LOTUS
PHARMACEUTICALS, INC. AND SUBSIDIARIES
NOTES
TO
UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH
31,
2008
NOTE
1 -
ORGANIZATION
AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Organization
Lotus
Pharmaceuticals, Inc. (“Lotus” or the “Company”), formerly S.E. Asia Trading
Company, Inc. (“SEAA”), was incorporated on January 28, 2004 under the laws of
the State of Nevada. SEAA operated as a retailer of jewelry, framed art and
home
accessories. In December 2006, SEAA changed its name to Lotus Pharmaceuticals,
Inc.
On
September 6, 2006, the Company entered into a definitive Share Exchange
Agreement with Lotus Pharmaceutical International, Inc. (“Lotus International”),
whereby the Company acquired all of the outstanding common stock of Lotus
International in exchange for newly-issued stock of the Company to Lotus
International’s shareholders. On September 28, 2006 (the closing date), Lotus
International became a wholly-owned subsidiary of the Company and Lotus
International’s shareholders became the owners of the majority of the Company’s
voting stock. The acquisition of Lotus International by the Company was
accounted for as a reverse merger because on a post-merger basis, the former
shareholders of Lotus International hold a majority of the outstanding
common stock of the Company on a voting and fully-diluted basis. As a result,
Lotus International is deemed to be the acquirer for accounting
purposes.
Lotus
International was incorporated under the laws the State of Nevada on August
28, 2006 to develop and market pharmaceutical products in the People’s Republic
of China (“PRC” or “China”). PRC law currently has limits on foreign ownership
of certain companies. To comply with these foreign ownership restrictions,
Lotus
operates its pharmaceutical business in China through Beijing Liang Fang
Pharmaceutical Co., Ltd. (“Liang Fang”) and an affiliate of Liang Fang, Beijing
En Zhe Jia Shi Pharmaceutical Co., Ltd. (“En Zhe Jia”), both of which are
pharmaceutical companies headquartered in the PRC and organized under the
laws
of the PRC (hereinafter, referred to together as “Lotus East”). Lotus
International has contractual arrangements with Lotus East and its shareholders
pursuant to which Lotus International will provide technology consulting
and
other general business operation services to Lotus East. Through these
contractual arrangements, Lotus International also has the ability to
substantially influence Lotus East’s daily operations and financial affairs,
appoint its senior executives and approve all matters requiring shareholder
approval. As a result of these contractual arrangements, which enable Lotus
International to control Lotus East, Lotus International is considered
the primary beneficiary of Lotus East. Accordingly, the consolidated financial
statements include the accounts of Lotus Pharmaceuticals, Inc. and its
wholly-owned subsidiary, Lotus International and companies under its control
(Lotus East).
On
September 6, 2006, Lotus International entered into the following
contractual arrangements:
Operating
Agreement
.
Pursuant to the operating agreement among Lotus, Lotus East and the shareholders
of Lotus East, (collectively “Lotus East’s Shareholders”), Lotus provides
guidance and instructions on Lotus East’s daily operations, financial management
and employment issues. The shareholders of Lotus East must designate the
candidates recommended by Lotus as their representatives on Lotus East’s Board
of Directors. Lotus has the right to appoint senior executives of Lotus East.
In
addition, Lotus agreed to guarantee Lotus East’s performance under any
agreements or arrangements relating to Lotus East’s business arrangements with
any third party. Lotus East, in return, agreed to pledge its accounts receivable
and all of its assets to Lotus. Moreover, Lotus East agreed that without
the
prior consent of Lotus, Lotus East would not engage in any transaction that
could materially affect the assets, liabilities, rights or operations of
Lotus
East, including, without limitation, incurrence or assumption of any
indebtedness, sale or purchase of any assets or rights, incurrence of any
encumbrance on any of its assets or intellectual property rights in favor
of a
third party or transfer of any agreements relating to its business operation
to
any third party. The term of this agreement is ten (10) years from September
6,
2006 and may be extended only upon Lotus’s written confirmation prior to the
expiration of the this agreement, with the extended term to be mutually agreed
upon by the parties.
LOTUS
PHARMACEUTICALS, INC. AND SUBSIDIARIES
NOTES
TO
UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH
31,
2008
NOTE
1 -
ORGANIZATION
AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Organization
(continued)
Consulting
Services Agreement
.
Pursuant to the exclusive consulting services agreements between Lotus and
Lotus
East, Lotus has the exclusive right to provide to Lotus East general
pharmaceutical business operations services as well as consulting services
related to the technological research and development of pharmaceutical products
as well as general business operation advice and strategic planning (the
“Services”). Under this agreement, Lotus owns the intellectual property rights
developed or discovered through research and development, in the course of
providing the Services, or derived from the provision of the Services. Lotus
East is required to pay quarterly consulting service fees in Renminbi (“RMB”),
the functional currency of the PRC, to Lotus that is equal to Lotus East’s
profits, as defined, for such quarter. To date, no consulting fees have been
paid by Lotus East.
Equity
Pledge Agreement
.
Under
the equity pledge agreement between the shareholders of Lotus East and Lotus,
the shareholders of Lotus East pledged all of their equity interests in Lotus
East to Lotus to guarantee Lotus East’s performance of its obligations under the
technology consulting agreement. If Lotus East or Lotus East’s Shareholders
breaches its respective contractual obligations, Lotus, as pledgee, will
be
entitled to certain rights, including the right to sell the pledged equity
interests. Lotus East’s Shareholders also agreed that upon occurrence of any
event of default, Lotus shall be granted an exclusive, irrevocable power
of
attorney to take actions in the place and stead of Lotus East’s
Shareholders to carry out the security provisions of the equity pledge agreement
and take any action and execute any instrument that Lotus may deem necessary
or
advisable to accomplish the purposes of the equity pledge agreement. The
shareholders of Lotus East agreed not to dispose of the pledged equity interests
or take any actions that would prejudice Lotus’ interest. The equity pledge
agreement will expire two (2) years after Lotus East’s obligations under the
exclusive consulting services agreements have been fulfilled.
Option
Agreement
.
Under
the option agreement between the shareholders of Lotus East and Lotus, the
shareholders of Lotus East irrevocably granted Lotus or its designated person
an
exclusive option to purchase, to the extent permitted under PRC law, all
or part
of the equity interests in Lotus East for the cost of the initial contributions
to the registered capital or the minimum amount of consideration permitted
by
applicable PRC law. Lotus or its designated person has sole discretion to
decide
when to exercise the option, whether in part or in full. The term of this
agreement is 10 years from September 6, 2006 and may be extended prior to
its
expiration by written agreement of the parties.
Proxy
Agreement
.
Pursuant to the proxy agreement among Lotus and Lotus East’s Shareholders, Lotus
East’s Shareholders agreed to irrevocably grant a person to be designated by
Lotus with the right to exercise Lotus East’s Shareholders’ voting rights and
their other rights, including the attendance at and the voting of Lotus East’s
Shareholders’ shares at the shareholders’ meetings (or by written consent in
lieu of such meetings) in accordance with applicable laws and its Article
of
Association, including but not limited to the rights to sell or transfer
all or
any of his equity interests of Lotus East, and appoint and vote for the
directors and Chairman as the authorized representative of the shareholders
of
Lotus East. The term of this Proxy Agreement is ten (10) years from September 6,
2006 and may be extended prior to its expiration by written agreement of
the
parties.
