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,
2008
|
or
o
|
TRANSITION
REPORT UNDER SECTION 13 OR 15(
d
)
OF THE SECURITIES EXCHANGE ACT OF 1934
|
For
the transition period from __________________ to
__________________________
|
|
Commission
file number:
000-30451
|
LOTUS
PHARMACEUTICALS, INC.
|
(
Name
of registrant as specified in its charter
)
|
NEVADA
|
|
20-0507918
|
(
State
or other jurisdiction of incorporation or organization)
|
|
(I.R.S.
Employer Identification No.)
|
16
Cheng Zhuang Road, Feng Tai District, Beijing100071
People’s
Republic of China
|
|
N/A
|
(
Address
of principal executive offices)
|
|
(Zip
Code)
|
86-10-63899868
|
(Registrant's
telephone number, including area
code)
|
N/A
|
(
Former
name, former address and former fiscal year, if changed since last
report)
|
Indicate
by check mark whether the registrant (1) has filed all reports required to
be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the
preceding 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
o
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
o
|
|
Accelerated
filer
o
|
Non-accelerated
filer
o
(Do
not check if 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
o
No
x
Indicated
the number of shares outstanding of each of the issuer's classes of common
stock, as of the latest practicable date, 42,420,239
shares
of
common stock are issued and outstanding as of August 14, 2008.
TABLE
OF CONTENTS
|
|
|
|
Page
No.
|
PART
I. - FINANCIAL INFORMATION
|
Item
1.
|
|
Financial
Statements
|
|
3
|
Item
2.
|
|
Management's
Discussion and Analysis of Financial Condition and Results of
Operations.
|
|
28
|
Item
3.
|
|
Quantitative
and Qualitative Disclosures About Market Risk.
|
|
|
Item
4T
|
|
Controls
and Procedures.
|
|
|
PART
II - OTHER INFORMATION
|
Item
1.
|
|
Legal
Proceedings.
|
|
|
Item
1A.
|
|
Risk
Factors.
|
|
|
Item
2.
|
|
Unregistered
Sales of Equity Securities and Use of Proceeds.
|
|
|
Item
3.
|
|
Defaults
Upon Senior Securities.
|
|
|
Item
4.
|
|
Submission
of Matters to a Vote of Security Holders.
|
|
|
Item
5.
|
|
Other
Information.
|
|
|
Item
6.
|
|
Exhibits.
|
|
|
CAUTIONARY
STATEMENT REGARDING FORWARD-LOOKING INFORMATION
Certain
statements in this report contain or may contain forward-looking statements
that
are subject to known and unknown risks, uncertainties and other factors which
may cause actual results, performance or achievements to be materially different
from any future results, performance or achievements expressed or implied by
such forward-looking statements. These forward-looking statements were based
on
various factors and were derived utilizing numerous assumptions and other
factors that could cause our actual results to differ materially from those
in
the forward-looking statements. These factors include, but are not limited
to,
our ability to enforce the Contractual Arrangements, Lotus East's strategic
initiatives, economic, political and market conditions and fluctuations, U.S.
and Chinese government and industry regulation, interest rate risk, U.S.,
Chinese and global competition, and other factors. Most of these factors are
difficult to predict accurately and are generally beyond our control. You should
consider the areas of risk described in connection with any forward-looking
statements that may be made herein. Readers are cautioned not to place undue
reliance on these forward-looking statements and readers should carefully review
this report in its entirety together with our Annual Report on Form 10-K for
the
year ended December 31, 2007 as filed with the SEC, including the risks
described in Item 1A. Risk Factors. Except for our ongoing obligations to
disclose material information under the Federal securities laws, we undertake
no
obligation to release publicly any revisions to any forward-looking statements,
to report events or to report the occurrence of unanticipated events. These
forward-looking statements speak only as of the date of this report, and you
should not rely on these statements without also considering the risks and
uncertainties associated with these statements and our business.
OTHER
PERTINENT INFORMATION
We
maintain a web site at www.lotuseast.com. Information on this web site is not
a
part of this report.
CERTAIN
DEFINED TERMS USED IN THIS PROSPECTUS
Unless
specifically set forth to the contrary, when used in this report the
terms:
|
·
|
"
Lotus
,"
"
we
,"
"
us
,"
"
our
,"
the "
Company
,"
and similar terms refer to Lotus Pharmaceuticals, Inc., a Nevada
corporation formerly known as S.E. Asia Trading Company, Inc.,
and its
subsidiary,
|
|
·
|
"
Lotus
International
"
refers to
Lotus
Pharmaceutical International, Inc., a Nevada corporation and a subsidiary
of Lotus,
|
|
·
|
"
Lotus
Century
"
refers to Lotus Century Pharmaceutical (Beijing) Technology co.,
Ltd., a
wholly foreign-owned enterprise (WFOE) Chinese company which is a
subsidiary of Lotus,
|
|
·
|
"
Liang
Fang
"
refers to Beijing Liang Fang Pharmaceutical Co., Ltd., a Chinese
limited
liability company formed on June 21, 2000 and an affiliate of En
Zhe
Jia,
|
|
·
|
"
En
Zhe Jia
"
refers to Beijing En Zhe Jia Shi Pharmaceutical Co., Ltd., a Chinese
limited liability company formed on September 17, 1999 and an affiliate
of
Liang Fang,
|
|
·
|
"
Lotus
East
"
collectively refers to Liang Fang and En Zhe
Jia,
|
|
·
|
"
Consulting
Services Agreements
"
refers to the Consulting Services Agreements dated September 20,
2006
between Lotus and Lotus East.
|
|
·
|
"
Operating
Agreements
"
refers to the Operating Agreements dated September 20, 2006 between
Lotus,
Lotus East and the stockholders of Lotus
East,
|
|
·
|
"
Equity
Pledge Agreements
"
refers to the Equity Pledge Agreements dated September 20, 2006 between
Lotus, Lotus East and the stockholders of Lotus
East,
|
|
·
|
"
Option
Agreements
"
refers to the Option Agreements dated September 20, 2006 between
Lotus,
Lotus East and the stockholders of Lotus
East,
|
|
·
|
"
Proxy
Agreements
"
refers to the Proxy Agreements dated September 20, 2006 between Lotus,
Lotus East and the stockholders of Lotus
East,
|
|
·
|
"
Contractual
Arrangements
"
collectively refers to the Consulting Services Agreements, Operating
Agreements, Equity Pledge Agreements, Option Agreements and the Proxy
Agreements,
|
|
·
|
"
China
"
or the "
PRC
"
refers to the People's Republic of China,
and
|
|
·
|
"
RMB
"
refers to the renminbi which is the currency of mainland PRC of which
the
yuan is the principal currency.
|
PART
1. - FINANCIAL INFORMATION
Item
1.
Financial
Statements.
LOTUS
PHARMACEUTICALS, INC. AND SUBSIDIARIES
|
CONSOLIDATED
BALANCE SHEETS
|
|
|
June
30,
|
|
December
31
|
|
|
|
2008
|
|
2007
|
|
ASSETS
|
|
(Unaudited)
|
|
|
|
|
|
|
|
|
|
CURRENT
ASSETS:
|
|
|
|
|
|
Cash
|
|
$
|
3,401,444
|
|
$
|
4,557,957
|
|
Accounts
receivable, net of allowance for doubtful accounts and sale
returns
|
|
|
20,786,631
|
|
|
20,430,827
|
|
Inventories,
net of reserve for obsolete inventory
|
|
|
7,086,895
|
|
|
3,410,739
|
|
Prepaid
expenses
|
|
|
284,819
|
|
|
1,009,382
|
|
Deferred
debt costs
|
|
|
398,067
|
|
|
29,340
|
|
|
|
|
|
|
|
|
|
Total
Current Assets
|
|
|
31,957,856
|
|
|
29,438,245
|
|
|
|
|
|
|
|
|
|
PROPERTY
AND EQUIPMENT - Net
|
|
|
6,551,138
|
|
|
6,169,966
|
|
|
|
|
|
|
|
|
|
OTHER
ASSETS
|
|
|
|
|
|
|
|
Deposit
on patent license
|
|
|
2,910,446
|
|
|
-
|
|
Deposit
on land use right
|
|
|
6,033,353
|
|
|
-
|
|
Intangible
assets, net of accumulated amortization
|
|
|
1,298,038
|
|
|
1,291,322
|
|
Deferred
debt costs
|
|
|
265,377
|
|
|
-
|
|
|
|
|
|
|
|
|
|
Total
Assets
|
|
$
|
49,016,208
|
|
$
|
36,899,533
|
|
|
|
|
|
|
|
|
|
LIABILITIES
AND SHAREHOLDERS' EQUITY
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
CURRENT
LIABILITIES:
|
|
|
|
|
|
|
|
Convertible
debt, net of debt discount
|
|
$
|
-
|
|
$
|
2,561,645
|
|
Accounts
payable and accrued expenses
|
|
|
1,027,999
|
|
|
764,491
|
|
Value-added
and service taxes payable
|
|
|
2,030,543
|
|
|
572,200
|
|
Advances
from customers
|
|
|
-
|
|
|
34,531
|
|
Unearned
revenue
|
|
|
641,162
|
|
|
530,063
|
|
Due
to related parties
|
|
|
1,272,153
|
|
|
323,178
|
|
|
|
|
|
|
|
|
|
Total
Current Liabilities
|
|
|
4,971,857
|
|
|
4,786,108
|
|
|
|
|
|
|
|
|
|
LONG-TERM
LIABILITIES:
|
|
|
|
|
|
|
|
Due
to related parties
|
|
|
654,850
|
|
|
738,300
|
|
Notes
payable - related parties
|
|
|
5,043,500
|
|
|
4,738,508
|
|
Series
A convertible redeemable preferred stock, $.001 par value; 10,000,000
shares
|
|
|
|
|
|
|
|
authorized;
5,747,118 and -0- shares issued and outstanding at June 31,
2008
|
|
|
|
|
|
|
|
and
December 31, 2007, respectively
|
|
|
3,305,813
|
|
|
-
|
|
Total
Liabilities
|
|
|
13,976,020
|
|
|
10,262,916
|
|
|
|
|
|
|
|
|
|
SHAREHOLDERS'
EQUITY:
|
|
|
|
|
|
|
|
Common
stock ($.001 par value; 200,000,000 shares authorized;
|
|
|
|
|
|
|
|
42,420,239
and 41,794,200 shares issued and outstanding
|
|
|
|
|
|
|
|
at
June 30, 2008 and December 31, 2007, respectively)
|
|
|
42,420
|
|
|
41,794
|
|
Additional
paid-in capital
|
|
|
11,277,143
|
|
|
8,095,848
|
|
Statutory
reserves
|
|
|
2,616,019
|
|
|
2,161,505
|
|
Retained
earnings
|
|
|
16,081,308
|
|
|
14,355,913
|
|
Other
comprehensive gain - cumulative foreign currency translation
adjustment
|
|
|
5,023,298
|
|
|
1,981,557
|
|
|
|
|
|
|
|
|
|
Total
Shareholders' Equity
|
|
|
35,040,188
|
|
|
26,636,617
|
|
Total
Liabilities and Shareholders' Equity
|
|
$
|
49,016,208
|
|
$
|
36,899,533
|
|
See
notes to unaudited consolidated financial
statements
|
LOTUS
PHARMACEUTICALS, INC. AND SUBSIDIARIES
|
CONSOLIDATED
STATEMENTS OF OPERATIONS
|
(UNAUDITED)
|
|
|
For
the Three Months Ended
|
|
For
the Six Months Ended
|
|
|
|
June
30,
|
|
June
30,
|
|
|
|
2008
|
|
2007
|
|
2008
|
|
2007
|
|
|
|
|
|
(As
Restated)
|
|
|
|
(As
Restated)
|
|
NET
REVENUES:
|
|
|
|
|
|
|
|
|
|
Wholesale
|
|
$
|
17,161,230
|
|
$
|
9,819,373
|
|
$
|
26,931,327
|
|
$
|
14,993,316
|
|
Retail
|
|
|
718,645
|
|
|
516,594
|
|
|
1,402,393
|
|
|
893,014
|
|
Other
revenues
|
|
|
1,505,737
|
|
|
2,469,485
|
|
|
2,761,069
|
|
|
5,208,657
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
Net Revenues
|
|
|
19,385,612
|
|
|
12,805,452
|
|
|
31,094,789
|
|
|
21,094,987
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
COST
OF SALES
|
|
|
9,696,718
|
|
|
7,311,471
|
|
|
17,465,143
|
|
|
12,974,387
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
GROSS
PROFIT
|
|
|
9,688,894
|
|
|
5,493,981
|
|
|
13,629,646
|
|
|
8,120,600
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
OPERATING
EXPENSES:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Selling
expenses
|
|
|
5,875,549
|
|
|
791,784
|
|
|
6,997,886
|
|
|
1,422,796
|
|
Research
and development
|
|
|
471,243
|
|
|
109,153
|
|
|
1,181,468
|
|
|
200,975
|
|
General
and administrative
|
|
|
542,043
|
|
|
988,233
|
|
|
1,168,460
|
|
|
1,718,810
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
Operating Expenses
|
|
|
6,888,835
|
|
|
1,889,170
|
|
|
9,347,814
|
|
|
3,342,581
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
INCOME
FROM OPERATIONS
|
|
|
2,800,059
|
|
|
3,604,811
|
|
|
4,281,832
|
|
|
4,778,019
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
OTHER
INCOME (EXPENSE):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Debt
issuance costs
|
|
|
(99,517
|
)
|
|
(58,680
|
)
|
|
(162,403
|
)
|
|
(88,020
|
)
|
Registration
rights penalty
|
|
|
-
|
|
|
(56,000
|
)
|
|
|
|
|
(110,000
|
)
|
Interest
income
|
|
|
2,027
|
|
|
-
|
|
|
2,588
|
|
|
-
|
|
Interest
expense
|
|
|
(522,660
|
)
|
|
(448,606
|
)
|
|
