 U.S. Food and Drug Administration (“U.S. FDA”) Medical Device Quality System Regulation. Also, the Company is proud to have received U.S. FDA clearance to import sterilized products into the United States. The Company also has 48 types of products registered and listed with the U.S. FDA, which include the sterilization pouches and face masks that have received 510K (a U.S. FDA regulatory standard) clearance. Currently, over 90% of the Company’s products have obtained European Union CE certificates. The remaining approximately 10% of the Company’s products are not required to obtain European Union CE certificates because these products are neither medical related products nor sold in international marketplace. The Japanese certificates, which are awarded to individual factories, have been granted to the Company’s Shenzhen, Jiayu and Chongyang factories, which are factories qualified and entitled to export products to Japan.

- Quality control on vertically integrated production capacities. The Company has shaped its integrated manufacturing lines to meet client preferences of procuring a range of products from a single trusted supplier. The Company’s services range from raw material processing, bleaching, folding, packaging and sterilization to finished product delivery. The Company is adamant about maintaining stringent quality control throughout each stage. The Company has factories in Hubei, Shenzhen and Shanghai. The production plants in Hubei province are primarily focused on upstream manufacturing, while the facilities in Shenzhen are focused on higher value-added processing to finished products. The Company’s Shanghai facilities are mainly concentrated on manufacturing and marketing self-adhesive bandages.   

- Innovation. The Company is dedicated to invest in research and development to drive innovation. The Company concentrates on innovation in value-added features for its medical dressings and medical disposables. It also focuses on the PurCotton® manufacturing process to improve product quality and enhance efficiency, and continues to expand its PurCotton® production line through line extensions and value-added features. The Company has already obtained invention patents in China, the United States, Russia, Singapore, South Africa, Mexico, Nigeria, the Philippines and member states of the European Patent Office for the invention of 100% spunlace cotton nonwoven manufacture process.

The Company’s Strategy

The Company’s primary business strategy is to achieve annual growth in revenue by building its brand and reputation. The Company seeks to implement its business strategy by focusing on:

Marketing Its Own Medical Branded Products Winner® Products in China

The surgical dressings and medical disposables market in China is expanding quickly. The Company believes that the demand for disposable medical products in China will experience rapid growth in the future as the Chinese government reforms the medical care system. These factors create opportunities for companies, such as Winner Medical, that already follow such strict conduct and quality control regulations.
 
7

 
During the nine months ended June 30, 2010, approximately 22.29% of the Company’s sales revenue was generated in China, and this percentage is expected to increase. The Company’s medical dressings and medical disposables sales channels in China include: hospitals, local distributors and chain drugstores.

PurCotton® Products

The PurCotton®, spunlace cotton nonwoven products, are expected to have advantages over woven cotton or synthetic nonwoven fabric, as they are natural, safe, strong, durable, healthy, environmentally friendly, and of higher quality. The Company intends to utilize its patented manufacturing process to produce PurCotton® at a lower cost than woven cotton products, so it believes that the launch of the cotton nonwoven spunlace products will provide a significant advantage to the Company. Patent applications covering the invention of spunlace cotton nonwoven process has been made in more than 50 countries. Patents have been granted in China, the United States, Russia, Singapore, South Africa, Mexico, Nigeria, the Philippines, and member states of the European Patent Office.

In order to build and market the PurCotton® brand in China, the Company’s subsidiary in Shenzhen, set up a wholly-owned subsidiary, Shenzhen PurCotton Technology Co., Ltd. (“Shenzhen PurCotton”), which aims at selling PurCotton® branded products by its own marketing and sales efforts in the China marketplace. The Company is expected to diversify its sales channels and product categories in the future. The main distribution channels consist of chain stores (PurCotton® stores), on-line sales, supermarkets and wholesale to large customers.

To execute its strategy, the Company entered into an agreement in 2005 with the local government agency of Huanggang to acquire 564,742 square meters of land, approximately 140 acres, that will mostly be dedicated to the construction of production facilities for 100% cotton spunlace nonwoven fabric in the Company’s subsidiary Winner Medical (Huanggang) Co., Ltd. (“Winner Huanggang”). Land use right certificates of this land were issued to the Company in November 2005 and July 2007. As of June 30, 2010, the first two PurCotton® manufacturing lines are producing at full capacity, with a total production capacity of 200 tons per month. The third manufacturing line has started production and is improving capacity. In August 2009, the Company entered into a contract with a supplier in China to purchase new machinery for setting up the fourth production line, which is expected to commence operation before December 2010.
 
During the nine months ended June 30, 2010 and 2009, sales revenue from PurCotton® products reached approximately $7,000,000, or 8.07% of total sales revenue and $3,158,000, or 4.47 % of total sales revenue respectively.