Liang
Fang is a Chinese limited liability company and was formed under laws of
the
People’s Republic of China on June 21, 2000. Liang Fang is engaged in the
production, trade and retailing of pharmaceuticals. Further, Liang Fang is
focused on development of innovative medicines and investing strategic growth
to
address various medical needs for patients worldwide. Liang Fang’s operations
are based in Beijing, China.
As
of March 31, 2008, Liang Fang owns and operates 10 drug stores throughout
Beijing, China. These drugstores sell Western and traditional Chinese medicines,
and medical treatment accessories.
LOTUS
PHARMACEUTICALS, INC. AND SUBSIDIARIES
NOTES
TO
UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH
31,
2008
NOTE
1 -
ORGANIZATION
AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(continued)
Organization
(continued)
Liang
Fang’s affiliate, En Zhe Jia is a Chinese limited liability company and was
formed under laws of the People’s Republic of China on September 17, 1999. En
Zhe Jia is the sole manufacturer for Liang Fang and maintains facilities
for the
production of medicines, patented Chinese medicine, as well as the research
and
production of other new medicines.
As
a result of the management agreements between Lotus International and Lotus
East, Lotus East was deemed to be the acquirer of Lotus International for
accounting purposes. Accordingly, the financial statement data presented
are
those of Lotus East for all periods prior to the Company’s acquisition of Lotus
International on September 28, 2006, and the financial statements of the
consolidated companies from the acquisition date forward.
On
May 29, 2007, the Company formed a new entity, Lotus Century Pharmaceutical
(Beijing) Technology Co., Ltd. (‘‘Lotus Century’’), a
wholly
foreign-owned enterprise (“WFOE”) organized under the laws of the Peoples’
Republic of China
.
Lotus Century is a Chinese limited liability company and a wholly-owned
subsidiary of Lotus Pharmaceutical International, Inc. Lotus Century intends
to
be engaged in development of innovative medicines, medical technology consulting
and outsourcing services, and related training services.
Basis
of presentation
The
interim consolidated financial statements included herein have been prepared
by
the Company, pursuant to the rules and regulations of the Securities and
Exchange Commission (the “SEC”). Certain information and footnote disclosures
normally included in an annual financial statement prepared in accordance
with
generally accepted accounting principles in the United States (“GAAP”) have been
condensed or omitted pursuant to such rules and regulations. In the opinion
of
management, the interim consolidated financial statements reflect all
adjustments (consisting only of normal recurring adjustments) necessary for
a
fair presentation of the statement of the results for the interim periods
presented. These interim consolidated financial statements should be read
in
conjunction with the audited consolidated financial statements and notes
thereto, as well as the accompanying Management’s Discussion and Analysis of
Financial Condition and Results of Operations for the year ended December
31,
2007 included in its Annual Report on Form 10-K. Interim financial results
are
not necessarily indicative of the results that may be expected for a full
year.
The
accompanying unaudited consolidated financial statements are prepared in
accordance with generally accepted accounting principles in the United States
of
America (“US GAAP”). The consolidated statements include the accounts of Lotus
Pharmaceuticals, Inc. and its wholly-owned subsidiaries, Lotus and Lotus
Century
and
variable
interest entities
under its control (Liang Fang and En Zhe Jia). All significant inter-company
balances and transactions have been eliminated.
Use
of estimates
The
preparation of financial statements in conformity with US GAAP requires
management to make estimates and assumptions that affect certain reported
amounts and disclosures. Accordingly, actual results could differ from those
estimates. Significant estimates in 2008 and 2007 include the allowance for
doubtful accounts, the allowance for obsolete inventory, the useful life
of
property and equipment and intangible assets, and accruals for taxes
due.
LOTUS
PHARMACEUTICALS, INC. AND SUBSIDIARIES
NOTES
TO
UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH
31,
2008
NOTE
1 -
BASIS
OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(continued)
Fair
value of financial instruments
The
carrying amounts reported in the balance sheet for cash, accounts receivable,
accounts payable and accrued expenses, convertible debt, customer advances,
and
amounts due to related parties approximate their fair market value based
on the
short-term maturity of these instruments.
Cash
and cash equivalents
For
purposes of the consolidated statements of cash flows, the Company considers
all
highly liquid instruments purchased with a maturity of three months or less
and
money market accounts to be cash equivalents.
The
Company maintains cash and cash equivalents with various financial institutions
mainly in the PRC and the United States. Balances in the United States are
insured up to $100,000 at each bank.
Accounts
receivable
The
Company records accounts receivable, net of an allowance for doubtful accounts
and sales returns. The Company maintains allowances for doubtful accounts
for
estimated losses. The Company reviews the accounts receivable on a periodic
basis and makes general and specific allowances when there is doubt as to
the
collectability of individual balances. In evaluating the collectability of
individual receivable balances, the Company considers many factors, including
the age of the balance, customer’s historical payment history, its current
credit-worthiness and current economic trends. The amount of the provision,
if
any is recognized in the consolidated statement of operations within “General
and administrative expenses”. Accounts are written off after exhaustive efforts
at collection. The Company policy regarding sales returns is discussed below.
The activity in the allowance for doubtful accounts and sales returns accounts
for accounts receivable for the periods ended March 31, 2008 and December
31,
2007 are as follows:
|
|
Allowance
for
doubtful accounts
|
|
Allowance
for
sales returns
|
|
Total
|
|
Balance
- December 31, 2006
|
|
$
|
539,627
|
|
$
|
2,297,399
|
|
$
|
2,837,026
|
|
Reductions
|
|
|
(26,617
|
)
|
|
(2,354,720
|
)
|
|
(2,381,337
|
)
|
Foreign
currency translation adjustments
|
|
|
35,073
|
|
|
57,321
|
|
|
92,394
|
|
Balance
- December 31, 2007
|
|
|
548,083
|
|
|
-
|
|
|
548,083
|
|
Additions
|
|
|
53,305
|
|
|
-
|
|
|
53,305
|
|
Foreign
currency translation adjustments
|
|
|
23,947
|
|
|
-
|
|
|
23,947
|
|
Balance
- March 31, 2008
|
|
$
|
625,335
|
|
$
|
-
|
|
$
|
625,335
|
|
Inventories
Inventories,
consisting of raw materials and finished goods related to the Company’s products
are stated at the lower of cost or market utilizing the weighted average
method.
An allowance is established when management determines that certain inventories
may not be saleable. If inventory costs exceed expected market value due
to
obsolescence or quantities in excess of expected demand, the Company will
record
reserves for the difference between the cost and the market value. These
reserves are recorded based on estimates and reflected in cost of sales.
LOTUS
PHARMACEUTICALS, INC. AND SUBSIDIARIES
NOTES
TO
UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH
31,
2008
NOTE
1 -
ORGANIZATION
AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(continued)
Property
and equipment
Property
and equipment are carried at cost and are depreciated on a straight-line
basis
over the estimated useful lives of the assets. The cost of repairs and
maintenance is expensed as incurred; major replacements and improvements
are
capitalized. When assets are retired or disposed of, the cost and accumulated
depreciation are removed from the accounts, and any resulting gains or losses
are included in income in the year of disposition. In accordance with Statement
of Financial Accounting Standards (SFAS) No. 144, “Accounting for the Impairment
or Disposal of Long-Lived Assets”, the Company examines the possibility of
decreases in the value of fixed assets when events or changes in circumstances
reflect the fact that their recorded value may not be recoverable.