(946,009
|
)
|
|
(701,173
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
Other Income (Expense)
|
|
|
(620,150
|
)
|
|
(563,286
|
)
|
|
(1,105,824
|
)
|
|
(899,193
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
INCOME
BEFORE INCOME TAXES
|
|
|
2,179,909
|
|
|
3,041,525
|
|
|
3,176,008
|
|
|
3,878,826
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
INCOME
TAXES
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
NET
INCOME
|
|
$
|
2,179,909
|
|
$
|
3,041,525
|
|
$
|
3,176,008
|
|
$
|
3,878,826
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
COMPREHENSIVE
INCOME:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
NET
INCOME
|
|
$
|
2,179,909
|
|
$
|
3,041,525
|
|
$
|
3,176,008
|
|
|
3,878,826
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
OTHER
COMPREHENSIVE INCOME:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Unrealized
foreign currency translation gain
|
|
|
1,587,538
|
|
|
248,403
|
|
$
|
3,041,741
|
|
|
371,920
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
COMPREHENSIVE
INCOME
|
|
$
|
3,767,447
|
|
$
|
3,289,928
|
|
$
|
6,217,749
|
|
$
|
4,250,746
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
NET
INCOME PER COMMON SHARE:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
0.05
|
|
$
|
0.07
|
|
$
|
0.08
|
|
$
|
0.09
|
|
Diluted
|
|
$
|
0.05
|
|
$
|
0.07
|
|
$
|
0.07
|
|
$
|
0.09
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
WEIGHTED
AVERAGE COMMON SHARES
OUTSTANDING:
|
|
|
|
|
|
|
|
|
|
Basic
|
|
|
42,352,139
|
|
|
41,389,362
|
|
|
42,194,048
|
|
|
41,297,531
|
|
Diluted
|
|
|
48,099,257
|
|
|
44,389,262
|
|
|
47,941,166
|
|
|
44,297,531
|
|
See
notes to unaudited consolidated financial
statements
|
LOTUS
PHARMACEUTICALS, INC. AND SUBSIDIARIES
|
CONSOLIDATED
STATEMENTS OF CASH FLOWS
|
(UNAUDITED)
|
|
|
For
the Six Month Ended
|
|
|
|
June
30,
|
|
|
|
2008
|
|
2007
|
|
|
|
|
|
(As
Restated)
|
|
CASH
FLOWS FROM OPERATING ACTIVITIES:
|
|
|
|
|
|
Net
income
|
|
$
|
3,176,008
|
|
$
|
3,878,826
|
|
Adjustments
to reconcile net income from operations to net cash
|
|
|
|
|
|
|
|
provided
by (used in) operating activities:
|
|
|
|
|
|
|
|
Depreciation
and amortization
|
|
|
307,713
|
|
|
275,197
|
|
Amortization
of deferred debt issuance costs
|
|
|
162,029
|
|
|
88,020
|
|
Amortization
of debt discount
|
|
|
208,355
|
|
|
433,735
|
|
Amortization
of discount on convertible redeemable preferred stock
|
|
|
338,838
|
|
|
-
|
|
Stock
base compensation
|
|
|
270,245
|
|
|
55,650
|
|
Warrant
repricing
|
|
|
74,593
|
|
|
-
|
|
Decrease
in allowance for doubtful accounts and sales returns
|
|
|
(14,101
|
)
|
|
(1,567,166
|
)
|
Changes
in assets and liabilities:
|
|
|
|
|
|
|
|
Accounts
receivable
|
|
|
946,083
|
|
|
(524,467
|
)
|
Inventories
|
|
|
(3,358,488
|
)
|
|
1,201,912
|
|
Prepaid
expenses and other current assets
|
|
|
986,132
|
|
|
113,540
|
|
Other
receivable
|
|
|
-
|
|
|
-
|
|
Accounts
payable and accrued expenses
|
|
|
224,627
|
|
|
78,398
|
|
Value-added
and service taxes payable
|
|
|
1,381,155
|
|
|
921,996
|
|
Unearned
revenue
|
|
|
74,796
|
|
|
132,461
|
|
Advances
from customers
|
|
|
(35,710
|
)
|
|
(145,138
|
)
|
|
|
|
|
|
|
|
|
NET
CASH PROVIDED BY OPERATING ACTIVITIES
|
|
|
4,742,275
|
|
|
4,942,964
|
|
|
|
|
|
|
|
|
|
CASH
FLOWS FROM INVESTING ACTIVITIES:
|
|
|
|
|
|
|
|
Collections
from related party advances
|
|
|
-
|
|
|
521,930
|
|
Deposit
on patent right
|
|
|
(2,827,814
|
)
|
|
-
|
|
Deposit
on land use right
|
|
|
(5,862,059
|
)
|
|
-
|
|
Purchase
of property and equipment
|
|
|
(217,982
|
)
|
|
(376,201
|
)
|
|
|
|
|
|
|
|
|
NET
CASH (USED IN) PROVIDED BY INVESTING ACTIVITIES
|
|
|
(8,907,855
|
)
|
|
145,729
|
|
|
|
|
|
|
|
|
|
CASH
FLOWS FROM FINANCING ACTIVITIES:
|
|
|
|
|
|
|
|
Net
proceeds (payments) from convertible debt
|
|
|
(2,520,000
|
)
|
|
2,950,000
|
|
Proceeds
from sale of convertible redeemable peferred stocks
|
|
|
5,000,000
|
|
|
-
|
|
Payment
of debt issuance costs
|
|
|
(468,568
|
)
|
|
(231,526
|
)
|
Proceeds
from related party advances
|
|
|
774,571
|
|
|
2,866
|
|
Repayments
of related party advances
|
|
|
-
|
|
|
(719,302
|
)
|
Repayments
of notes payable - related parties
|
|
|
-
|
|
|
(846,781
|
)
|
|
|
|
|
|
|
|
|
NET
CASH PROVIDED BY FINANCING ACTIVITIES
|
|
|
2,786,003
|
|
|
1,155,257
|
|
|
|
|
|
|
|
|
|
EFFECT
OF EXCHANGE RATE ON CASH
|
|
|
223,064
|
|
|
107,929
|
|
|
|
|
|
|
|
|
|
NET
(DECREASE) INCREASE IN CASH
|
|
|
(1,156,513
|
)
|
|
6,351,879
|
|
|
|
|
|
|
|
|
|
CASH
- beginning of period
|
|
|
4,557,957
|
|
|
2,089,156
|
|
|
|
|
|
|
|
|
|
CASH
- end of period
|
|
$
|
3,401,444
|
|
$
|
8,441,035
|
|
|
|
|
|
|
|
|
|
SUPPLEMENTAL
DISCLOSURE OF CASH FLOW INFORMATION:
|
|
|
|
|
|
|
|
Cash
paid for:
|
|
|
|
|
|
|
|
Interest
|
|
$
|
56,557
|
|
$
|
267,438
|
|
Income
taxes
|
|
$
|
-
|
|
$
|
-
|
|
|
|
|
|
|
|
|
|
Non-cash
operting, investing and financing activities:
|
|
|
|
|
|
|
|
Warrants
issued for prepaid financing costs
|
|
$
|
327,565
|
|
$
|
-
|
|
Warrants
issued for prepaid consulting
|
|
$
|
178,187
|
|
|
-
|
|
Common
stock issued for compensation
|
|
$
|
318,551
|
|
|
-
|
|
Common
stock issued for conversion of convertible debt
|
|
$
|
250,000
|
|
$
|
-
|
|
Debt
discount for grant of warrants and beneficial conversion
feature
|
|
$
|
2,033,025
|
|
$
|
-
|
|
See
notes to unaudited consolidated financial
statements.
|
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.
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
June 30, 2008, Liang Fang owns and operates 10 drug stores throughout Beijing,
China. These drugstores sell Western and traditional Chinese medicines, and
medical treatment accessories.
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.
The
Company has adopted FASB Interpretation No. 46R "Consolidation of Variable
Interest Entities" ("FIN 46R"), an Interpretation of Accounting Research
Bulletin No. 51. FIN 46R requires a Variable Interest Entity (VIE) to be
consolidated by a company if that company is subject to a majority of the risk
of loss for the VIE or is entitled to receive a majority of the VIE's residual
returns. VIEs are those entities in which the Company, through contractual
arrangements, bears the risks of, and enjoys the rewards normally associated
with ownership of the entities, and therefore the Company is the primary
beneficiary of these entities.
As
a VIE,
Lotus
East’s revenues are included in the Company’s total revenues, its income from
operations is consolidated with the Company’s, and the Company’s net income
includes all of
Lotus
East’s net income.
NOTE
1 -
BASIS
OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(continued)
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.
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 June 30, 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
|
|
Reductions
|
|
|
(14,101
|
)
|
|
-
|
|
|
(14,101
|
)
|
Foreign
currency translation adjustments
|
|
|
34,865
|
|
|
-
|
|
|
34,865
|
|
Balance
- June 30, 2008
|
|
$
|
568,847
|
|
$
|
-
|
|
$
|
568,847
|
|
NOTE
1 -
ORGANIZATION
AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
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.
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 six months ended June 30, 2008.
Advances
from customers
Advances
from customers at June 30, 2008 and December 31, 2007 of $0 and $34,531,
respectively,
consist
of prepayments from third party customers to the Company for merchandise
that had not yet shipped. The Company will recognize the deposits as revenue
as
customers take delivery of the goods, in compliance with its revenue recognition
policy.
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.
NOTE
1 -
ORGANIZATION
AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
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
June
30,
|
|
|
|
2008
|
|
2007
|
|
Net
income for basic and diluted earnings per share
|
|
$
|
2,179,909
|
|
$
|
3,041,525
|
|
|
|
|
|
|
|
|
|
Weighted
average shares outstanding - basic
|
|
|
42,352,139
|
|
|
41,389,362
|
|
Effect
of dilutive securities:
|
|
|
|
|
|
|
|
Unexercised
warrants
|
|
|
—
|
|
|
—
|
|
Convertible
debentures
|
|
|
—
|
|
|
3,000,000
|
|
Convertible
redeemable preferred shares
|
|
|
5,747,118
|
|
|
—
|
|
Weighted
average shares outstanding- diluted
|
|
|
48,099,257
|
|
|
44,389,362
|
|
Earnings
per share - basic
|
|
$
|
0.05
|
|
$
|
0.07
|
|
Earnings
per share - diluted
|
|
$
|
0.05
|
|
$
|
0.07
|
|
|
|
For
the Six Months Ended
June
30,
|
|
|
|
2008
|
|
2007
|
|
Net
income for basic and diluted earnings per share
|
|
$
|
3,176,008
|
|
$
|
3,878,826
|
|
|
|
|
|
|
|
|
|
Weighted
average shares outstanding - basic
|
|
|
42,194,048
|
|
|
41,297,531
|
|
Effect
of dilutive securities:
|
|
|
|
|
|
|
|
Unexercised
warrants
|
|
|
—
|
|
|
—
|
|
Convertible
debentures
|
|
|
—
|
|
|
3,000,000
|
|
Convertible
redeemable preferred shares
|
|
|
5,747,118
|
|
|
—
|
|
Weighted
average shares outstanding- diluted
|
|
|
47,941,166
|
|
|
44,297,531
|
|
Earnings
per share - basic
|
|
$
|
0.08
|
|
$
|
0.09
|
|
Earnings
per share - diluted
|
|
$
|
0.07
|
|
$
|
0.09
|
|
At
June
30, 2008 and 2007, 5,166,999 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 June 30, 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 June 30, 2008 and 2007.
Accordingly, the Company has excluded any effect of outstanding warrants as
their effect would be anti-dilutive.
NOTE
1 -
ORGANIZATION
AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
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 June 30, 2008 and December
31, 2007, the Company’s allowance for returns was $0 and $0, respectively.
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 $206,818 and $505,697 for the
six months ended June 30, 2008 and 2007, respectively.
A
dvertising
Advertising
is expensed as incurred. Advertising expenses amounted to $155,530 and $263,529
for the six months ended June 30, 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 six months ended June 30,
2008
and 2007, the Company expensed $1,181,468 and $200,975 as research and
development expense, respectively, and paid for future research and development
services in the amount of $0 and $769,742 at June 30, 2008 and December 31,
2007, respectively, which has been included in prepaid expenses on the
accompanying balance sheets. The December 31, 2007 prepaid research and
development expense has been fully expensed during the period ended June 30,
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 six months ended June 30, 2008 and 2007
was $223,064 and $107,929, 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 June 30, 2008 and December 31, 2007 were translated at
6.8718 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 six months ended June 30, 2008 and 2007
were 7.0726 RMB and 7.7300 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 June 30, 2008 and December 31, 2007, accumulated other
comprehensive income was $5,023,298 and $1,981,557, respectively.
Reclassifications
Certain
accounts and amounts in the period ended June 30, 2007 financial statements
have
been reclassified in order to conform with the period ended June 30, 2008
presentation. These reclassifications have no effect on net income.
Recent
Accounting Pronouncements
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.
NOTE
1 -
ORGANIZATION
AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
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. Should we decide
to
enter future business combinations, 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.