Focus on higher margin products

Regarding its long term plan, the Company is executing a systematic plan for the marketing and sales of PurCotton® products, which have a higher margin than its traditional products. Even though it experienced low margins during the initial stage of the PurCotton® product launch, the Company believes it will generate a higher margin than its traditional products once PurCotton® products commence mass production and are well accepted by its customers. At the same time, the Company is working on technical improvements to its equipment at Winner Huanggang to increase production efficiency and capacity.  

Recent Developments

On April 15, 2010, Winner Medical signed an employment agreement with Mr. Zihan Wu, who was appointed as the general manager of Shenzhen PurCotton. The strong e-commerce and brand building experience of Mr. Wu is expected to assist the Company's efforts in building its PurCotton® Business-to-Consumer online stores in order to better meet consumer's diversified shopping requirements. Also effective April 15, 2010, the Company’s board approved the granting of stock units to Mr. Wu in the aggregate sum of five hundred thousand (500,000) units. Expansion of PurCotton’s consumer business is fairly new for the Company. After Shenzhen PurCotton was in operation for six months, the Company concluded that the current operation, marketing strategy as well as sales techniques and targets are different from its initial plan. Hence, the Company and Mr. Wu agreed to terminate this stock unit scheme and re-evaluate and re-assess the operational targets and reward conditions.

On July 27, 2009, the Company entered into a consulting agreement and a restricted common stock incentive plan agreement with a consulting firm. Pursuant to the agreement, the consulting firm provides market research and analysis, brand building, and promotion services to develop PurCotton® products in China. Effective June 19, 2010, in order to harmonize the Company's marketing and development plans, Shenzhen PurCotton and the consulting firm entered into re-negotiation, after which both parties agreed to take three months to reconsider whether to continue the cooperation or to modify the terms of the consulting agreement. All rights and obligations stated in the consulting agreement signed on July 27, 2009 have been temporarily suspended.

Winner Medical completed a shelf registration on Form S-3 (File No. 333-165164), which was filed with the Securities and Exchange Commission on March 3, 2010, and became effective March 18, 2010. Under the shelf registration statement, the Company may, from time to time, sell up to $50,000,000 in aggregate of common stock, preferred stock, warrants, debt securities, or a combination of these securities, or units. On April 30 and May 19, 2010, the Company completed a public offering from the shelf registration of 1,587,000 shares of common stock at a price of $6.10 per share. After the public offering, the Company received net proceeds of approximately $8.8 million, having paid approximately $0.53 million to the underwriters as underwriting discounts and commissions and approximately $0.35 million for miscellaneous offering expenses. The Company intends to use the net proceeds from this offering to expand the production capacity of its PurCotton® product lines and for general corporate and working capital purposes.  

8

 
As of August 11, 2010, Shenzhen PurCotton, owned and operated 17 PurCotton® chain stores in Shenzhen, Guangdong Province. Each store contains four types of PurCotton® branded personal products and healthcare supplies, which include PurCotton® baby personal products, feminine personal products, daily home care products and medical care products. The main distribution channels for these products include chain stores (PurCotton® stores), on-line sales, supermarkets and wholesale to large customers. PurCotton® stores are mainly located in downtown shopping malls. The projected average total cost of each store, with sizes ranging from 50 to 200 square meters, is approximately $40,000 to $60,000, which includes the lease, deposit, build out, instruments, inventory stocking and one month salary for salespersons. Future minimum lease payments for non-cancelable chain stores was $1,308,000 for the nine months ended June 30, 2010 compared with $Nil for the same period of 2009, as a result of the Company entering into lease agreements relating to these chain stores. The Company is slowing down the pace of chain stores opening because management has been operating the PurCotton’s consumer business for less than one year. In order to build a healthy and sustainable retail business, the Company is carefully evaluating all relevant operating and financial metrics, including store location and size, product packaging and pricing, brand image, customer service and marketing. Recently, the Company opened its first online PurCotton® store featuring its entire array of products on Taobao.com, which is the leading online trading platform in China. This is the Company’s first initiative to establish PurCotton® Business-to-Consumer online stores in order to address the consumer's evolving shopping preferences. The Company is also planning to build its own Business-to-Customer trading website that will be co-branded through its retail stores, in addition to other online mediums to reach a much broader customer base throughout China.
 
Results of Operations

Comparison for the Three Months Ended June 30, 2010 and 2009

The following sets forth certain of the Company’s income statement information for the three months ended June 30, 2010 and 2009.

Comparison of the Three Months Ended June 30, 2010 and 2009
(All amounts, other than percentages, in thousand of U.S. Dollars)