I
mpairment
of long-lived assets
In
accordance with Statement of Financial Accounting Standards (SFAS) No. 144,
“Accounting for the Impairment or Disposal of Long-Lived Assets”, the Company
periodically reviews its long-lived assets for impairment whenever events
or
changes in circumstances indicate that the carrying amount of the assets
may not
be fully recoverable. The Company recognizes an impairment loss when the
sum of
expected undiscounted future cash flows is less than the carrying amount
of the
asset. The amount of impairment is measured as the difference between the
asset’s estimated fair value and its book value.
The
Company did not consider it necessary to record any impairment charges during
the year ended December 31, 2007 and during the three months ended March
31,
2008.
Advances
from customers
Income
taxes
The
Company is governed by the Income Tax Law of the People’s Republic of China and
the United States. Income taxes are accounted for under Statement of Financial
Accounting Standards No. 109, “Accounting for Income Taxes,” which is an asset
and liability approach that requires the recognition of deferred tax assets
and
liabilities for the expected future tax consequences of events that have
been
recognized in the Company’s financial statements or tax returns.
Earnings
per common share
Basic
earnings per share is computed by dividing net earnings by the weighted average
number of shares of common stock outstanding during the period. Diluted income
per share is computed by dividing net income by the weighted average number
of
shares of common stock, common stock equivalents and potentially dilutive
securities outstanding during each period. Potentially dilutive common shares
consist of the common shares issuable upon the conversion of convertible
debt
(using the if-converted method). The following table presents a reconciliation
of basic and diluted earnings per share:
|
|
For
the Three Months Ended March 31,
|
|
|
|
2008
|
|
2007
|
|
Net
income for basic and diluted earnings per share
|
|
$
|
996,099
|
|
$
|
837,301
|
|
|
|
|
|
|
|
|
|
Weighted
average shares outstanding - basic
|
|
|
42,035,958
|
|
|
41,280,000
|
|
Effect
of dilutive securities:
|
|
|
|
|
|
|
|
Unexercised
warrants
|
|
|
—
|
|
|
—
|
|
Convertible
debentures
|
|
|
—
|
|
|
3,000,000
|
|
Convertible
redeemable preferred shares
|
|
|
5,747,118
|
|
|
—
|
|
Weighted
average shares outstanding- diluted
|
|
|
47,783,076
|
|
|
44,280,000
|
|
Earnings
per share - basic
|
|
$
|
0.02
|
|
$
|
0.02
|
|
Earnings
per share - diluted
|
|
$
|
0.02
|
|
$
|
0.02
|
|
LOTUS
PHARMACEUTICALS, INC. AND SUBSIDIARIES
NOTES
TO
UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH
31,
2008
NOTE
1 -
ORGANIZATION
AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(continued)
At
March
31, 2008 and 2007, 5,227,000 and 1,500,000 outstanding warrants have not
been
included in the calculation of diluted earnings per shares as the effect
would
be anti-dilutive. The closing market price of the Company on March 31,
2008 and
2007 was lower than the exercise price of all outstanding warrants. Because
of
that, the Company assumes that none of the outstanding warrants at that
date
would have been exercised and therefore none were included in the computation
of
the diluted earnings per share for period ended March 31, 2008 and 2007.
Accordingly, the Company has excluded any effect of outstanding warrants
as
their effect would be anti-dilutive.
Revenue
recognition
Product
sales
Product
sales are generally recognized when title to the product has transferred
to
customers in accordance with the terms of the sale. The Company recognizes
revenue in accordance with the Securities and Exchange Commission’s (SEC) Staff
Accounting Bulletin (SAB) No. 101, “
Revenue Recognition in Financial Statements
“
as
amended by SAB No. 104 (together, “SAB 104”), and Statement of
Financial Accounting Standards (SFAS) No. 48 “
Revenue Recognition When Right of Return Exists.
“
SAB 104 states that revenue should not be recognized until it is
realized or realizable and earned. In general, the Company records revenue
when
persuasive evidence of an arrangement exists, services have been rendered
or
product delivery has occurred, the sales price to the customer is fixed or
determinable, and collectability is reasonably assured.
SFAS No. 48 states
that revenue from sales transactions where the buyer has the right to return
the
product shall be recognized at the time of sale only if the seller’s price to
the buyer is substantially fixed or determinable at the date of sale, the
buyer
has paid the seller, or the buyer is obligated to pay the seller and the
obligation is not contingent on resale of the product, the buyer’s obligation to
the seller would not be changed in the event of theft or physical destruction
or
damage of the product, the buyer acquiring the product for resale has economic
substance apart from that provided by the seller, the seller does not have
significant obligations for future performance to directly bring about resale
of
the product by the buyer, and the amount of future returns can be
reasonably estimated.
The
Company’s net product revenues represent total product revenues less allowances
for returns.
Allowance
for returns
The
Company accounts for sales returns in accordance with Statements of Financial
Accounting Standards (SFAS) No. 48,
Revenue
Recognition When Right of Return Exists
,
by
establishing an accrual in an amount equal to its estimate of sales recorded
for
which the related products are expected to be returned. The Company determines
the estimate of the sales return accrual primarily based on historical
experience regarding sales returns, but also by considering other factors
that
could impact sales returns. These factors include levels of inventory in
the
distribution channel, estimated shelf life, product discontinuances, and
price
changes of competitive products, introductions of generic products and
introductions of competitive new products. In general, for wholesale sales,
the
Company provides credit for product returns that are returned six months
prior
to and up to six months after the product expiration date. Upon sale, the
Company estimates an allowance for future product returns. The Company provides
additional reserves for contemporaneous events that were not known and knowable
at the time of shipment. In order to reasonably estimate future returns,
the
Company analyzed both quantitative and qualitative information including,
but
not limited to, actual return rates, the level of product manufactured by
the
Company, the level of product in the distribution channel, expected shelf
life
of the product, current and projected product demand, the introduction of
new or
generic products that may erode current demand, and general economic and
industry wide indicators. The Company also utilizes the guidance provided
in
SAB 104 in establishing its return estimates. At March 31, 2008 and
December 31, 2007, the Company’s allowance for returns was $0.
LOTUS
PHARMACEUTICALS, INC. AND SUBSIDIARIES
NOTES
TO
UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH
31,
2008
NOTE
1 -
ORGANIZATION
AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(continued)
Other
revenues
Other
revenues consist of (i) leasing revenues received for the lease of retail
space
to various retail merchants; (ii) advertising revenues from the lease of
counter
space at the Company’s retail locations; (iii) leasing revenue from the lease of
retail space to licensed medical practitioners; (iv) revenues received by
the
Company for research and development projects and lab testing jobs conducted
on
behalf of third party companies, and; (v) revenues received for performing
third
party contract manufacturing projects. In connection with third-party
manufacturing, the customer supplies the raw materials and the Company is
paid a
fee for manufacturing their product and revenue is recognized at the completion
of the manufacturing job. The Company recognizes revenues from leasing of
space
and advertising revenues as earned from contracting third parties. The Company
recognizes revenues upon performance of any research or lab testing jobs.
Revenues received in advance are reflected as deferred revenue on the
accompanying balance sheet. Additionally, the Company receives income from
the
sale of developed drug formulas. Income from the sale of drug formulas are
recognized upon performance of all of the Company’s obligations under the
respective sales contract and are included in other income on the accompanying
consolidated statement of operations.