In
May
2008, the Financial Accounting Standards Board (FASB”) issued FASB Staff
Position (FSP”) APB 14-1,
Accounting for Convertible Debt Instruments That May Be Settled in Cash upon
Conversion (Including Partial Cash Settlement)
. FSP
APB 14-1 clarifies that convertible debt instruments that may be settled in
cash
upon either mandatory or optional conversion (including partial cash settlement)
are not addressed by paragraph 12 of APB Opinion No. 14,
Accounting for Convertible Debt and Debt issued with Stock Purchase
Warrants
.
Additionally, FSP APB 14-1 specifies that issuers of such instruments should
separately account for the liability and equity components in a manner that
will
reflect the entity’s nonconvertible debt borrowing rate when interest cost is
recognized in subsequent periods. FSP APB 14-1 is effective for financial
statements issued for fiscal years beginning after December 15, 2008, and
interim periods within those fiscal years. We will adopt FSP APB 14-1 beginning
in the first quarter of fiscal 2010, and this standard must be applied on a
retrospective basis. We are evaluating the impact the adoption of FSP APB 14-1
will have on our consolidated financial position and results of
operations.
NOTE
1 -
ORGANIZATION
AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
In
May
2008, the FASB issued Statement of Financial Accounting Standards (SFAS”) No.
162,
The
Hierarchy of Generally Accepted Accounting Principles
. This
standard is intended to improve financial reporting by identifying a consistent
framework, or hierarchy, for selecting accounting principles to be used in
preparing financial statements that are presented in conformity with generally
accepted accounting principles in the United States for non-governmental
entities. SFAS No. 162 is effective 60 days following approval by the U.S.
Securities and Exchange Commission (SEC”) of the Public Company Accounting
Oversight Board’s amendments to AU Section 411,
The
Meaning of Present Fairly in Conformity with Generally Accepted Accounting
Principles
. We do
not expect SFAS No. 162 to have a material impact on the preparation of our
consolidated financial statements.
On
June
16, 2008, the FASB issued final Staff Position (FSP) No. EITF 03-6-1,
Determining
Whether Instruments Granted in Share-Based Payment Transactions Are
Participating Securities”
to
address the question of whether instruments granted in share-based payment
transactions are participating securities prior to vesting. The FSP determines
that unvested share-based payment awards that contain rights to dividend
payments should be included in earnings per share calculations. The guidance
will be effective for fiscal years beginning after December 15, 2008. We are
currently evaluating the requirements of (FSP) No. EITF 03-6-1.
NOTE
2 -
ACCOUNTS
RECEIVABLE
At
June
30, 2008 and December 31, 2007, accounts receivable consisted of the
following:
|
|
June
30,
2008
|
|
December
31,
2007
|
|
Accounts
receivable
|
|
$
|
21,355,478
|
|
$
|
20,978,910
|
|
Less:
allowance for doubtful accounts
|
|
|
(568,847
|
)
|
|
(548,083
|
)
|
|
|
$
|
20,786,631
|
|
$
|
20,430,827
|
|
NOTE
3 -
INVENTORIES
At
June
30, 2008 and December 31, 2007, inventories consisted of the
following:
|
|
June
30,
2008
|
|
December
31,
2007
|
|
Raw
materials
|
|
$
|
2,231,592
|
|
$
|
2,312,111
|
|
Work
in process
|
|
|
310,768
|
|
|
279,759
|
|
Packaging
materials
|
|
|
24,721
|
|
|
52,967
|
|
Finished
goods
|
|
|
4,565,107
|
|
|
808,456
|
|
|
|
|
7,132,188
|
|
|
3,453,293
|
|
Less:
reserve for obsolete inventory
|
|
|
(45,293
|
)
|
|
(42,554
|
)
|
|
|
$
|
7,086,895
|
|
$
|
3
,410,739
|
|
NOTE
4 -
PROPERTY
AND EQUIPMENT
At
June
30, 2008 and December 31, 2007, property and equipment consist of the
following:
|
|
Useful
Life
|
|
June
30,
2008
|
|
December
31,
2007
|
|
Office
equipment and furniture
|
|
|
5-8
Years
|
|
$
|
170,500
|
|
$
|
154,488
|
|
Manufacturing
equipment
|
|
|
10
- 15 Years
|
|
|
5,574,805
|
|
5,032,601
|
Building
and building improvements
|
|
|
20
- 40 Years
|
|
|
3,128,131
|
|
2,938,966
|
|
|
|
|
|
|
8,873,436
|
|
8,126,055
|
Less:
accumulated depreciation
|
|
|
|
|
|
(2,322,298
|
)
|
(1,956,089)
|
|
|
|
|
|
$
|
6,551,138
|
|
$
6,169,966
|
For
the
six months ended June 30, 2008 and 2007, depreciation expense amounted to
$233,483
and
$209,512, of which
$226,593
and
$188,209 is included in cost of sales, respectively.
NOTE
5 -
Deposit
on patent
The
Company has made a deposit to acquire a Chinese Class I drug patent in
accordance with a technoloy transfer agreement the Company’ entered into in
April 2008. The Company will need to make additional installment payments to
obtain the patent. Accordingly, the Company recorded $2,910,446 as deposit
on
patent as of June 30, 2008.
NOTE
6 -
Deposit
on land use right
The
Company has recorded as a deposit on land use rights for the amounts paid to
a
local government agency in Cha You to acquire a long-term interest to utilize
certain land to construct a new manufacture facility. The Company will need
to
make additional payments to obtain the full land use right and construct the
new
facility. Accordingly, the Company has not received the full land use right
title and has reflected amounts paid of $6,033,353 as of June 30, 2008 as a
deposit on land use rights. The deposit is non-refundable in the event the
Company decides not to construct the manufacture facility.
NOTE
7 -
INTANGIBLE
ASSETS
The
Company’s intangible assets included two approved drugs’ manufacturing rights.
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.
NOTE
7 -
INTANGIBLE
ASSETS (continued)
At
June
30, 2008 and December 31, 2007, intangible assets consist of the
following:
|
|
June
30,
2008
|
|
December
31,
2007
|
|
Manufacturing
rights
|
|
$
|
1,263,969
|
|
$
|
1,187,569
|
|
Revenue
rights
|
|
|
1,309,738
|
|
|
1,230,500
|
|
|
|
|
2,573,707
|
|
|
2,418,069
|
|
Less:
accumulated amortization
|
|
|
(1,275,669
|
)
|
|
(1,126,747
|
)
|
|
|
$
|
1,298,038
|
|
$
|
1,291,322
|
|
Amortization
expense amounted to approximately $74,230 and $65,685 for six months ended
June
30, 2008 and 2007, respectively. The projected amortization for the next five
calendar years and thereafter is:
2008
|
|
$
|
76,399
|
|
2009
|
|
|
124,765
|
|
2010
|
|
|
65,485
|
|
2011
|
|
|
65,486
|
|
2012
and thereafter
|
|
|
965,904
|
|
Total
|
|
|
1,298,038
|
|
NOTE
8 -
RELATED
PARTY TRANSACTIONS
Notes
payable - related parties
Notes
payable - related parties consisted of the following at June 30, 2008 and
December 31, 2007:
|
|
June
30,
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 June 30, 2008 and December 31, 2007),
and
unsecured
|
|
$
|
759,943
|
|
$
|
1,895,424
|
|
|
|
|
|
|
|
|
|
Note
to Zheng Gui Xin, employee, due on December 30, 2015 with with variable
annual interest at 80% of current bank rate (6.26% at June 30, 2008
and
December 31, 2007), and unsecured
|
|
|
1,645,129
|
|
|
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 June 30, 2008 and
December
31, 2007), and unsecured
|
|
|
658,870
|
|
|
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 June
30,
2008 and December 31, 2007), and unsecured
|
|
|
1,402,492
|
|
|
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 June 30, 2008 and
December
31, 2007), and unsecured
|
|
|
577,066
|
|
|
542,168
|
|
|
|
|
|
|
|
|
|
Total
notes payable - related parties, long term
|
|
$
|
5,043,500
|
|
$
|
4,738,508
|
|
NOTE
8 -
RELATED
PARTY TRANSACTIONS (continued)
For
the
six months ended June 30, 2008 and 2007, interest expense related to these
related loans amounted to $153,898 and $107,605, respectively.
Due
to related parties
Several
employees of the Company, from time to time, provided advances to the Company
for operating expenses. During the six months ended June 30, 2008 and 2007,
the
Company repaid
approximately
$0 and
$118,800
of these advances, respectively. At June 30, 2008 and December 31, 2007, the
Company had a payable to these employees amounting to $
440,204
and
$323,178, 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 six months ended June 30, 2008 and 2007, the Company repaid approximately$0
and $489,500 of these advances, respectively.
At
June
30, 2008 and December 31, 2007, the Company had a payable to the chief executive
officer and his spouse amounting to $831,949 and $0, respectively. These
advances are short-term in nature and non-interest bearing.
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 six months ended
June
30, 2008 and for the year ended December 31, 2007, the Company paid
approximately
$0
and
$195,000 of this related party liability, respectively. At June 30, 2008 and
December 31, 2007, amounts due under this assignment agreement amounted to
$1,047,760 and $966,198 of which $
654,850
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
June
30, 2008 and December 31, 2007, the Company has recorded accrued interest
relating to notes payable - related parties of $158,395 and $61,208,
respectively which has been included in due to related parties on the
accompanying balance sheets.
NOTE
9 -
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
January 2008, the Company issued 250,000 shares of its common stock in
connection with the conversion of $250,000 of convertible debt.
In
February 2008, in connection with a private placement (See Note 10), the
remaining $2,520,000 of convertible debt and any unpaid interest was repaid
in
full. The Company amortized the remaining $208,355 in discount on debentures
in
the six months ended June 30, 2008. As of June 30, 2008, the balance of the
convertible debt is $0.
NOTE
10 -
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 recorded the approximately $469,000 in fees as
a
deferred debt cost and amortized approximately $99,500 of the deferred cost
during the six months ended June 30, 2008. The Company has presented the
convertible redeembable preferred stocks as long term debt due to the mandatory
redeemable feature of the preferred stocks.
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.
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.
NOTE
10 -
CONVERTIBLE
REDEEMABLE PREFERRED STOCKS (continued)
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. The Company successfully
met the 2007 earning target.
|
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
six
months ended June 30, 2008, amortization of debt discount amounted to $338,838
and has been included in interest expense.
NOTE
10 -
CONVERTIBLE
REDEEMABLE PREFERRED STOCKS (continued)
For
the
six months ended June 30, 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 June 30, 2008:
Series
A convertible redeemable preferred stock
|
|
$
|
5,000,000
|
|
Less:
unamortized discount
|
|
|
(1,694,187
|
)
|
Series
A convertible redeemable preferred stock, net
|
|
$
|
3,305,813
|
|
NOTE
11
-
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.
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 $0.87
per
share or $288,551 in total.
In
connection with issuance of these shares, the Company recorded prepaid
stock-based expenses of $288,551. As of June 30, 2008, the Company recorded
amortization on prepaid stock-based expenses of approximately $166,000 related
to those issuances.
In
April
2008, in connection with a cashless exercise of 60,000 warrants, the Company
issued 9,077 shares of common stock accordingly.
In
June 2008, the Company issued 35,294 shares of restricted common stock to a
consultant for services rendered to the Company. The Company valued these common
shares at the fair market value on the date of the grant at $0.85 per share
or
$30,000 in total. The Company recorded stock-based compensation expenses of
$30,000 for the six months ended June 30, 2008 accordingly.
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
$178,187 in total and recorded a prepaid consulting expense of $178,187 for
the
period ended
June 30,
2008. Those warrants will expire in January 2012. For the six months ended
June
30, 2008, the Company recorded amortization expenses of $74,245 related to
the
consulting contract.
In
connection with the preferred share financing (See Note 10), 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
$327,565 in total and recorded a deferred financing costs of $327,565. The
Company amortized approximately $55,000 of this deferred cost during the six
months ended June 30, 2008. Those warrants will expire in February
2013.
On
February 25, 2008, pursuant to a Convertible Redeemable Preferred Share and
Warrant Purchase Agreement (See
Note
10),
the exercise price of the 1,500,000 warrants granted in February 2007 were
reduced and repriced to $0.87 per share.
As
a
result of the repricing, the Company recorded an interest expense of $74,593
for
the six months ended June 30, 2008.
NOTE
11
-
SHAREHOLDERS’
EQUITY (continued)
Stock
warrants issued, terminated/forfeited and outstanding during the six months
ended June 30, 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
|
|
|
(60,000
|
)
|
|
0.87
|
|
Warrants
outstanding, June 30, 2008
|
|
|
5,166,999
|
|
|
1.13
|
|
NOTE
12 -
SEGMENT
INFORMATION
The
following information is presented in accordance with SFAS No. 131, Disclosure
about Segments of an Enterprise and Related Information. For the six months
ended June 30, 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
June 30, 2008 and 2007 is as follows:
2008
|
|
Wholesale
and third-party manufacturing
|
|
Retail
Operations
|
|
Unallocated
|
|
Total
|
|
Net
Revenues
|
|
$
|
18,382,332
|
|
$
|
903,404
|
|
$
|
99,876
|
|
$
|
19,385,612
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost
of Sales (excluding depreciation)
|
|
|
9,003,234
|
|
|
551,612
|
|
|
6,337
|
|
|
9,561,183
|
|
Operating
expenses (excluding depreciation and
amortization)
|
|
|
-
|
|
|
-
|
|
|
6,866,102
|
|
|
6,866,102
|
|
Depreciation
and Amortization
|
|
|
126,492
|
|
|
9,043
|
|
|
23,294
|
|
|
158,829
|
|
Other
Expense
|
|
|
-
|
|
|
-
|
|
|
96,929
|
|
|
96,929
|
|
Interest
Expense
|
|
|
-
|
|
|
-
|
|
|
522,660
|
|
|
522,660
|
|
Net
Income
|
|
$
|
9,252,606
|
|
$
|
342,749
|
|
$
|
(7,415,446
|
)
|
$
|
2,179,909
|
|
|
|
Wholesale
and third-party manufacturing
|
|
|
|
|
|
|
|
Net
Revenues
|
|
$
|
11,845,544
|
|
$
|
701,421
|
|
$
|
258,487
|
|
$
|
12,805,452
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost
of Sales (excluding depreciation)
|
|
|
6,702,701
|
|
|
498,391
|
|
|
7,173
|
|
|
7,208,265
|
|
Operating
expenses (excluding depreciation and
amortization)
|
|
|
-
|
|
|
-
|
|
|
1,841,813
|
|
|
1,841,813
|
|
Depreciation
and Amortization
|
|
|
98,044
|
|
|
5,162
|
|
|
47,357
|
|
|
150,563
|
|
Other
Expense
|
|
|
-
|
|
|
-
|
|
|
114,680
|
|
|
114,680
|
|
Interest
Expense
|
|
|
-
|
|
|
-
|
|
|
448,606
|
|
|
448,606
|
|
Net
Income
|
|
$
|
5,044,799
|
|
$
|
197,868
|
|
|
($
2,201,142
|
)
|
$
|
3,041,525
|
|
NOTE
12 -
SEGMENT
INFORMATION (continued)
Information
with respect to these reportable business segments for the six months ended
June
30, 2008 and 2007 is as follows:
2008
|
|
Wholesale
and third-party manufacturing
|
|
Retail
Operations
|
|
Unallocated
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
Net
Revenues
|
|
$
|
29,061,319
|
|
$
|
1,766,887
|
|
$
|
266,583
|
|
$
|
31,094,789
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost
of Sales (excluding depreciation)
|
|
|
16,193,198
|
|
|
1,033,608
|
|
|
11,744
|
|
|
17,238,550
|
|
Operating
expenses (excluding depreciation and
amortization)
|
|
|
-
|
|
|
-
|
|
|
9,266,694
|
|
|
9,266,694
|
|
Depreciation
and Amortization
|
|
|
212,997
|
|
|
13,596
|
|
|
81,120
|
|
|
307,713
|
|
Other
Expense
|
|
|
-
|
|
|
-
|
|
|
159,815
|
|
|
159,815
|
|
Interest
Expense
|
|
|
-
|
|
|
-
|
|
|
946,009
|
|
|
946,009
|
|
Net
Income
|
|
$
|
12,655,124
|
|
$
|
719,683
|
|
$
|
(10,198,799
|
)
|
$
|
3,176008
|
|
|
|
Wholesale
and third-party manufacturing
|
|
|
|
|
|
|
|
Net
Revenues
|
|
$
|
19,130,594
|
|
$
|
1,627,972
|
|
$
|
336,421
|
|
$
|
21,094,987
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost
of Sales (excluding depreciation)
|
|
|
11,843,631
|
|
|
928,364
|
|
|
14,202
|
|
|
12,786,197
|
|
Operating
expenses (excluding depreciation and
amortization)
|
|
|
-
|
|
|
-
|
|
|
3,255,574
|
|
|
3,255,574
|
|
Depreciation
and Amortization
|
|
|
178,779
|
|
|
9,411
|
|
|
87,007
|
|
|
275,197
|
|
Other
Expense
|
|
|
-
|
|
|
-
|
|
|
198,020
|
|
|
198,020
|
|
Interest
Expense
|
|
|
-
|
|
|
-
|
|
|
701,173
|
|
|
701,173
|
|
Net
Income
|
|
$
|
7,108,184
|
|
$
|
690,197
|
|
|
($
3,919,555
|
)
|
$
|
3,878,826
|
|
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
13 -
RESTATEMENT
For
the
six months ending June 30, 2007, the Company revised certain accounting
treatment related to the recording of an intangible asset and a corresponding
related party liability associated with an assignment agreement and exclusive
revenue rights as described in Note 7. The Company initially did not record
the
value of the intangible asset and corresponding liability and treated payment
due under the assignment agreement as a periodic payment of interest expense
to
the Company’s chief executive officer. Subsequently, the Company determined that
an intangible asset and a corresponding related party liability should have
been
recorded. Accordingly, the adjustments to the financial statements for this
adjustment were as follows:
NOTE
13 -
RESTATEMENT (continued)
1.
Balance Sheet:
a)
Intangible assets increased by $1,136,096 to $1,309,551 from $173,455 and total
assets increased by $1,136,096. This increase reflects the addition of an
intangible asset of approximately $1,165,000 offset by an increase in
accumulated amortization of approximately $29,000.
b)
Due to
related parties increased by $1,003,304 which increased total current
liabilities by $236,071 and long-term liabilities by $767,233. This increase
reflects the addition of a related party payable of approximately $1,119,000
offset by the repayment of this payable of approximately $116,000. Stockholders’
equity increased $87,198 which reflect the changes made to the balance sheet
and
statement of operations as well as an increase in comprehensive income of
$1,486.
2.
Statement of Operations:
a)
For
the six months ended June 30, 2007, general and administrative expenses
decreased by $87,323 which reflects an increase in depreciation and amortization
expenses of $29,108 offset by a decrease in assignment fee expenses of $116,431
due to the reversal of the periodic assignment fee expense previously
recorded.
3.
Statement of Cash Flows:
a)
For
the six months ended June 30, 2007, net cash flows provided by operating
activities increased by $116,431 and net cash provided by financing activities
decreased by $116,431.
NOTE
14—COMMITMENTS AND CONTINGENCIES
Technology
Transfer Agreement
In
April
2008, one of the Company’s affiliates, En Ze Jia, entered into a Technology
Transfer Agreement with Dong Guan Kai Fa Biologicals Medicine LTD (“Dong Guan”)
pursuant to which Dong Guan agreed to transfer the technology material, new
medicine research and rights to the Chinese patent of the anti-asthma new
medicine R-BM to En Ze Jia on an exclusive basis in exchange for a transfer
technology fee of approximately $7 million (RMB 48 million) to be paid at
various intervals. Under the terms of the agreement, En Ze Jia is obligated
to:
|
|
complete
the filing with the Chinese State Food and Drug Administration (SFDA)
of
the medicine’s clinical research ratification document,
|
|
|
|
|
|
complete
the clinical research,
|
|
|
|
|
·
|
complete
the medicine’s trial production, and
|
|
|
|
|
·
|
providing
raw materials and formulation related documentation and apply for
the new
medicine certification and production
approval.
|
In
addition to the payment of the technology transfer fee, En Ze Jia is responsible
for paying all costs associated with its responsibility under the agreement
which are presently estimated at $2.3 million (RMB 16 million). Lotus East
intends to use its working capital to fund the project costs.
Dong
Guan
is responsible for preparing and transferring the clinical research and
application documents as well as assisting En Ze Jia in the completing the
clinical research and applying for the new medicine certification and production
approval documents.
NOTE
14—COMMITMENTS AND CONTINGENCIES (continued)
Under
the
terms of the agreement, the technology transfer fee is to be paid upon the
following schedule:
|
·
|
Approximately
$1.5 million is due by the 15th business day following the receipt
of the
processing notice of the receipt of the clinical application and
all
related material from SFDA is
received,
|
|
·
|
Approximately
$1.2 million (RMB 8 million) is due by the 10th business day after
the
receipt of the medicine’s clinical ratification
document,
|
|
·
|
Approximately
$1.5 million (RMB 10 million) is due by the 15th business day after
the
medicine’s Phase I clinical study is completed and ratification from the
SFDA is obtained, and
|
|
·
|
Approximately
$2.9 million (RMB 20 million) is due by the 10th business day after
the
medicine’s Phase II clinical study is completed and ratification from the
SFDA is obtained.
|
En
Ze Jia
paid Dong Guan a deposit of approximately $2.9 million(RMB 20 million) which
is
returned to En Ze Jia with 10 days after the transfer technology fee is paid.
In
the event Dong Guan should be unable to timely return the deposit, it will
pay
En Ze Jia a late fee and En Ze Jia is entitled to damages for Dong Guan’s
failure to timely return the deposit.
The
intellectual property arising from the agreement will be jointly shared by
the
parties. In addition, En Ze Jia has guaranteed that both parties must jointly
apply for related government grants prior to when the new medicine is marketed.
Upon receipt of the government grants En Ze Jia guaranteed that the grant monies
will be shared equally by both parties. The agreement can be terminated by
Dong
Guan if En Ze Jia should fail to make any of the aforedescribed payments in
which event the patent rights would revert to Dong Guan and it is entitled
to
transfer the project rights to a third party.
New
Manufacturing Facility
In
June
2008, one of the Company’s affiliates, Liang Fang, entered into an
agreement with Cha You Qian Qi Economy Commission, a governmental agency (“Cha
You”) related to the construction of a pharmaceutical plant in Cha You's Cha Ha
Er Industrial Garden District. The new facility, which will be comprised
approximately 40,000 square meters situated on 600 MU of land (approximately
400,200 square meters), will be used to expand Liang Fang's current
manufacturing capacity. The new facility, which will manufacture medical
injection products, including 0.9% physiological saline injection, hydroxyethyl
starch 130/0.4 injection and hydroxyethyl starch 200/0.5 injection, Qiang Yi
Ji
starch, a medical corn starch commonly known as O-2-hydeoxyethyl starch, dextran
and additional pharmaceuticals, will require a total investment of RMB 500
million, or approximately $72.8 million. It anticipated that construction will
begin on the project in September 2008 and that it will take between 12 to
30
months to complete the facility.
Included
in the total cost of the project is land cost of approximately $15.7 million
(RMB 108 million) which is paid to Cha You. Other components of the project
include construction costs of approximately $23.3 million (RMB 160 million)
costs associated with the various production lines estimated at approximately
$26.5 million (RMB 182 million) and working capital of approximately $7.3
million (RMB 50 million).
Liang
Fang intends to use its present working capital together with bank loans and
government grants to fund the project. The funds are required to be invested
over the next 18 months under a specified schedule ending in December 2010.
As
of June 30, 2008, Liang Fang has paid approximately $6 million (approximately
RMB 39 million) of the total investment. Liang Fang, however, has not secured
either the bank loans or government grants and does not have sufficient working
capital to complete this project without securing substantial funds from those
third party sources.
Under
the
terms of the agreement, Cha You agreed to abate fees associated with water
resources, waste and other relative supplies for a period of 30 years and agreed
to ensure that the land use tax to be paid by Liang Fang after it begins normal
production will be at the lowest tax rate imposed for five years. Once the
project is completed, for a period of eight years the local reserved portion
of
the imposed corporation income tax will be returned to Liang Fang. Liang Fang
is
required to commence construction by September 3, 2008. If for any reason Liang
Fang should fail to begin construction within 90 days from the date of the
agreement, Cha You has the right to restore the land use rights to it and Liang
Fang will forfeit any funds invested to date. In addition, Liang Fang is
prohibited from changing the land use designation.
NOTE
15 -
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.
Item
2.
Management's
Discussion and Analysis of Financial Condition and Results of
Operations.
Overview
We
operate, control and beneficially own the pharmaceutical businesses in China
of
Lotus East under the terms of the Contractual Arrangements. Other than the
Contractual Arrangements with Lotus East, we do not have any business or
operations. Pursuant to the Contractual Arrangements we provide business
consulting and other general business operation services to Lotus East. Through
these Contractual Arrangements, we have the ability to control the daily
operations and financial affairs of Lotus East, appoint each of their senior
executives and approve all matters requiring stockholder approval. As a result
of these Contractual Arrangements, which enable us to control Lotus East, we
are
considered the primary beneficiary of Lotus East. Accordingly, we consolidate
Lotus East's results, assets and liabilities in our financial statements. The
creditors of Lotus East, however, do not have recourse to any assets we may
have.
PRC
law
currently places certain limitations on foreign ownership of Chinese companies.
To comply with these foreign ownership restrictions, we operate our business
in
China through the Contractual Arrangements with Lotus East. The contractual
relationship among the above companies as follows:
Based
in
Beijing, China, Lotus East is engaged in the production, trade and retailing
of
pharmaceuticals, focusing on the development of innovative medicines and
investing in strategic growth to address various medical needs. Lotus East
owns
and operates 10 drug stores throughout Beijing, China that sell Western and
traditional Chinese medications, lease medical treatment facilities to licensed
physicians, and generate revenues from the leasing of retail space to third
party vendors and the leasing of advertising locations at its retail stores.
When
used
in this section, and except as may be set forth otherwise, the terms "we,"
"us,"
"ours," and similar terms includes Lotus and its subsidiary Lotus International
as well as Lotus East.
CRITICAL
ACCOUNTING POLICIES AND ESTIMATES
Our
discussion and analysis of our financial condition and results of operations
are
based on our financial statements, which have been prepared in accordance with
accounting principles generally accepted in the United States of America. The
preparation of these financial statements requires us to make estimates and
judgments that affect the reported amounts of assets, liabilities and expenses.
On an ongoing basis, we evaluate our estimates and judgments, including those
related to accrued expenses, fair valuation of stock related to stock-based
compensation and income taxes. We based our estimates on historical experience
and on various other assumptions that we believe to be reasonable under the
circumstances, the results of which form the basis for making judgments about
the carrying values of assets and liabilities that are not readily apparent
from
other sources. Actual results may differ from these estimates under different
assumptions or conditions.
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. We recognize
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, we record 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.