Concentrations
of credit risk
Financial
instruments which potentially subject the Company to concentrations of credit
risk consist principally of cash and trade accounts receivable. Substantially
all of the Company’s cash is maintained with state-owned banks within the
People’s Republic of China of which no deposits are covered by insurance. The
Company has not experienced any losses in such accounts and believes it is
not
exposed to any risks on its cash in bank accounts. A significant portion
of the
Company’s sales are credit sales which are primarily to customers whose ability
to pay is dependent upon the industry economics prevailing in these areas;
however, concentrations of credit risk with respect to trade accounts
receivables is limited due to generally short payment terms. The Company
also
performs ongoing credit evaluations of its customers to help further reduce
credit risk.
Shipping
costs
Shipping
costs are included in cost of sales and totaled $91,949 and $240,425 for
the
three months ended March 31, 2008 and 2007, respectively.
A
dvertising
Advertising
is expensed as incurred. Advertising expenses amounted to $153,295 and $130,454
for the three months ended March 31, 2008 and 2007, respectively.
Research
and development
Research
and development costs are expensed as incurred. These costs primarily consist
of
cost of material used and salaries paid for the development of the Company’s
products and fees paid to third parties. For the three months ended March
31,
2008 and 2007, the Company expensed $710,225 and $91,822 as research and
development expense, respectively, and paid for future research and development
services in the amount of $156,246 and 769,742 at March 31, 2008 and December
31, 2007, respectively, which has been included in prepaid expenses on the
accompanying balance sheets and will be expensed over the contract
term.
LOTUS
PHARMACEUTICALS, INC. AND SUBSIDIARIES
NOTES
TO
UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH
31,
2008
NOTE
1 -
ORGANIZATION
AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(continued)
Foreign
currency translation
The
reporting currency of the Company is the U.S. dollar. The functional currency
of
the Company is the local currency, the Chinese Renminbi (“RMB”). Results of
operations and cash flows are translated at average exchange rates during
the
period, assets and liabilities are translated at the unified exchange rate
at
the end of the period, and equity is translated at historical exchange rates.
Translation adjustments resulting from the process of translating the local
currency financial statements into U.S. dollars are included in determining
comprehensive income. The cumulative translation adjustment and effect of
exchange rate changes on cash for the three months ended March 31, 2008 and
2007
was $272,856 and $20,122, respectively. Transaction gains and losses that
arise
from exchange rate fluctuations on transactions denominated in a currency
other
than the functional currency are included in the results of operations as
incurred.
Asset
and
liability accounts at March 31, 2008 and December 31, 2007 were translated
at
7.0222 RMB to $1.00 USD and at 7.3141 RMB to $1.00 USD, respectively. Equity
accounts were stated at their historical rate. The average translation rates
applied to income statements for the three months ended March 31, 2008 and
2007
were 7.1757 RMB and 7.7714 RMB to $1.00 USD, respectively. In accordance
with
Statement of Financial Accounting Standards No. 95, "Statement of Cash Flows,"
cash flows from the Company's operations is calculated based upon the local
currencies using the average translation rate. As a result, amounts related
to
assets and liabilities reported on the statement of cash flows will not
necessarily agree with changes in the corresponding balances on the balance
sheet.
Accumulated
other comprehensive income
Accumulated
other comprehensive income consisted of unrealized gains on currency translation
adjustments from the translation of financial statements from Chinese RMB
to US
dollars. As of March 31, 2008 and December 31, 2007, accumulated other
comprehensive income was $3,435,760 and $1,981,557, respectively.
Recent
Accounting Pronouncements
In
September 2006, the FASB issued SFAS No. 157,
“Fair
Value Measurements”
(SFAS 157), which provides guidance for how companies should measure fair
value when required to use a fair value measurement for recognition or
disclosure purposes under generally accepted accounting principle (GAAP).
SFAS 157 is effective for fiscal years beginning after November 15,
2007. The adoption of this interpretation did not have an impact on the
Company’s financial position, results of operations, or cash flows.
In
September 2006, the EITF reached a consensus on EITF Issue No. 06-1,
Accounting
for Consideration Given by a Service Provider to Manufacturers or Resellers
of
Equipment Necessary for an End-Customer to Receive Service from the Service
Provider
(EITF 06-1).
EITF 06-1 provides that consideration provided to the manufacturers or
resellers of specialized equipment should be accounted for as a reduction
of
revenue if the consideration provided is in the form of cash and the service
provider directs that such cash be provided directly to the customer. Otherwise,
the consideration should be recorded as an expense. The provisions of
EITF 06-1 will be effective on January 1, 2008.
The
adoption of this interpretation did not have an impact on the Company’s
financial position, results of operations, or cash flows.
In
December 2006, FASB Staff Position No. EITF 00-19-2,
“Accounting
for Registration Payment Arrangements”
was
issued. The FSP specifies that the contingent obligation to make future payments
or otherwise transfer consideration under a registration payment arrangement,
whether issued as a separate agreement or included as a provision of a financial
instrument or other agreement, should be separately recognized and measured
in
accordance with SFAS No. 5,
“Accounting
for Contingencies.”
The Company believes that its current accounting is consistent with the
FSP.
LOTUS
PHARMACEUTICALS, INC. AND SUBSIDIARIES
NOTES
TO
UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH
31,
2008
NOTE
1 -
ORGANIZATION
AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
In
February 2007, the FASB issued SFAS No. 159,
“The
Fair Value Option for Financial Assets and Financial Liabilities, Including
an
Amendment of FASB Statement No. 115”
, under which entities will now be permitted to measure many financial
instruments and certain other assets and liabilities at fair value on an
instrument-by-instrument basis. This Statement is effective as of the beginning
of an entity’s first fiscal year that begins after November 15, 2007. Early
adoption is permitted as of the beginning of a fiscal year that begins on
or
before November 15, 2007, provided the entity also elects to apply the
provisions of SFAS 157. The adoption of this interpretation did not have an
impact on the Company’s financial position, results of operations, or cash
flows.
In
December 2007, the FASB issued Statement of Financial Accounting Standards
No.
141R, Business Combinations (SFAS 141R) and Statement of Financial Accounting
Standards No. 160, Accounting and Reporting of Non-controlling Interests
in
Consolidated Financial Statements, an amendment of ARB No. 51 (SFAS 160).
These
two standards must be adopted in conjunction with each other on a prospective
basis. The most significant changes to business combination accounting pursuant
to SFAS 141R and SFAS 160 are the following: (a) recognize, with certain
exceptions, 100 percent of the fair values of assets acquired, liabilities
assumed and non-controlling interests in acquisitions of less than a 100
percent
controlling interest when the acquisition constitutes a change in control
of the
acquired entity, (b) acquirers’ shares issued in consideration for a business
combination will be measured at fair value on the closing date, not the
announcement date, (c) recognize contingent consideration arrangements at
their
acquisition date fair values, with subsequent changes in fair value generally
reflected in earnings, (d) the expensing of all transaction costs as incurred
and most restructuring costs, (e) recognition of pre-acquisition loss and
gain
contingencies at their acquisition date fair values, with certain exceptions,
(f) capitalization of acquired in-process research and development rather
than
expense recognition, (g) earn-out arrangements may be required to be re-measured
at fair value and (h) recognize changes that result from a business combination
transaction in an acquirer’s existing income tax valuation allowances and tax
uncertainty accruals as adjustments to income tax expense. The Company
anticipates these new standards will significantly affect the Company’s
accounting for future business combinations following adoption on January
1,
2009.