We
recognize revenue for the sale of pharmaceutical products and for payments
received, if any, under reimbursement of development costs as follows:
Product
Sales
.
Revenue
from product sales, net of estimated provisions, is recognized when there is
persuasive evidence that an arrangement exists, delivery has occurred, the
selling price is fixed or determinable, and collectability is reasonably
probable. Our customers consist of pharmaceutical wholesalers who sell directly
into the retail channel, hospitals, and retail customers. Provisions for sales
discounts, and estimates for chargebacks, and product returns are established
as
a reduction of product sales revenue at the time revenues are recognized, based
on historical experience adjusted to reflect known changes in the factors that
impact these reserves. Factors include current contract prices and terms,
estimated wholesaler inventory levels, remaining shelf life of product, and
historical information for similar products in the same distribution channel.
These revenue reductions are generally reflected either as a direct reduction
to
accounts receivable through an allowance, or as an addition to accrued expenses
if the payment is due to a party other than the customer.
PRODUCT
RETURNS.
We
account 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. We determine 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, we provide credit
for
product returns that are returned six months prior to and up to six months
after
the product expiration date. Upon sale, we estimate an allowance for future
product returns. We provide additional reserves for contemporaneous events
that
were not known and knowable at the time of shipment.
In
order
to reasonably estimate future returns, we analyzed both quantitative and
qualitative information including, but not limited to, actual return rates,
the
level of product manufactured by us, 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. We also utilize
the
guidance provided in SAB 104 in establishing our return estimates.
Other
revenues. Other revenues consist of (i) rental income received for the lease
of
retail space to various retail merchants; (ii) advertising revenues from the
lease of counter space at our retail locations; (iii) rental income from the
lease of retail space to licensed medical practitioners; and (iv) revenues
received by us for research and development projects. We recognize revenues
upon
performance of such funded research. We recognize revenues from leasing of
space
as earned from contracting third parties. Revenues received in advance are
reflected as deferred revenue on the accompanying balance sheets. Additionally,
we receive income from the sale of developed drug formulas. Income from the
sale
of drug formulas are recognized upon performance of all of our obligations
under
the respective sales contract and are included in other income on the
accompanying consolidated statement of operations.
ACCOUNTS
RECEIVABLE
Accounts
receivable are carried at original invoice amount less an estimate made for
doubtful receivables based on a review of all outstanding amounts on a monthly
basis. Management judgment and estimates are made in connection with
establishing the allowance for doubtful accounts. Specifically, we analyze
the
aging of accounts receivable balances, historical bad debts, customer
concentrations, customer credit-worthiness, current economic trends and changes
in our customer payment terms. Significant changes in customer concentration
or
payment terms, deterioration of customer credit-worthiness or weakening in
economic trends could have a significant impact on the collectability of
receivables and our operating results. If the financial condition of our
customers were to deteriorate, resulting in an impairment of their ability
to
make payments, additional allowances may be required.
INVENTORIES
Inventories
are stated at the lower of cost or market with cost determined under the
weighted-average method. Inventory consists of finished capsules, liquids,
finished oral suspension powder and other western and traditional Chinese
medicines and medical equipment. At least on a quarterly basis, we review our
inventory levels and write down inventory that has become obsolete or has a
cost
basis in excess of its expected net realizable value or is in excess of expected
requirements. Inventory levels are evaluated by management relative to product
demand, remaining shelf life, future marketing plans and other factors, and
reserves for obsolete and slow-moving inventories are recorded for amounts
which
may not be realizable.
PROPERTY
AND EQUIPMENT
Property
and equipment are carried at cost. 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", we examine 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.
Depreciation
is calculated on a straight-line basis over the estimated useful lives of the
assets. The useful lives for property and equipment are as follows:
Buildings
and leasehold improvement
|
|
|
20
to 40 years
|
|
Manufacturing
equipment
|
|
|
10
to 15 years
|
|
Office
equipment and furniture
|
|
|
5
to 8 years
|
|
INCOME
TAXES
Taxes
are
calculated in accordance with taxation principles currently effective in the
United States and PRC. We account for income taxes using the liability method.
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases. Deferred tax assets and liabilities are measured using enacted tax rates
expected to apply to taxable income in the years in which those temporary
differences are expected to be recovered or settled. The effect on deferred
tax
assets and liabilities of a change in tax rates is recognized as income in
the
period that includes the enactment date. A valuation allowance is provided
for
the amount of deferred tax assets that, based on available evidence, are not
expected to be realized.
RECENT
ACCOUNTING PRONOUNCEMENTS
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 SFAS 159 did not have a material impact
on our financial statements.
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. Should we decide
to
enter into future business combinations, these new standards will significantly
affect our 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-- an amendment of FASB Statement No. 133" ("FAS 161").
FAS 161 changes the disclosure requirements for derivative instruments and
hedging activities. Entities are required to provide enhanced disclosures about
(a) how and why an entity uses 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 an entity's financial position, financial performance,
and
cash flows. The guidance in FAS 161 is effective for financial statements issued
for fiscal years and interim periods beginning after November 15, 2008, with
early application encouraged. This Statement encourages, but does not require,
comparative disclosures for earlier periods at initial adoption. We are
currently assessing the impact of FAS 161.
In
May
2008, the Financial Accounting Standards Board (FASB”) issued FASB Staff
Position (FSP”) APB 14-1,
Accounting for Convertible Debt Instruments That May Be Settled in Cash upon
Conversion (Including Partial Cash Settlement)
. FSP
APB 14-1 clarifies that convertible debt instruments that may be settled in
cash
upon either mandatory or optional conversion (including partial cash settlement)
are not addressed by paragraph 12 of APB Opinion No. 14,
Accounting for Convertible Debt and Debt issued with Stock Purchase
Warrants
.
Additionally, FSP APB 14-1 specifies that issuers of such instruments should
separately account for the liability and equity components in a manner that
will
reflect the entity’s nonconvertible debt borrowing rate when interest cost is
recognized in subsequent periods. FSP APB 14-1 is effective for financial
statements issued for fiscal years beginning after December 15, 2008, and
interim periods within those fiscal years. We will adopt FSP APB 14-1 beginning
in the first quarter of fiscal 2010, and this standard must be applied on a
retrospective basis. We are evaluating the impact the adoption of FSP APB 14-1
will have on our consolidated financial position and results of
operations.
In
May
2008, the FASB issued Statement of Financial Accounting Standards (SFAS”) No.
162,
The
Hierarchy of Generally Accepted Accounting Principles
. This
standard is intended to improve financial reporting by identifying a consistent
framework, or hierarchy, for selecting accounting principles to be used in
preparing financial statements that are presented in conformity with generally
accepted accounting principles in the United States for non-governmental
entities. SFAS No. 162 is effective 60 days following approval by the U.S.
Securities and Exchange Commission (SEC”) of the Public Company Accounting
Oversight Board’s amendments to AU Section 411,
The
Meaning of Present Fairly in Conformity with Generally Accepted Accounting
Principles
. We do
not expect SFAS No. 162 to have a material impact on the preparation of our
consolidated financial statements.
On
June
16, 2008, the FASB issued final Staff Position (FSP) No. EITF 03-6-1,
Determining
Whether Instruments Granted in Share-Based Payment Transactions Are
Participating Securities”
to
address the question of whether instruments granted in share-based payment
transactions are participating securities prior to vesting. The FSP determines
that unvested share-based payment awards that contain rights to dividend
payments should be included in earnings per share calculations. The guidance
will be effective for fiscal years beginning after December 15, 2008. We are
currently evaluating the requirements of (FSP) No. EITF 03-6-1.
Results
of Operations
For
the Six Months and Three Months Ended June 30, 2008 and Ended June 30,
2007
Six
Months ended June 30, 2008 compared to six months ended June 30,
2007
Total
Net Revenues
Total
revenues for the six months ended June 30, 2008 were $31,094,789 as compared
to
total revenues of $21,094,987 for the six months ended June 30, 2007, an
increase of $9,999,802 or approximately
47.40%.
For the
six months ended June 30, 2008 and 2007, net revenues consisted of the
following:
|
|
2008
|
|
2007
|
|
Wholesale
|
|
$
|
26,931,327
|
|
$
|
14,993,316
|
|
Retail
|
|
|
1,402,393
|
|
|
893,014
|
|
Other
revenues
|
|
|
2,761,069
|
|
|
5,208,657
|
|
Total
net revenues
|
|
$
|
31,094,789
|
|
$
|
21,094,987
|
|
|
|
For
the six months ended June 30, 2008, wholesale revenues increased
by
$11,938,011
or
79.62%.
The significant increase in tangible product revenues is mainly attributed
to strong sales in Brimonidine Tartrate Eye Drops, a drug used to
constrict adrenaline receptors, an important step in treating glaucoma
and
significant increase in third party manufactured pharmaceutical products
and partially offset by the decrease in sales in Levofloxacin, an
anti-bacterial drug used for the treatment of mild, moderate, and
severe
infections and Nicergoline for Injection, an a-receptor blockage
system
blood-brain medicine, and revenue recorded from collection of our
previous
reversed allowance for sales returned in the six months ended June
30,
2007. The decrease in sales in Levofloxacin and Nicergoline for Injection
was due to more competitors entered into the market. During the six
months
ended June 30, 2007, the Company collected approximately $1.8 million
that
was previously recorded as allowance for sales returns at December
31,
2006. The collection of sales return allowance had the effect of
increasing the Company’s net revenues for the six months ended June 30,
2007 by approximately $1.8 million, even though the sales of these
products were actually made during the fourth quarter of fiscal 2006.
The
significant increased sales in Brimonidine Tartrate Eye Drops was
primarily due to our strong marketing, heavy advertising spending
in 2007
and sales effort on promoting this drug since it was first introduced
in
late 2006. We also have few domestic competitors in this drug market
in
China. In late 2007, we also obtained exclusive distribution rights
from a
third party Beijing based pharmaceutical company for four drugs:
Octreotide Acetate Injection, Recombinant Human Erythropoietin Injection,
Recombinant Human Granulocyte Colony-stimulating Factor Injection,
and
Recombinant Human Interleukin-2 for Injection. As a result, we experienced
a significant increase in our third party manufactured drug sales
during
the six months ended June 30, 2008. We expect the sales in Brimonidien
Tartrate Eye Drops and third party manufactured drugs will continue
to
have steady growths in the remaining of 2008.
|
|
|
|
|
|
For
the six months ended June 30, 2008, retail revenues increased by
$509,379
or 57%. The
increase is attributable to our continuous efforts to diversify products
carried by our retail stores to provide more varieties as well as
better
quality products and the favorable RMB currency appreciation which
converted our revenue in RMB into higher US dollar amounts. As a
result,
our retail revenue increased.
|
|
|
|
|
|
For
the six months ended June 30, 2008, other revenues decreased by
$2,447,588
or 47%.
The decrease in other revenues is attributed to the
following:
|
|
|
2008
|
|
2007
|
|
Leasing
revenues
|
|
$
|
364,279
|
|
$
|
439,615
|
|
Third-party
manufacturing
|
|
|
2,129,992
|
|
|
4,137,278
|
|
Advertising
revenues
|
|
|
215
|
|
|
295,343
|
|
Research
and development and lab testing services
|
|
|
266,583
|
|
|
336,421
|
|
Total
other revenues
|
|
$
|
2,761,069
|
|
$
|
5,208,657
|
|
|
·
|
We
sublease certain portion our retail stores and counter spaces to
various
other vendors and generate leasing revenue.
The
decrease was primarily due to less counter spaces were leased to
third
parties due to less demand for our counter spaces during the first
quarter
of 2008 and partially offset by the increase in second quarter of
2008 as
we were able to lease more counter spaces to third party vendors
in the
second quarter of 2008.
|
|
|
For
third-party manufacturing, customers supply the raw materials and
we are
paid a fee for manufacturing their products. We had less large
manufacturing contracts during the six months ended June 30, 2008
as
the demand for the third-party manufacturing decreased
as
compared to the same period in 2007. Several of our old large third
party
manufacturing customers have built their own facilities and started
manufacturing products on their own in 2008 and we were unable to
find new
customers to replace them. As a result, our third-party manufacturing
revenue decreased. We anticipate the third-party manufacturing revenue
will continue to decrease for the remainder of fiscal 2008 as we
do not
expect to have new customers with large third party manufacturing
contracts.
|
|
|
|
|
|
A
large advertisement contract whereby we receive approximately $50,000
per
month for the lease of counter and other space at our retail locations
ended in December 2007. Accordingly, our advertising revenues
decreased
during
the six months ended June 30, 2008 as compared to the same period
in 2007.
As the local government tightens the advertising rules and regulations
in
the pharmaceutical industry, we do not anticipate signing similar
advertisement contracts in the near future.
|
|
|
|
|
|
We
performed research and development and lab testing projects for various
third parties and performed drug testing and analysis. We preformed
less
R&D testing services and drug testing and analysis work for third
parties during the six months ended June 30, 2008
as
c
ompared
to the same period in 2007. Some of our old customers were able to
find
other companies that provide similar R&D and lab testing serves at a
lower price and decided not to use our services in 2008. We expect
the
revenue from R&D and lab testing will maintain at its current level
with minimal growth in the remaining of 2008.
|
Cost
of Sales
Cost
of
sales includes raw materials, packing materials, shipping, and manufacturing
costs, which includes allocated portion of overhead expenses such as utilities
and depreciation directly related to product production. For the six months
ended June 30, 2008, cost of sales amounted to $17,465,143 or approximately
56.17% of total revenues as compared to cost of sales of $12,974,387 or
approximately 61.5% of total revenues for the six months ended June 30, 2007.
The collections on the previously reserved allowance for sales return of
approximately $1.8 million in 2007 mentioned above had the effect of decreasing
the Company’s cost of sales as a percentage of total revenue by 5.7% for the six
months ended June 30, 2007as the Company recorded the costs associated with
these products in its cost of sales during fiscal 2006 and the revenue was
recognized in the second quarter of 2007. The decrease in cost of sales as
a
percentage of total revenue was primarily due to better purchase pricing
management and more efficient production cost controls.
Gross
Profit
Gross
profit for the six months ended June 30, 2008 was
$13,629,646
or 43.83%
of total
revenues, as compared to $8,120,600 or 38.5% of revenues for the six months
ended June 30, 2007. The collections on the previously reserved allowance for
sales return of approximately $1.8 million in 2007 mentioned above had the
effect of increasing the Company’s profit margin by approximately $1.8 million
for the six months ended June 30, 2007, even though the sales of these products
were actually made during the fourth quarter of fiscal 2006. As the costs
associated with these products was recorded in our cost of sales during fiscal
2006, both the Company’s gross profit margin and income from operations for the
six months ended June 30, 2007 increased by approximately $1.8 million. The
increase in gross profit was attributable to the decrease in cost of sales
as a
percentage of revenue. Although we recognized higher than average gross profits
during the six months ended June 30, 2008, there could be no assurance that
we
will continue to recognize similar gross profit margin in the
future.
Operating
Expenses
Total
operating expenses for the six months ended June 30, 2008 were
$9,347,814
,
an
increase of $6,005,233
or
179.66%,
from
total operating expenses in the six months ended June 30, 2007 of $3,342,581.
This increase included the following:
For
the
six months ended June 30, 2008, selling expenses amounted to $6,997,886 as
compared to $1,422,796 for the six months ended June 30, 2007, an increase
of
$5,575,090
or 391.84%.
This
increase is primarily attributable to an increase of approximately $3.7 million
in commission paid on sales generated to our sales representatives to provide
better incentives.
Additionally,
we paid bonuses of approximately $2.5 million to improve our collections on
accounts receivables and cash flows. We expect our selling expenses to increase
as our revenues increase and we continue to pay out commission and bonuses
to
our sales representatives to increase sales and collections. As a result, the
significant increase in the selling expenses negatively impacted of our net
income. We expect to continue paying commission on sales to increase our sales
and provide bonuses based on the collection personnel’s performance to generate
sufficient cash to meet our near term capital commitments such as new facility
construction project and acquiring Chinese Class I drug patent.
For
the
six months ended June 30, 2008, research and development costs amounted to
$1,181,468 as compared to $200,975 for the six months ended June 30, 2007,
an
increase of $980,493
or
487.87%.
In late
2007, we entered into several research and development agreements with third
parties for the design, research and development of designated pharmaceutical
projects and as a result, expenses related to those research and development
projects increased during the six months ended June 30, 2008.
For
the
six months ended June 30, 2008, general and administrative expenses were
$1,168,460
as
compared to $1,718,810 for the six months ended June 30, 2007, a decrease of
$550,350
or
32%
as
summarized below:
|
|
Six
months ended
June
30,
|
|
|
|
2008
|
|
2007
|
|
Salaries
and related benefits
|
|
$
|
544,454
|
|
$
|
826,963
|
|
Amortization
and depreciation expenses
|
|
|
81,120
|
|
|
50,117
|
|
Rent
|
|
|
149,443
|
|
|
133,512
|
|
Travel
and entertainment
|
|
|
37,039
|
|
|
94,029
|
|
Professional
fees
|
|
|
185,618
|
|
|
148,260
|
|
Other
|
|
|
170,786
|
|
|
465,929
|
|
Total
|
|
$
|
1,168,460
|
|
$
|
1,718,810
|
|
The
changes in these expenses from the six months ended June 30, 2008 as compared
to
the six months ended June 30, 2007 included the following:
|
|
Salaries
and related benefits
decreased
$282,509 or 34.16%
primarily due to decrease bonuses paid to administrative personnel
as we
are in an effort of controlling corporate spending and decreased
use of
part time employees. Additionally, starting in 2008, we no longer
provided
certain benefits that were provided to employees in the 2007 including
insurance, car allowances and other fringe benefits. The related
benefit
costs reduced approximately $120,000 accordingly. As a result, the
salaries and related benefits costs decreased accordingly.
|
|
|
|
|
|
Amortization
of our intangible assets and depreciation on our fixed assets
increased
by $31,003
or
approximately
61.86%
which is primarily attributable to additional fixed assets purchased
and
started depreciating. As such, there was an increase in depreciation
for
the six months ended June 30, 2008.
|
|
|
|
|
|
Rent
increased
by $15,931 or approximately 11.93% primarily due to appreciation
in RMB
currency exchange rate.
|
|
|
|
|
|
Travel
and entertainment expenses
decreased
by $56,990 or 60.61%
as
a result of corporate spending control effort.
|
|
|
|
|
|
Professional
fees
increased
$37,358 or 25.2%
due to increase in compensations paid to consultants.
|
|
|
|
|
|
Other
selling, general and administrative expenses, which includes utilities,
office supplies and training and other office expenses
decreased
by $295,143 or approximately 63.35% as an effort of reducing non-sales
related corporate training and other activities as well as stricter
controls on corporate spending.
|
Income
from Operations
We
reported income from operations of
$4,281,832
for the
six months ended June 30, 2008 as compared to income from operations of
$4,778,019 for the six months ended June 30, 2007, a
decrease
of $496,187 or approximately 10.38%.
Other
Expense
For
the
six months ended June 30, 2008, total other expense amounted to
$1,105,824
as
compared to other expense of $899,193 for the six months ended June 30, 2007,
an
increase of
$206,631
or 22.98%.
This
change is primarily attributable to:
|
|
For
the six months ended June 30, 2008, we recorded debt issuance costs
of
$162,403
compared to $88,020 for the six months ended June 30, 2007 due to
our
recent funding during the
six
months
of
2008.
|
|
|
|
|
|
For
the six months ended June 30, 2007, we recorded registration rights
penalties of $110,000 related to the late filing of our registration
statement on Form SB-2 for which there was
no
comparable
expense in the 2008 period.
|
|
|
|
|
|
For
the six months ended June 30, 2008, interest expense was
$946,009
as
compared to $701,173 for the six months ended June 30, 2007, an increase
of
$244,836
.
This increase is primarily attributable to the amortization of discount
on
convertible redeemable preferred stock and repricing expense of previously
issued warrants in connection with our February 2008 private placement
financing.
|
NET
INCOME, OTHER COMPREHENSIVE INCOME AND COMPREHENSIVE
INCOME
As
a
result of these factors, we reported net income of $3,176,008 for the six months
ended June 30, 2008 as compared to net income of $3,878,826 for the six months
ended June 30, 2007. This translates to basic and diluted net income per common
share of
$0.08,
$0.07 and
$0.09,
$0.09 for the six months ended June 30, 2008 and 2007,
respectively.
During
the six months ended June 30, 2008, we reported an unrealized gain on foreign
currency translation of $3,041,741, an
increase
of
$2,669,821, or approximately 717.85
%
,
from
the same period in 2007. We report in U.S. dollars, but the functional currency
of Lotus East is the RMB. Translation adjustments result from the process of
translating the local currency financial statements into U.S. dollars, with
the
average translation rates applied to our income statement of 7.0726 RMB to
$1.00
during the six months ended June 30, 2008. As a result of this non-cash gain,
we
reported comprehensive income of
$6,217,749
for the
six months ended June 30, 2008 as compared to $4,250,746 for the same period
in
2007.
Three
Months ended June 30, 2008 compared to three months ended June 30,
2007
Total
Net Revenues
Total
revenues for the three months ended June 30, 2008 were $19,385,612 as compared
to total revenues of $12,805,452 for the three months ended June 30, 2007,
an
increase of $6,580,160 or approximately
51.39%.
For the
three months ended June 30, 2008 and 2007, net revenues consisted of the
following:
|
|
2008
|
|
2007
|
|
Wholesale
|
|
$
|
17,161,230
|
|
$
|
9,819,373
|
|
Retail
|
|
|
718,645
|
|
|
516,594
|
|
Other
revenues
|
|
|
1,505,737
|
|
|
2,469,485
|
|
Total
net revenues
|
|
$
|
19,385,612
|
|
$
|
12,805,452
|
|
|
|
For
the three months ended June 30, 2008, wholesale revenues increased
by
$7,341,857 or 74.77%. The significant increase in tangible product
revenues is mainly attributed to strong sales in Brimonidine Tartrate
Eyes
Drops, a drug used to constrict adrenaline receptors, an important
step in
treating glaucoma and significant increase in third party manufactured
pharmaceutical products and partially offset by the decrease in sales
in
Levofloxacin, an anti-bacterial drug used for the treatment of mild,
moderate, and severe infections and Nicergoline for Injection, an
a-receptor blockage system blood-brain medicine, and revenue recorded
from
collection of our previous reversed allowance for sales returned
in the
three months ended June 30, 2007. The decrease in sales in Levofloxacin
and Nicergoline for Injection was due to more competitors entered
into the
market. During the three months ended June 30, 2007, the Company
collected
approximately $1.8 million that was previously recorded as allowance
for
sales returns at December 31, 2006. The collection of sales return
allowance had the effect of increasing the Company’s net revenues for the
three months ended June 30, 2007 by approximately $1.8 million, even
though the sales of these products were actually made during the
fourth
quarter of fiscal 2006. The significant increased sales in Brimonidine
Tartrate Eye Drops was primarily due to our strong marketing, heavy
advertising spending in 2007 and sales effort on promoting this drug
since
it was first introduced in late 2006. We also have few domestic
competitors in this drug market in China. In late 2007, we also obtained
exclusive distribution rights from a third party Beijing based
pharmaceutical company for four drugs: Octreotide Acetate Injection,
Recombinant Human Erythropoietin Injection, Recombinant Human Granulocyte
Colony-stimulating Factor Injection, and Recombinant Human Interleukin-2
for Injection. As a result, we experienced a significant increase
in our
third party manufactured drug sales during the three months ended
June 30,
2008. We expect the sales in Brimonidien Tartrate Eye Drops and third
party manufactured drugs will continue to have steady growth in the
remaining of 2008.
|
|
|
For
the three months ended June 30, 2008, retail revenues increased by
$202,051
or 39.11%. The
increase is attributable to our continuous efforts to diversify products
carried by our retail stores to provide more varieties as well as
better
quality products and the favorable RMB currency appreciation which
converted our revenue in RMB into higher US dollar amounts.
A
s
a
result, our average per retail store increased.
|
|
|
|
|
|
For
the three months ended June 30, 2008, other revenues decreased by
$963,748
or 39.03%.
The decrease in other revenues is attributed to the
following:
|
|
|
2008
|
|
2007
|
|
Leasing
revenues
|
|
$
|
184,756
|
|
$
|
160,998
|
|
Third-party
manufacturing
|
|
|
1,221,102
|
|
|
1,901,349
|
|
Advertising
revenues
|
|
|
-
|
|
|
148,651
|
|
Research
and development and lab testing services
|
|
|
99,879
|
|
|
258,487
|
|
Total
other revenues
|
|
$
|
1,505,737
|
|
$
|
2,469,485
|
|
|
·
|
We
sublease certain portion our retail stores and counter spaces to
various
other vendors and generate leasing revenue.
The
increase was primarily due to the favorable RMB currency application
which
converted our leasing revenue in RMB into higher US dollar amounts
and
slightly more counter spaces being leased to third party vendors
during
the three months ended June 30, 2008.
|
|
|
|
|
|
For
third-party manufacturing, customers supply the raw materials and
we are
paid a fee for manufacturing their products. We had less large
manufacturing contracts during the three months ended June 30, 2008
as
the demand for the third-party manufacturing decreased
as
compared to the same period in 2007. Several of our old large third
party
manufacturing customers have built their own facilities and started
manufacturing products on their own in 2008 and we were unable to
find new
customers to replace them. As a result, our third-party manufacturing
revenue decreased. We anticipate the third-party manufacturing revenue
will continue to decrease for the remainder of fiscal 2008 as we
do not
expect to have new customers with large third party manufacturing
contracts.
|
|
|
|
|
|
A
large advertisement contract whereby we receive approximately $50,000
per
month for the lease of counter and other space at our retail locations
ended in December 2007. Accordingly, our advertising revenues
decreased
during
the three months ended June 30, 2008 as compared to the same period
in
2007. As the local government tightens the advertising rules and
regulations in the pharmaceutical industry, we do not anticipate
signing
similar advertisement contracts in the near future.
|
|
|
|
|
|
We
performed research and development and lab testing projects for various
third parties and performed drug testing and analysis. We preformed
less
R&D testing services and drug testing and analysis work for third
parties during the three months ended June 30, 2008
as
c
ompared
to the same period in 2007. Some of our old customers were able to
find
other companies that provide similar R&D and lab testing serves at a
lower price and decided not to use our services in 2008. We expect
the
revenue from R&D and lab testing will maintain at its current level
with minimal growth in the remaining of 2008.
|
Cost
of Sales
Cost
of
sales includes raw materials, packing materials, shipping, and manufacturing
costs, which includes allocated portion of overhead expenses such as utilities
and depreciation directly related to product production. For the three months
ended June 30, 2008, cost of sales amounted to $9,696,718 or approximately
50.02% of total revenues as compared to cost of sales of $7,311,471 or
approximately 57.10% of total revenues for the three months ended June 30,
2007.