In
March 2008, the FASB issued SFAS No. 161,
Disclosures about Derivative Instruments and Hedging Activities
(“SFAS 161”). This statement requires companies to provide enhanced
disclosures about (a) how and why they use derivative instruments,
(b) how derivative instruments and related hedged items are accounted for
under Statement 133 and its related interpretations, and (c) how derivative
instruments and related hedged items affect a company’s financial position,
financial performance, and cash flows. SFAS 161 is effective for financial
statements issued for fiscal years and interim periods beginning after
November 15, 2008. The Company will adopt the new disclosure requirements
on or before the required effective date and thus will provide additional
disclosures in its consolidated financial statements when adopted.
In
April 2008, FASB Staff Position No. 142-3, Determination of the Useful Life
of Intangible Assets (FSP 142-3) was issued. This standard amends the factors
that should be considered in developing renewal or extension assumptions
used to
determine the useful life of a recognized intangible asset under FASB Statement
No. 142, Goodwill and Other Intangible Assets. FSP 142-3 is effective for
financial statements issued for fiscal years beginning after December 15,
2008, and interim periods within those fiscal years. Early adoption is
prohibited. The Company has not determined the impact on its financial
statements of this accounting standard.
LOTUS
PHARMACEUTICALS, INC. AND SUBSIDIARIES
NOTES
TO
UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH
31,
2008
NOTE
2 -
ACCOUNTS
RECEIVABLE
At
March
31, 2008 and December 31, 2007, accounts receivable consisted of the
following:
|
|
March
31, 2008
|
|
December
31, 2007
|
|
Accounts
receivable
|
|
$
|
21,969,425
|
|
$
|
20,978,910
|
|
Less:
allowance for doubtful accounts
|
|
|
(625,335
|
)
|
|
(548,083
|
)
|
|
|
$
|
21,344,090
|
|
$
|
20,430,827
|
|
NOTE
3 -
INVENTORIES
At
March
31, 2008 and December 31, 2007, inventories consisted of the
following:
|
|
March
31, 2008
|
|
December
31, 2007
|
|
Raw
materials
|
|
$
|
2,727,781
|
|
$
|
2,312,111
|
|
Work
in process
|
|
|
-
|
|
|
279,759
|
|
Packaging
materials
|
|
|
60,125
|
|
|
52,967
|
|
Finished
goods
|
|
|
4,039,399
|
|
|
808,456
|
|
|
|
|
6,827,305
|
|
|
3,453,293
|
|
Less:
reserve for obsolete inventory
|
|
|
(44,323
|
)
|
|
(42,554
|
)
|
|
|
$
|
6,782,982
|
|
$
|
3
,410,739
|
|
NOTE
4 -
PROPERTY
AND EQUIPMENT
At
March
31, 2008 and December 31, 2007, property and equipment consist of the
following:
|
|
Useful
Life
|
|
March
31, 2008
|
|
December
31, 2007
|
|
Office
equipment and furniture
|
|
5-8
Years
|
|
$
|
160,910
|
|
$
|
154,488
|
|
Manufacturing
equipment
|
|
10
- 15 Years
|
|
|
5,241,797
|
|
|
5,032,601
|
|
Building
and building improvements
|
|
20
- 40 Years
|
|
|
3,061,134
|
|
|
2,938,966
|
|
|
|
|
|
|
|
8,463,841
|
|
|
8,126,055
|
|
Less:
accumulated depreciation
|
|
|
|
|
|
(2,152,157
|
)
|
|
(1,956,089
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
6,311,684
|
|
$
|
6,169,966
|
|
For
the three months ended March 31, 2008 and 2007, depreciation expense amounted
to
$112,302 and $88,293, of which $91,058 and $80,785 is included in cost of
sales,
respectively.
LOTUS
PHARMACEUTICALS, INC. AND SUBSIDIARIES
NOTES
TO
UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH
31,
2008
NOTE
5 -
INTANGIBLE
ASSETS
The
Company has manufacturing rights for two issued drugs. The manufacturing
rights
issued are in connection with the Company’s products Valsartan and Brimonidine.
The manufacturing rights for Valsartan became effective in November 2000
and had
a life of 6.5 years, which expired in 2007. The manufacturing rights for
Brimonidine became effective on August 27, 2005 and have a life of 5
years.
On
October 9, 2006, the Company entered into a five-year loan agreement and
a
contract with Wu Lan Cha Bu Emergency Hospital (“Wu Lan”), whereby the Company
agreed to lend to Wu Lan approximately $3,840,000 for the construction of
a
hospital ward in Inner Mongolia, China. In exchange for agreeing to lend
to Wu
Lan the funds, Wu Lan agreed
that
the Company will be the exclusive provider for all medicines and disposable
medical treatment apparatus to Wu Lan for a period of twenty (20) years.
In
October 2006, the Company’s chief executive officer, Mr. Liu, lent these funds
to Wu Lan on behalf of the Company. The Company entered into an assignment
agreement whereby the Company assigned all of its rights, obligations, and
receipts under the Loan Agreement to Mr. Liu, except for the rights to revenues
from the sale of medical and disposable medical treatment apparatus which
will
remain with the Company. As compensation to Mr. Liu for accepting the assignment
under the loan agreement including all of the risks and obligations and for
Liu
not accepting the rights to revenues from the sale of medical and disposable
medical treatment apparatus which will remain with the Company, the Company
agreed to pay Mr. Liu an aggregate of approximately $1,150,000 in 5 equal
annual
installments of approximately $230,000. Accordingly, the Company recorded
an
intangible asset of $1,151,263 related to exclusive rights to provide all
medicines and disposable medical treatment apparatus to Wu Lan for a period
of
twenty (20) years. The Company will amortize this exclusive right over a
term of
20 years.
At
March 31, 2008 and December 31, 2007, intangible assets consist of the
following:
|
|
March
31, 2008
|
|
December
31, 2007
|
|
Manufacturing
rights
|
|
$
|
1,236,898
|
|
$
|
1,187,569
|
|
Revenue
rights
|
|
|
1,281,686
|
|
|
1,230,500
|
|
|
|
|
2,518,584
|
|
|
2,418,069
|
|
|
|
|
|
|
|
|
|
Less:
accumulated amortization
|
|
|
(1,210,965
|
)
|
|
(1,126,747
|
)
|
|
|
|
|
|
|
|
|
|
|
$
|
1,307,619
|
|
$
|
1,291,322
|
|
Amortization
expense amounted to approximately $36,582 and $36,341 for three months ended
March 31, 2008 and 2007, respectively.
NOTE
6 -
OTHER
RECEIVABLES
In
February 2008, the Company entered into an agreement with a Beijing based
biotech company to advance the biotech company approximately RMB 19.8 million
($2,825,321). In return, the biotech company agreed to assist the Company
to
complete certain transactions. The advance is non-interest bearing and short
term in nature. As of May 15, 2008, such advanced amount has been fully repaid.
At March 31, 2008 and December 31, 2007, the Company’s other receivable balance
amounted to $2,825,321 and $0, respectively.