The collections on the previously reserved allowance for sales return of
approximately $1.8 million in 2007 mentioned above had the effect of decreasing
the Company’s cost of sales as a percentage of total revenue by 9.33% for the
six months ended June 30, 2007as the Company recorded the costs associated
with
these products in its cost of sales during fiscal 2006 and the revenue was
recognized in the second quarter of 2007. The decrease in cost of sales as
a
percentage of total revenue was primarily due to better purchase pricing
management and more efficient production cost controls.
Gross
Profit
Gross
profit for the three months ended June 30, 2008 was
$9,688,894
or 49.98%
of total
revenues, as compared to $5,493,981 or 42.90% of revenues for the three months
ended June 30, 2007. The collections on the previously reserved allowance for
sales return of approximately $1.8 million in 2007 mentioned above had the
effect of increasing the Company’s profit margin by approximately $1.8 million
for the three months ended June 30, 2007, even though the sales of these
products were actually made during the fourth quarter of fiscal 2006. As the
costs associated with these products was recorded in our cost of sales during
fiscal 2006, both the Company’s gross profit margin and income from operations
for the three months ended June 30, 2007 increased by approximately $1.8
million. The increase in gross profit was attributable to the decrease in cost
of sales as a percentage of revenue. Although we recognized higher than average
gross profits during the three months ended June 30, 2008, there could be no
assurance that we will continue to recognize similar gross profit margin in
the
future.
Operating
Expenses
Total
operating expenses for the three months ended June 30, 2008 were
$6,888,835
,
an
increase of $4,999,665
or
264.65%,
from
total operating expenses in the three months ended June 30, 2007 of $1,889,170.
This increase included the following:
For
the
three months ended June 30, 2008, selling expenses amounted to $5,875,549 as
compared to $791,784 for the three months ended June 30, 2007, an increase
of
$5,083,765
or 642.06%.
This
increase is primarily attributable to an increase of approximately $3.0 million
in commission paid on sales to our sales representatives to provide better
incentives. Additionally, we paid bonuses of approximately $2.4 million to
improve our collections on accounts receivables and cash flows. We expect our
selling expenses to increase as our revenues increase and we continue to pay
out
commission and bonuses to our sales representatives to increase sales and
collections. As a result, the significant increase in the selling expenses
negatively impacted of our net income. We expect to continue paying commission
on sales to increase our sales and provide bonuses based on the collection
personnel’s performance to generate sufficient cash to meet our near term
capital commitments such as new facility construction project and acquiring
Chinese Class I drug patent.
For
the
three months ended June 30, 2008, research and development costs amounted to
$471,243 as compared to $109,153 for the three months ended June 30, 2007,
an
increase of $362,090
or
331.73%.
In late
2007, we entered into several research and development agreements with third
parties for the design, research and development of designated pharmaceutical
projects and as a result, expenses related to those research and development
projects increased during the three months ended June 30, 2008.
For
the
three months ended June 30, 2008, general and administrative expenses were
$542,043
as
compared to $988,233 for the three months ended June 30, 2007, a decrease of
$446,190
or
45.15%
as
summarized below:
|
|
Three
months
ended
June 30,
|
|
|
|
2008
|
|
2007
|
|
Salaries
and related benefits
|
|
$
|
274,986
|
|
$
|
437,482
|
|
Amortization
and depreciation expenses
|
|
|
23,294
|
|
|
6,301
|
|
Rent
|
|
|
78,275
|
|
|
66,235
|
|
Travel
and entertainment
|
|
|
17,277
|
|
|
42,525
|
|
Professional
fees
|
|
|
130,638
|
|
|
95,160
|
|
Other
|
|
|
17,573
|
|
|
340,530
|
|
Total
|
|
$
|
542,043
|
|
$
|
988,233
|
|
The
changes in these expenses from the three months ended June 30, 2008 as compared
to the three months ended June 30, 2007 included the following:
|
|
Salaries
and related benefits
decreased
$162,496 or 37.14%
primarily due to decrease bonuses paid to administrative personnel
and
decreased use of part time employees as we are in an effort of controlling
corporate expenses. Additionally, starting in 2008, we no longer
provided
certain benefits such as insurance and car allowance and other fringe
benefits that were provided to employees in the 2007. The related
benefit
costs for the three months ended June 30, 2008 reduced approximately
$55,000 as compared to the same period in 2007.As a result, the salaries
and related benefits costs decreased accordingly.
|
|
|
Amortization
of our intangible assets and depreciation on our fixed assets
increased
by $16,993
or
approximately
269.69%
which is primarily attributable to additional fixed assets purchased
and
started depreciating. As such, there was an increase in depreciation
for
the three months ended June 30, 2008.
|
|
|
|
|
|
Rent
increased
by $12,040 or approximately 18.18% primarily due to slight increase
in
rent rate and appreciation in RMB currency exchange
rate.
|
|
|
|
|
|
Travel
and entertainment expenses
decreased
by $25,248 or 59.37%
as
a result of corporate spending control effort.
|
|
|
|
|
|
Professional
fees
increased
$35,478 or 37.28%
due to increase in compensations paid to consultants.
|
|
|
|
|
|
Other
selling, general and administrative expenses, which includes utilities,
office supplies and training and other office expenses
decreased
by $322,957 or approximately 94.84% as an effort of reducing non-sales
related corporate training and other activities as well as stricter
controls on corporate spending.
|
Income
from Operations
We
reported income from operations of
$2,800,059
for the
three months ended June 30, 2008 as compared to income from operations of
$3,604,811 for the three months ended June 30, 2007, a
decrease
of $804,752 or approximately 22.32%.
Other
Expense
For
the
three months ended June 30, 2008, total other expense amounted to
$620,150
as
compared to other expense of $563,286 for the three months ended June 30, 2007,
an increase of
$56,864
or 10.10%.
This
change is primarily attributable to:
|
|
For
the three months ended June 30, 2008, we recorded debt issuance
costs
related to amortization on debt issuance costs of
$99,517
compared to $58,680 for the three months ended June 30, 2007
due to our
recent funding during the
three
months
of
2008.
|
|
|
|
|
|
For
the three months ended June 30, 2007, we recorded registration
rights
penalties of $56,000 related to the late filing of our registration
statement on Form SB-2 for which there was
no
comparable
expense in the 2008 period.
|
|
|
|
|
|
For
the three months ended June 30, 2008, interest expense was
$522,660
as
compared to $448,606 for the three months ended June 30, 2007,
an increase
of $74,054 primarily due to the 2007 warrant repricing expense.
|
NET
INCOME, OTHER COMPREHENSIVE INCOME AND COMPREHENSIVE
INCOME
As
a
result of these factors, we reported net income of $2,179,909 for the three
months ended June 30, 2008 as compared to net income of $3,041,525 for the
three
months ended June 30, 2007. This translates to basic and diluted net income
per
common share of
$0.05,
$0.05 and
$0.07,
$0.07 for the three months ended June 30, 2008 and 2007,
respectively.
During
the three months ended June 30, 2008, we reported an unrealized gain on foreign
currency translation of $1,587,538, an
increase
of
$1,339,135 or approximately 539.10
%
,
from
the same period in 2007. These gains are non-cash items. As described elsewhere
herein, our functional currency is the Chinese Renminbi; however the
accompanying consolidated financial statements have been translated and
presented in U.S. dollars using period-end rates of exchange for assets and
liabilities, and average rates of exchange for the period for revenues, costs,
and expenses. Net gains and losses resulting from foreign exchange transactions
are included in the consolidated statements of operations and can have a
significant effect on our financial statements. As a result of this non-cash
gain, we reported comprehensive income of
$3,767,447
for the
three months ended June 30, 2008 as compared to $3,289,928 for the same period
in 2007.
Liquidity
and Capital Resources
Liquidity
is the ability of a company to generate funds to support its current and future
operations, satisfy its obligations and otherwise operate on an ongoing basis.
At
June
30, 2008, we had a cash balance of
$3,401,444
.
These
funds are located in financial institutions located as follows:
China
|
|
$
|
3,285,478
|
|
USA
|
|
|
115,966
|
|
Total
|
|
$
|
3,401,444
|
|
Our
working capital
position
increased
$2,333,862
to $26,985,999
at June
30, 2008 from $24,652,137 at December 31, 2007. This increase in working capital
is primarily attributable to an increase in accounts receivable net of allowance
of approximately
$355,804,
and an
increase of
approximately
$3,676,156 in
inventories, a decrease in convertible debt of
$2,561,645, in
crease
in
accounts payable and accrued expenses of
$263,508
offset
by decrease in cash of approximately
$1.2
million,
a decrease in prepaid expense of
$724,563,
increase
in unearned revenue of approximately
$111,000
and
increase in due to related parties of approximately
$949,000
.
At
June
30, 2008, our inventories of raw materials, work in progress, packaging
materials and finished goods
totaled
$7,086,895
,
an
increase of approximately
$3.7
million,
or
107.78%,
from
December 31, 2007. We expect to maintain higher inventory levels to accommodate
for anticipated future sales growth, new products development and productions
as
well as a wider variety of products.
At
June
30, 2008, we maintain an allowance for doubtful accounts and sales return on
accounts receivable balances of
$568,847
as
compared to $548,083 at December 31, 2007, an
increase
of $20,764
($14,108
reflects as a reduction to allowance for doubtful accounts and sales return
and
$34,872 as foreign currency translation adj
ustment)
and reflects our best estimate of probable losses. In determining the allowance
for doubtful accounts, our management reviews our accounts receivable aging
as
well as the facts and circumstances of specific customers which may indicate
the
collection of specific amounts are at risk. As is customary in the PRC, we
extend relatively long payment terms to our customers. Our terms of sale
generally require payment within four months to a year, which is considerably
longer than customary terms offered in the United States, however, we believe
that our terms of sale are customary among our competitors for a company in
our
size within our industry. We also occasionally offer established customers
longer payment terms on new products as an incentive to purchase these products,
which has served to further increase the average days outstanding for accounts
receivable. As the market for these new products is established, we will
discontinue offering this sales incentive. Occasionally we will request a
customer to prepay an order prior to shipment. At June 30, 2008, our balance
sheet reflected advances from customers of
$0,
a
decrease of $34,531, or 100%,
from
December 31, 2007.
At
June
30, 2008, we have a deposit on patent of $2,910,446 to acquire a new Chinese
Class I
anti-asthma
medicine
drug
patent in accordance with a technoloy transfer agreement the Company entered
into in April 2008. Additionally, in accordance with the agreement we entered
into in June 2008, we also have a deposit on land use right of $6,033,353
for
the
amounts paid to a local government agency in Cha You to acquire a long-term
interest to utilize certain land to construct a new manufacture facility. We
did
not have the two deposit amounts at December 31, 2007. We will need to make
additional payments totaling approximately $73.7 million in the future.
At
June
30, 2008, we have a value-added and services taxes payable of $2,030,543 as
compared to $572,200 at December 31, 2007. The amounts are related to accrued
but unpaid value added and services taxes for the six months ended June 30,
2008. The increase in the taxes payable is primarily due to increase in our
revenues during the six months ended June 30, 2008 and the tax payment timing
differences.
Our
balance sheet at June 30, 2008, also reflects a balance due to related parties
of $1,272,153 which was a working capital advances made to us by our president,
vice-president and an officer of the Company and a Board member as well as
an
amount payable of
approximately
$654,850 related to an assignment agreement as discussed elsewhere in this
report. These advances are non-interest bearing and are due on
demand
.
We are
currently repaying these balances as operating cash become
available.
Our
balance sheet at June 30, 2008 also reflects notes payable to related parties
of
approximately
$5
million
due on December 30, 2015 which is a working capital loan made to us by the
Company’s Chief Executive Officer, two employees of the Company and a Board
member. These loans bear a variable annual interest at 80% of current bank
rate
and are unsecured. During the three months ended June 30, 2008, we did not
repay
any portion of these loan balances.
The
changes in asset and liabilities discussed above is based on a comparison of
amounts on our balance sheets at June 30, 2008 and December 31, 2007 and does
necessarily reflect changes in assets and liabilities reflected on our cash
flow
statement, which we use the average foreign exchange rate during the period
to
calculate these changes.
Net
cash
provided by operating activities for the six months ended June 30, 2008 was
$4,742,275 as compared to net cash provided by operating activities of
$4,942,964 for the six months ended June 30, 2007. For the six months ended
June
30, 2008, net cash provided by operating activities was attributable primarily
to decrease in accounts receivable of $946,083, increase in inventories of
$3,358,488
,
increase in value-added and service taxes payable of 1,381,155 offset by the
net
income of $3,176,008, the add back of depreciation and amortization of $307,713,
amortization of debt discount of $
208,355
,
amortization of debt issuance costs of $162,029, stock based compensation of
$270,245 and the amortization of discount on convertible redeemable preferred
stock of $338,838, and decrease in allowance for doubtful accounts and sales
return of $14,101, a decrease in prepaid and other current assets of $986,132,
and an increase in unearned revenue of $74,796. Net cash provided by operating
activities for the six months ended June 30, 2007 was $4,942,964. For the six
months ended June 30, 2007, net cash provided by operating activities was
attributable primarily to our net income of $3,878,826, the add back of
depreciation and amortization of $275,197, amortization of debt issuance costs
of $88,020 and the amortization of debt discount of $433,735, a increase in
accounts receivable of $524,467, an increase in accounts payable and accrued
expenses of $78,398, an increase in value-added and service taxes payable of
$921,996, and an increase in unearned revenues of $132,461 offset by an decrease
in inventory balance of $1,201,912, an decrease in prepaid expenses and other
current assets of $113,540, and a decrease in advances from customers of
$145,138.