LOTUS
PHARMACEUTICALS, INC. AND SUBSIDIARIES
NOTES
TO
UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH
31,
2008
NOTE
7 -
RELATED
PARTY TRANSACTIONS
Notes
payable - related parties
Notes
payable - related parties consisted of the following at March 31, 2008 and
December 31, 2007:
|
|
March
31, 2008
|
|
December
31, 2007
|
|
Note
to Song Guoan, father of Song Zheng Hong, director and spouse of
Liu Zhong
Yi, due on December 30, 2015 with variable annual interest at 80%
of
current bank rate (6.26% at March 31, 2008 and December 31, 2007),
and
unsecured
|
|
$
|
743,666
|
|
$
|
1,895,424
|
|
|
|
|
|
|
|
|
|
Note
to Zheng Gui Xin, employee, due on December 30, 2015 with variable annual interest at 80% of current bank rate (6.26% at March 31,
2008 and December 31, 2007), and unsecured
|
|
|
1,609,894
|
|
|
1,545,645
|
|
|
|
|
|
|
|
|
|
Note
to Ma Zhao Zhao, employee, due on December 30, 2015 with variable
annual
interest at 80% of current bank rate (6.26% at March 31, 2008 and
December
31, 2007), and unsecured
|
|
|
644,759
|
|
|
619,027
|
|
|
|
|
|
|
|
|
|
Note
to Liu Zhong Yi, officer and director, due on December 30, 2015
with
variable annual interest at 80% of current bank rate (6.26% at
March 31,
2008 and December 31, 2007), and unsecured
|
|
|
1,372,454
|
|
|
136,244
|
|
|
|
|
|
|
|
|
|
Note
to Song Zheng Hong, director and spouse of the Company chief executive
officer, Liu Zhong Yi, due on December 30, 2015 with variable annual
interest at 80% of current bank rate (6.26% at March 31, 2008 and
December
31, 2007), and unsecured
|
|
|
564,706
|
|
|
542,168
|
|
|
|
|
|
|
|
|
|
Total
notes payable - related parties, long term
|
|
$
|
4,935,479
|
|
$
|
4,738,508
|
|
For
the
three months ended March 31, 2008 and 2007, interest expense related to these
related loans amounted to $76,258 and $55,489, respectively.
Due
to related parties
Several
employees of the Company, from time to time, provided advances to the Company
for operating expenses. During the three months ended March 31, 2008 and
2007,
the Company repaid approximately $0 and $58,300 of these advances, respectively.
At March 31, 2008 and December 31, 2007, the Company had a payable to these
employees amounting to $89,956 and $95,280, respectively. These advances
are
short-term in nature and non-interest bearing.
The
chief
executive officer of the Company and his spouse, from time to time, provided
advances to the Company for operating expenses.
During
the three months ended March 31, 2008 and 2007, the Company repaid approximately
$0 and $116,500 of these advances, respectively.
At
March
31, 2008 and December 31, 2007, the Company had a payable to the chief executive
officer and his spouse amounting to $317,854 and $0, respectively. These
advances are short-term in nature and non-interest bearing.
LOTUS
PHARMACEUTICALS, INC. AND SUBSIDIARIES
NOTES
TO
UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH
31,
2008
NOTE
7 -
RELATED
PARTY TRANSACTIONS (continued)
On
October 9, 2006, the Company entered into a five-year loan agreement and
a
contract with Wu Lan Cha Bu Emergency Hospital (“Wu Lan”), whereby the Company
agreed to lend to Wu Lan approximately $3,840,000 for the construction of
a
hospital ward in Inner Mongolia, China. In exchange for agreeing to lend
to Wu
Lan the funds, Wu Lan agreed that the Company will be the exclusive provider
for
all medicines and disposable medical treatment apparatus to Wu Lan for a
period
of twenty (20) years. In October 2006, the Company’s chief executive officer,
Mr. Liu, lent these funds to Wu Lan on behalf of the Company. Accordingly,
the
Company entered into an assignment agreement whereby the Company assigned
all of
its rights, obligations, and receipts under the Loan Agreement to Mr. Liu,
except for the rights to revenues from the sale of medical and disposable
medical treatment apparatus which will remain with the Company. As compensation
to Mr. Liu for accepting the assignment under the loan agreement including
all
of the risks and obligations and for Mr. Liu not accepting the rights to
revenues from the sale of medical and disposable medical treatment apparatus
which will remain with the Company, the Company agreed to pay Mr. Liu an
aggregate of approximately $1,137,000 to be paid in 5 equal annual installments
of approximately $230,000. Accordingly, the Company recorded an intangible
asset
of approximately $1,137,000 related to exclusive rights to provide all medicines
and disposable medical treatment apparatus to Wu Lan for a period of twenty
(20)
years and a corresponding related party liability. For the three months ended
March 31, 2008 and for the year ended December 31, 2007, the Company paid
approximately $0 and $195,000 of this related party liability, respectively.
At
March 31, 2008 and December 31, 2007, amounts due under this assignment
agreement amounted to $1,062,985 and $966,198 of which $768,990 and $ 738,300
is
included in long-term liabilities and has been included in due to related
parties on the accompanying balance sheet, respectively.
At
March 31, 2008 and December 31, 2007, the Company has recorded accrued interest
relating to notes payable - related parties of $77,925 and $61,208, respectively
which has been included in due to related parties on the accompanying balance
sheets.
NOTE
8 -
CONVERTIBLE
DEBT
The
convertible debenture liability is as follows at December 31, 2007:
Convertible
debentures payable
|
|
$
|
2,770,000
|
|
Less:
unamortized discount on
debentures
|
|
|
(208,355
|
)
|
|
|
|
|
|
Convertible
debentures, net
|
|
$
|
2,561,645
|
|
In
February 2008, in connection with a private placement (See Note 9), the
convertible debt and any unpaid interest was repaid in full. As of March
31,
2008, the balance of the convertible debt is $0.
NOTE
9 -
CONVERTIBLE
REDEEMABLE PREFERRED STOCKS
On
February 25, 2008, the Company entered into a Convertible Redeemable Preferred
Share and Warrant Purchase Agreement (the "Purchase Agreement") by and among
the
Company, Dr. Liu Zhong Yi and Mrs. Song Zhenghong (the "Founders"), and
accredited investors (each a "Purchaser" and collectively, the "Purchasers"),
pursuant to which the Company sold to the Purchasers 5,747,118 shares of
the
Company's series A convertible redeemable preferred stock and
warrants
to purchase 2,873,553 shares of the Company's common stock, in a private
placement
(
the
“February 2008 Private Placement”)
pursuant
to Regulation D under the Securities Act of 1933, for the aggregate purchase
price of $5 million (the "Transaction"). The Transaction closed on February
25,
2008 (the "Closing Date"). Net proceeds, exclusive of expenses of the
Transaction, from the sale to the Company were $4.6 million, after the Company
paid fees of
approximately
$469,000 of which $400,000 was paid to Maxim Group, LLC, its placement agent
for
the Transaction. The Company used $2,576,556 of the net proceeds of the
Transaction to repay in full all of its outstanding principal obligations
including accrued interest under the 14% Secured Convertible Notes due February
2008 and the Company will use the remainder of the net proceeds for working
capital and general corporate purposes.