Net
cash
used in investing activities for the six months ended June 30, 2008 amounted
to
$8,907,855
.
For the
six months ended June 30, 2008, net cash used in investing activities was
attributable to the deposit on patent right of $2,827,814, the deposit on land
use right of $5,862,059 and the purchase of property and equipment of $217,982.
Net cash provided by investing activities for the six months ended June 30,
2007
was $145,729 attributable to the purchase of property and equipment of $376,201
offset by payment received on due from related parties of
$521,930.
Net
cash
provided by financing activities was
$2,786,003
for the
six months ended June 30, 2008 and was attributable to the receipt of net
proceeds of
$5,000,000
from our
private financing and proceeds from related party advances of
$774,571
offset
by payments on convertible debt of
$2,520,000
and debt
issuance costs of $
468,568
.
Net
cash provided by financing activities was $1,155,257 for the six months ended
June 30, 2007 and was primarily attributable to the receipt of net proceeds
of
$2,950,000 from our debt financing offset by payments on related party advances
and loans of $1,566,083 and the payment of debt issuance costs of $231,526.
We
reported a net decrease in cash for the six months ended June 30, 2008 of
$1,156,513
as
compared to a net increase in cash of $6,351,879 for the six months ended June
30, 2007.
In
2007,
we lent approximately $2 million of the net proceeds received from the sale
of
$3 million principal amount convertible debt to Lotus East, which they used
as
working capital. These advances are unsecured and interest free. During the
first quarter of 2008, we used a portion of the proceeds from the sale of equity
to satisfy these notes, lent Lotus East an additional $1.6 million and retained
the balance to fund our operating expenses. We have no operations other than
the
Contractual Arrangements with Lotus East and, accordingly, we are dependent
upon
the quarterly service fees due us to provide cash to pay our operating expenses.
Such payments have not been tendered to us and those funds are being retained
by
Lotus East to fund their operations. At June 30, 2008, Lotus East owned us
approximately $13.5million for such fees and we do not know when such funds
will
be paid to us. Our CEO is also the CEO and principal shareholder of Lotus East.
Accordingly, we are solely reliant upon his judgment to ensure that the funds
advanced to Lotus East are repaid to us. If these funds should not be repaid,
or
if Lotus East should continue to withhold payment of the quarterly service
fee
due us under the Contractual Arrangement, it is possible that we will not have
sufficient funds to pay our operating expenses in future periods.
Other
than our existing cash we presently have no other alternative source of working
capital. We believe that our working capital may not be sufficient to fund
our
current operations for the next 12 months unless Lotus East pays us the amounts
due to us. Lotus East has historically funded its capital expenditures from
their working capital and has advised us that they believe this capital is
sufficient for their current needs.
Lotus
East has contractual commitments for approximately $80.6 million related to
a
Technology Transfer Agreement and the construction of the new manufacturing
facility. While it intends to fund the costs associated with the Technology
Transfer Agreement and a portion of the construction of the new manufacturing
facility with its existing working capital, it is dependent upon the continued
growth of its operations and prompt payment of outstanding accounts receivables
by its customers to ensure that it has sufficient cash for these commitments.
In
addition, its ability to fully fund the costs associated with the new
manufacturing facility is materially dependent upon its ability to secured
bank
financing and/or government grants. As it has no firm commitments for either,
while its management believes the company will be successful in securing the
necessary funding based upon its preliminary discussions with various commercial
banks, there are no assurances the funding will be available in the amounts
or
at the time required to meet Liang Fang's commitment.
However,
the ability of Lotus East to raise any significant capital to expand their
operations is very limited. We believe that it is in our best long term
interests to assist Lotus East in their growth plans. Accordingly, it is likely
that we will seek to raise working capital not only for our operating expense
but to provide capital to Lotus East for these projects as well as providing
working capital necessary for its ongoing operations and obligations. No
assurances can be given that we will be successful in obtaining additional
capital, or that such capital will be available in terms acceptable to our
company. If we are unable to raise capital as necessary for our operations,
and
we were no longer able to timely file our reports with the Securities and
Exchange Commission, our common stock would be removed from quotation on the
OTC
Bulletin Board. In this event, the ability of our stockholders to liquidate
their investment in our company would be adversely impacted and it is possible
that an event of default would occur under various agreements we are a party
to
with the purchases of our Series A Convertible Redeemable Preferred Stock and
common stock purchase warrants.
Contractual
Obligations and Off-Balance Sheet Arrangements
Contractual
Obligations
We
have
certain fixed contractual obligations and commitments that include future
estimated payments. Changes in our business needs, cancellation provisions,
changing interest rates, and other factors may result in actual payments
differing from the estimates. We cannot provide certainty regarding the timing
and amounts of payments. We have presented below a summary of the most
significant assumptions used in our determination of amounts presented in the
tables, in order to assist in the review of this information within the context
of our consolidated financial position, results of operations, and cash
flows.
The
following tables summarize our contractual obligations as of June 30, 2008,
and
the effect these obligations are expected to have on our liquidity and cash
flows in future periods.
|
|
Payments
Due by
Period
|
|
|
|
Total
|
|
Less
than
1
year
|
|
1-3
Years
|
|
3-5
Years
|
|
5
Years
+
|
|
|
|
In
Thousands
|
|
Contractual
Obligations:
|
|
|
|
|
|
|
|
|
|
|
|
Related
Parties Indebtedness
|
|
|
5,829,320
|
|
|
130,970
|
|
$
|
654,850
|
|
|
|
|
$
|
5,043,500
|
|
Patent
Purchase Obligations
|
|
$
|
6,985,069
|
|
$
|
2,619,401
|
|
$
|
4,365,668
|
|
|
|
|
$
|
-
|
|
Construction
Obligations
|
|
$
|
66,727,786
|
|
$
|
16,483,309
|
|
$
|
50,244,477
|
|
$
|
-
|
|
$
|
-
|
|
Total
Contractual Obligations:
|
|
$
|
79,542,175
|
|
$
|
19,233,680
|
|
$
|
55,264,995
|
|
$
|
0
|
|
$
|
5,043,500
|
|
Off-balance
Sheet Arrangements
As
of the
date of this report, we do not have any off-balance sheet arrangements that
have
or are reasonably likely to have a current or future effect on our financial
condition, changes in financial condition, revenues or expenses, results of
operations, liquidity, capital expenditures or capital resources that are
material to investors,
however
we have agreed to guarantee loans for Lotus East, if required. As of the date
of
this report, we have not entered into any guarantee arrangements with Lotus
East
.
The
term "off-balance sheet arrangement" generally means any transaction, agreement
or other contractual arrangement to which an entity unconsolidated with us
is a
party, under which we have: (i) any obligation arising under a guarantee
contract, derivative instrument or variable interest; or (ii) a retained or
contingent interest in assets transferred to such entity or similar arrangement
that serves as credit, liquidity or market risk support for such
assets.
Item
3.
Quantitative
and Qualitative Disclosures About Market Risk.
Not
applicable for a smaller reporting company.
Item
4T.
Controls
and Procedures.
Evaluation
of Disclosure Controls and Procedures
.
We
maintain "disclosure controls and procedures" as such term is defined in Rule
13a-15(e) under the Securities Exchange Act of 1934. In designing and evaluating
our disclosure controls and procedures, our management recognized that
disclosure controls and procedures, no matter how well conceived and operated,
can provide only reasonable, not absolute, assurance that the objectives of
disclosure controls and procedures are met. Additionally, in designing
disclosure controls and procedures, our management necessarily was required
to
apply its judgment in evaluating the cost-benefit relationship of possible
disclosure controls and procedures. The design of any disclosure controls and
procedures also is based in part upon certain assumptions about the likelihood
of future events, and there can be no assurance that any design will succeed
in
achieving its stated goals under all potential future conditions. Our
management, including our Chief Executive Officer and Chief Financial Officer,
has evaluated the effectiveness of our disclosure controls and procedures as
of
the end of the period covered by this report. Based on such evaluation, our
Chief Executive Officer and Chief Financial Officer have concluded that, as
of
the end of the period covered by this report, our disclosure controls and
procedures were not effective:
|
·
|
to
give reasonable assurance that the information required to be disclosed
by
us in reports that we file under the Securities Exchange Act of
1934 is
recorded, processed, summarized and reported within the time periods
specified in the Securities and Exchange Commission's rules and
forms, and
|
|
·
|
to
ensure that information required to be disclosed in the reports
that we
file or submit under the Securities Exchange Act of 1934 is accumulated
and communicated to our management, including our CEO and our
CFO, to
allow timely decisions regarding required disclosure.
|
Our
internal accounting staff was primarily engaged in ensuring compliance with
PRC
accounting and reporting requirements for our operating affiliates and their
U.S. GAAP knowledge was limited. As a result, majority of our internal
accounting staff, on a consolidated basis, is relatively inexperienced with
U.S.
GAAP and the related internal control procedures required of U.S. public
companies. Although our accounting staff is professional and experienced in
accounting requirements and procedures generally accepted in the PRC, management
has determined that they require additional training and assistance in U.S.
GAAP
matters. Management has determined that our internal audit function is also
significantly deficient due to insufficient qualified resources to perform
internal audit functions. Finally, management determined that the lack of an
Audit Committee of our Board of Directors also contributed to insufficient
oversight of our accounting and audit functions.
In
order
to correct the foregoing weaknesses, we have taken the following remediation
measures:
|
·
|
In
first quarter of 2008, under our CEO and CFO's supervision, we have
started a new accounting system implementation project to improve
our
financial reporting process. We intend to rely on our CFO, a senior
financial executive from the U.S. with extensive experience in internal
control and U.S. GAAP, and together with our CEO to oversee and manage
the
financial reporting process. In connection with the new accounting
system
implementation, we also plan to increase training of our accounting
staff
both accounting system and U.S. GAAP related knowledge. The new accounting
system implementation project is currently in progress.
|
|
·
|
We
have started searching for an independent director qualified to serve
on
an audit committee to be established by our Board of Directors and
we
anticipate that our Board of Directors will also establish a compensation
committee to be headed by one of an independent
director.
|
Due
to
our size and nature, segregation of all conflicting duties may not always be
possible and may not be economically feasible. However, to the extent possible,
we will implement procedures to assure that the initiation of transactions,
the
custody of assets and the recording of transactions will be performed by
separate individuals.
We
believe that the foregoing steps will remediate the material weaknesses
identified above, and we will continue to monitor the effectiveness of these
steps and make any changes that our management deems appropriate. Due to the
nature of these material weaknesses in our internal control over financial
reporting, there is more than a remote likelihood that misstatement
which
could be material to our annual or interim financial statements could occur
that
would not be prevented or detected.
A
material weakness (within the meaning of PCAOB Auditing Standard No. 5) is
a
deficiency, or a combination of deficiencies, in internal control over financial
reporting, such that there is a reasonable possibility that a material
misstatement of our annual or interim financial statements will not be prevented
or detected on a timely basis. A significant deficiency is a deficiency, or
a
combination
of deficiencies, in internal control over financial reporting that is less
severe than a material weakness, yet important enough to merit attention by
those responsible for oversight of the company's financial
reporting.
Because
of its inherent limitations, internal control over financial reporting may
not
prevent or detect misstatements. Projections of any evaluation of effectiveness
to future periods are subject to the risk that controls may become inadequate
because of changes in conditions, or that the degree of compliance with the
policies and procedures may deteriorate.
Changes
in Internal Control over Financial Reporting.
There
have been no changes in our internal control over financial reporting during
our
last fiscal quarter that has materially affected, or is reasonably likely to
materially affect, our internal control over financial reporting.
PART
II -
OTHER INFORMATION
Item
1.
Legal Proceedings
None.
Not
applicable to smaller reporting company.
Item
2.
Unregistered
Sales of Equity Securities and Use of Proceeds
In
June
30, 2008, we issued 35,294 shares of restricted common stock to a consultant
for
technical services rendered to us. We valued these common shares at the fair
market value on the date of the grant at $0.85 per share or $30,000 in total.
We
recorded stock-based compensation expenses of $30,000 for the three months
ended
June 30, 2008 accordingly. The securities were issued in a transaction exempt
from registration under the Securities Act of 1933 in reliance on an exemption
provide by Section 4(2) of that act. The recipient was a sophisticated investor
who had such knowledge and experiences in business matters that he was capable
of evaluating the merits and risks of the prospective investment in our
securities. The recipient had access to business and financial information
concerning our company.
Item
3.
Defaults
Upon Senior Securities
None.
Item
4.
Submissions
of Matters to a Vote of Security Holders
None.
Item
5.
Other
Information
None.
No.
|
|
Description
|
31.1
|
|
Rule
13a-14(a)/ 15d-14(a) Certification
of
Chief Executive Officer
|
|
|
|
31.2
|
|
Rule
13a-14(a)/ 15d-14(a) Certification
of
Chief Financial Officer
|
|
|
|
32.1
|
|
Section
1350 Certification of Chief Executive Officer
|
|
|
|
32.2
|
|
Section
1350 Certification of Chief Financial
Officer
|
SIGNATURES
In
accordance with the requirements of the Exchange Act, the registrant has caused
this report to be signed on its behalf by the undersigned thereunto duly
authorized.
|
|
|
|
Lotus
Pharmaceuticals, Inc.
|
|
|
|
Date: August
14, 2008
|
By:
|
/s/
Liu Zhong Yi
|
|
Liu
Zhong Yi
|
|
Chief
Executive Officer
|
|
|
|
Date: August
14, 2008
|
By:
|
/s/
Adam Wasserman
|
|
Adam
Wasserman
|
|
Chief
Financial Officer
|
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