LOTUS
PHARMACEUTICALS, INC. AND SUBSIDIARIES
NOTES
TO
UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH
31,
2008
NOTE
9 -
CONVERTIBLE
REDEEMABLE PREFERRED STOCKS (continued)
The
Purchase Agreement includes customary representations and warranties by each
party thereto. The following is a brief description of the terms and conditions
of the Purchase Agreement and the transactions contemplated there under that
are
material
to the Company:
Pursuant
to the Purchase Agreement, the Company issued to the Purchasers an aggregate
of
5,747,118 shares of the Company's series A convertible redeemable preferred
stock, par value $0.001 per share, at a price equal to $0.87 per share
(the
"Preferred Shares"). Each of these Preferred Shares may be converted into
one
share of the Company's common stock, par value $0.001 per share (as adjusted
for
stock splits, stock dividends, reclassification and the like). The Preferred
Shares
pay an 8% dividend annually, which is payable in additional Preferred Shares.
Preferred Shares also pay any dividend paid on the common shares on an as
converted basis. For a period of 90 days after February 25, 2010, these
Preferred
Shares may also be redeemed at the option of the Purchasers at the redemption
price of $0.87 per share (as adjusted for stock splits, stock dividends,
reclassification and the like), and no other capital stock of the Company
may be
redeemable prior to the Preferred Shares. Holders of Preferred Shares may
not
convert Preferred Shares to common shares if the conversion would result
in the
holder beneficially owning more than 4.99% of the Company's outstanding common
shares. That limitation may be waived by a holder of Preferred Shares on
not
less than 61 days written notice to the Company. In addition, the Company
issued
to the Purchasers warrants to purchase up to 2,873,553 shares of the Company's
common stock in the aggregate. The warrants have an initial exercise price
of
$1.20 (subject to adjustment pursuant to the terms of the warrants). The
warrants are exercisable for a period of five (5) years from the Closing
Date.
Holders of the warrants may not exercise the warrants if the exercise would
result in the holder beneficially owning more than 4.99% of the Company's
outstanding common shares. That limitation may be waived by a holder of the
warrants on not less than 61 days written notice to the Company.
Other
key provisions of the February 2008 Private Placement:
|
The
Preferred Shares vote with the common stock on an as converted basis,
except that the Preferred Shares are not entitled to vote for directors.
The Company is prohibited from taking certain corporate actions,
including, without limitation, issuing securities senior to the Preferred
Shares, selling substantially all assets, repurchasing securities
and
declaring or paying dividends, without the approval of the holders
of a
majority of the Preferred Shares
outstanding.
|
|
The
Company agreed to undertake to file a registration statement within
60
days following the Closing Date in order to register the maximum
number of
common stock issuable from conversion of the Preferred Shares and
underlying the warrants that is allowable under applicable federal
securities regulations. The Company is also obligated to have the
registration statement declared effective within 120 days following
the
Closing Date. If the Company is informed by the SEC that there are
no
comments to the registration statement, then the registration statement
must be effective within five (5) business days thereafter or on
the 60th
day after the filing date, whichever is sooner. The registration
statement
must be declared effective by the 120th day after its filing if the
SEC
has comments. Otherwise, the Company is subject to liquidated damages,
equal to 1% of the total conversion price and exercise price for
the
common stock being registered under the registration statement, for
every
30-day period following the date that the registration statement
should
have been effective, prorated for any period less than 30 days, until
either all of common shares registered under the registration statement
have been sold or all such common shares may be sold in any three
(3)
month period pursuant to Rule 144 promulgated under the Securities
Act,
whichever is earlier. The Company must also pay the liquidated damages
if
sales cannot be made pursuant to the registration statement for any
reason
(excepting market conditions). The maximum amount of liquidated damages
is
$500,000.
|
|
The
Founders delivered in the aggregate 7,500,000 shares of the Company's
common stock owned by them (the "Escrow Shares") to an escrow account.
Portions of the Escrow Shares are being held in escrow subject to
the
Company meeting certain earning targets in fiscal years 2007, 2008
and
2009. The target for 2007 is $8.5 million in net income. The target
for
2008 is 95% of $13.8 million in net income after eliminating the
effect of
non-cash charges associated with the Transaction and adjusting for
differences in the exchange rate between Chinese
|
LOTUS
PHARMACEUTICALS, INC. AND SUBSIDIARIES
NOTES
TO
UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH
31,
2008
NOTE
9 -
CONVERTIBLE
REDEEMABLE PREFERRED STOCKS (continued)
Renminbi
and US dollars used in the Company's 2008 financial statements and an exchange
rate of RMB 7.30 to USD 1.00. The target for 2009 is 95% of $17.5 million
in net
income after eliminating the effect of non-cash charges associated with the
Transaction and adjusting for differences in the exchange rate between Chinese
Renminbi and US dollars used in the Company's 2009 financial statements and
an
exchange rate of RMB 7.30 to USD 1.00. These Escrow Shares will be transferred
to the Purchasers if the Company does not meet the earning targets, and released
back to the Founders if the Company does. Another portion of the Escrow Shares
is being held in escrow subject to the Company listing on the NASDAQ Stock
Market within 18 months following the Closing Date. These Escrow Shares will
be
transferred to the Purchasers if the listing is not completed within that
time
period, and released back to the Founders if it is. Finally, two-thirds of
the
Escrow Shares are held in escrow to ensure that the Purchasers receive their
full redemption payments if they choose to redeem their Preferred Shares.
Each
Preferred Share may be redeemed for $0.87 per share (adjusted for stock splits,
stock dividends, reclassification and the like). If a Purchaser receives
less
than the full redemption amount for each Preferred Share being redeemed,
the
Purchaser will receive a number of Escrow Shares to make up the difference,
based on the then-current market price of the common shares. Following the
end
of the redemption period, these Escrow Shares, less those transferred to
any
Purchasers that redeemed their Preferred Shares, will be released back to
the
Founders.
In
connection with the issuance of the series
A
convertible redeemable preferred stock and warrants to purchase 2,873,553
shares
of the Company's common stock, the Company recorded a total debt discount
of
$2,033,025 to be amortized over the term of this Purchase Agreement. For
the
three months ended March 31, 2008, amortization of debt discount amounted
to
$84,709 and has been included in interest expense.
For
the
three months ended March 31, 2008, the Company evaluated whether or not the
series A convertible redeemable preferred stock contain embedded conversion
options, which meet the definition of derivatives under SFAS 133 “Accounting for
Derivative Instruments and Hedging Activities” and related interpretations. The
Company concluded that since the series A convertible redeemable preferred
stock
had a fixed redemption price of $0.87, the convertible redeemable preferred
stock was not a derivative instrument. The Company analyzed this provision
under
EITF 05-04 and therefore it qualified as equity under EITF 00-19.
The
series
A
convertible redeemable preferred stock
is as follows at March 31, 2008:
Series
A convertible redeemable preferred
stock
|
|
$
|
5,000,000
|
|
Less:
unamortized discount
|
|
|
(1,948,316
|
)
|
|
|
|
|
|
Series
A convertible redeemable preferred
stock
,
net
|
|
$
|
3,051,684
|
|
NOTE
10 -
SHAREHOLDERS’
EQUITY
In
January 2008, the Company issued 250,000 shares of its common in connection
with
the conversion of $250,000 of convertible debt.
Stock
warrants
In
January, 2008, the Company granted 250,000 stock warrants to a consulting
company at an exercise price of $1.50 per share in connection with a one
year
contract. The warrants are not vested until January 2009. The Company valued
these warrants utilizing the Black-Scholes options pricing model at
approximately $0.71 per warrant or $171,187 in total and recorded a prepaid
consulting expense of $171,187 for the period ended March 31, 2008. Those
warrants will expire in January 2012. For the three months ended March 31,
2008,
the Company recorded amortization expenses of $ 29,698 related to the consulting
contract.
LOTUS
PHARMACEUTICALS, INC. AND SUBSIDIARIES
NOTES
TO
UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH
31,
2008
NOTE
10 -
SHAREHOLDERS’
EQUITY (continued)
In
connection with the preferred share financing (See Note 9), the Company granted
2,873,553 warrants to investors purchase up to 2,873,553 shares of common
stock
of the Company at an exercise price of $1.20 per share. The Warrants have
a term
of 5 years after the issue date of February 12, 2007. Additionally,
the
Company granted 603,446 stock warrants to an investment banking firm at an
exercise price of $1.21 per share. The Company valued these warrants utilizing
the Black-Scholes options pricing model at approximately $0.54 per warrant
or
$323,565 in total and recorded a deferred financing costs of $323,565. Those
warrants will expire in February 2013
.
On
February 25, 2008, pursuant to a Convertible Redeemable Preferred Share and
Warrant Purchase Agreement (See
Note
9),
the exercise price of the 1,500,000 warrants granted in February 2007 were
reduced to $0.87 per share.
Stock
warrants issued, terminated/forfeited and outstanding during the three months
ended March 31, 2008 (unaudited) are as follows:
|
|
Shares
|
|
Average
Exercise
price per
share
|
|
Warrants
outstanding December 31, 2007
|
|
|
1,500,000
|
|
|
0.87
|
|
Warrants
issued
|
|
|
3,726,999
|
|
|
1.22
|
|
Warrants
terminated/forfeited
|
|
|
-
|
|
|
-
|
|
Warrants
exercised
|
|
|
-
|
|
|
-
|
|
Warrants
outstanding, March 31, 2008
|
|
|
5,226,999
|
|
|
1.12
|
|
N
OTE
11 -
SEGMENT
INFORMATION
The
following information is presented in accordance with SFAS No. 131, Disclosure
about Segments of an Enterprise and Related Information. For the three months
ended March 31, 2008 and 2007, the Company operated in two reportable business
segments - (1) the manufacture and distribution of pharmaceutical products
and
(2) the retailing of traditional and Chinese medicines and supplies through
ten
drug stores located in Beijing China and other ancillary revenues generated
from
retail location such as advertising income, rental income, and examination
income. The Company's reportable segments are strategic business units that
offer different products. They are managed separately based on the fundamental
differences in their operations.
Information
with respect to these reportable business segments for the three months ended
March 31, 2008 and 2007 is as follows:
2008
|
|
Wholesale
and
third-party manufacturing
|
|
Retail
Operations
|
|
Unallocated
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
Net
Revenues
|
|
$
|
10,678,987
|
|
$
|
863,483
|
|
$
|
166,707
|
|
$
|
11,709,177
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost
of Sales (excluding depreciation)
|
|
|
7,189,964
|
|
|
481,996
|
|
|
5,407
|
|
|
7,677,367
|
|
Operating
expenses (excluding depreciation and
amortization)
|
|
|
-
|
|
|
-
|
|
|
2,401,153
|
|
|
2,401,153
|
|
Depreciation
and Amortization
|
|
|
86,505
|
|
|
4,553
|
|
|
57,826
|
|
|
148,884
|
|
Other
Expense
|
|
|
-
|
|
|
-
|
|
|
62,886
|
|
|
62,886
|
|
Interest
Expense
|
|
|
-
|
|
|
-
|
|
|
422,788
|
|
|
422,788
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
Income
|
|
$
|
3,402,518
|
|
$
|
376,934
|
|
$
|
(2,783,353
|
)
|
$
|
996,099
|
|
LOTUS
PHARMACEUTICALS, INC. AND SUBSIDIARIES
NOTES
TO
UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH
31,
2008
N
OTE
11 -
SEGMENT
INFORMATION (continued)
2007
|
|
Wholesale
and
third-party manufacturing
|
|
Retail
Operations
|
|
Unallocated
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
Net
Revenues
|
|
$
|
7,285,050
|
|
$
|
926,551
|
|
$
|
77,934
|
|
$
|
8,289,535
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost
of Sales (excluding depreciation)
|
|
|
5,140,930
|
|
|
429,973
|
|
|
7,029
|
|
|
5,577,932
|
|
Operating
expenses (excluding depreciation and
amortization)
|
|
|
-
|
|
|
-
|
|
|
1,413,761
|
|
|
1,413,761
|
|
Depreciation
and Amortization
|
|
|
80,735
|
|
|
4,249
|
|
|
39,650
|
|
|
124,634
|
|
Other
Expense
|
|
|
-
|
|
|
-
|
|
|
83,340
|
|
|
83,340
|
|
Interest
Expense
|
|
|
-
|
|
|
-
|
|
|
252,567
|
|
|
252,567
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
Income
|
|
$
|
2,063,385
|
|
$
|
492,329
|
|
$
|
(1,718,413
|
)
|
$
|
837,301
|
|
The
Company does not allocate all of its operating expenses to its reportable
segments, because these activities are managed at a corporate
level.
Asset
information by reportable segment is not reported to or reviewed by the chief
operating decision maker and, therefore, the Company has not disclosed asset
information for each reportable segment. Substantially all of the Company’s
assets are located in China.
NOTE
12 -
OPERATING
RISK
(a)
Country risk
Currently,
the Company’s revenues are primarily derived from the sale of pharmaceutical
products to customers in the Peoples Republic of China (PRC). The Company
hopes
to expand its operations to countries outside the PRC, however, such expansion
has not been commenced and there are no assurances that the Company will
be able
to achieve such an expansion successfully. Therefore, a downturn or stagnation
in the economic environment of the PRC could have a material adverse effect
on
the Company’s financial condition.
(b)
Products risk
In
addition to competing with other manufacturers of pharmaceutical product
offerings, the Company competes with larger Chinese and International companies
who may have greater funds available for expansion, marketing, research and
development and the ability to attract more qualified personnel. These Chinese
companies may be able to offer products at a lower price. There can be no
assurance that the Company will remain competitive.
(c)
Political risk
Currently,
PRC is in a period of growth and is openly promoting business development
in
order to bring more business into PRC. Additionally PRC allows a Chinese
corporation to be owned by a United States corporation. If the laws or
regulations are changed by the PRC government, the Company's ability to operate
the PRC subsidiaries could be affected.
LOTUS
PHARMACEUTICALS, INC. AND SUBSIDIARIES
NOTES
TO
UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH
31,
2008
NOTE
13 -
SUBSEQUENT
EVENTS
In
April 2008, the Company issued in aggregate 331,668 shares of restricted
common
stock to the several directors, consultants and officers of the Company for
services rendered. The Company valued these common shares
at
the
fair market value on the date of grant at $1.16
per share or $384,735 in total.
In
connection with issuance of these shares, the Company recorded stock-based
expenses of approximately $385,000.
In
April 2008, in connection with a cashless exercise of 60,000 warrants, the
Company issued 9,077 shares of common stock accordingly.