Unassociated Document
UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
Washington,
D.C. 20549
FORM
10-Q
(Mark
One)
x
|
QUARTERLY
REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
|
o
|
TRANSITION
REPORT PURSUANT SECTION 13 OR 15(d) OF THE EXCHANGE
ACT
|
For
the
transition period from ________________ to ______________
Commission
file number: 333-86347
GENESIS
PHARMACEUTICALS ENTERPRISES, INC.
|
(Exact
name of small business issuer as specified in its
charter)
|
Florida
|
|
65-1130026
|
(State
or other jurisdiction of incorporation or organization)
|
|
(IRS
Employer Identification No.)
|
Middle
Section, Longmao Street, Area A, Laiyang Waixiangxing Industrial
Park
Laiyang
City, Yantai, Shandong Province, People’s Republic of China
265200
|
(Address
of principal executive offices)
|
(0086)
535-7282997
|
(issuer’s
telephone number)
|
|
(Former
name, former address and former fiscal year, if changed since last
report)
|
Indicate
by check mark whether the registrant (1) filed all reports required to be filed
by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the past
12
months (or for such shorter period that the issuer 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
APPLICABLE
ONLY TO CORPORATE ISSUERS:
Indicate
the number of shares outstanding of each of the issuer’s classes of common
stock, as of the latest practicable date. The total shares outstanding at
November 12, 2008 was 10,331,448.
|
Page
|
PART
I - FINANCIAL INFORMATION
|
|
|
|
Item
1. Financial Statements
|
3
|
|
|
Consolidated
Balance Sheets as of September 30, 2008 (Unaudited) and June 30,
2008
|
3
|
|
|
Consolidated
Statements of Income and Other Comprehensive Income for
the three months ended September 30, 2008 and 2007
(Unaudited)
|
4
|
|
|
Consolidated
Statements of Cash Flows for the three months ended September 30,
2008 and
2007 (Unaudited)
|
5
|
|
|
Notes
to Consolidated Financial Statements (Unaudited)
|
6
|
|
|
Item
2. Management’s Discussion and Analysis or Plan of
Operation
|
31
|
|
|
Item
3. Quantitative and Qualitative Disclosure About Market
Risk
|
38
|
|
|
Item
4T. Controls and Procedures
|
38
|
|
|
PART
II - OTHER INFORMATION
|
|
|
|
Item
1. Legal Proceedings
|
39
|
|
|
Item
2. Unregistered Sales of Equity Securities and Use of
Proceeds
|
40
|
|
|
Item
3. Defaults upon Senior Securities
|
40
|
|
|
Item
4. Submission of Matters to a Vote of Securities
Holders
|
40
|
|
|
Item
5. Other Information
|
40
|
|
|
Item
6. Exhibits
|
41
|
CONSOLIDATED
BALANCE SHEETS
|
|
September 30,
|
|
June 30,
|
|
|
|
2008
|
|
2008
|
|
|
|
(Unaudited)
|
|
|
|
ASSETS
|
|
|
|
|
|
|
|
CURRENT
ASSETS:
|
|
|
|
|
|
|
|
Cash
|
|
$
|
61,269,936
|
|
$
|
48,195,798
|
|
Restricted
cash
|
|
|
7,894,348
|
|
|
7,839,785
|
|
Investment
|
|
|
886,509
|
|
|
2,055,241
|
|
Accounts
receivable, net of allowance for doubtful accounts of
|
|
|
|
|
|
|
|
$219,400
and $155,662, respectively
|
|
|
25,354,209
|
|
|
24,312,077
|
|
Accounts
receivable - related parties
|
|
|
187,509
|
|
|
673,808
|
|
Inventories
|
|
|
3,066,280
|
|
|
3,906,174
|
|
Other
receivables
|
|
|
192,954
|
|
|
152,469
|
|
Other
receivables - related parties
|
|
|
377,941
|
|
|
-
|
|
Advances
to suppliers and other assets
|
|
|
892,489
|
|
|
1,718,504
|
|
Total
current assets
|
|
|
100,122,175
|
|
|
88,853,856
|
|
|
|
|
|
|
|
|
|
PLANT
AND EQUIPMENT, net
|
|
|
11,129,878
|
|
|
11,225,844
|
|
|
|
|
|
|
|
|
|
OTHER
ASSETS:
|
|
|
|
|
|
|
|
Restricted
investments
|
|
|
1,078,875
|
|
|
2,481,413
|
|
Financing
cost, net
|
|
|
1,746,868
|
|
|
1,916,944
|
|
Intangible
assets, net
|
|
|
9,870,494
|
|
|
9,916,801
|
|
Total
other assets
|
|
|
12,696,237
|
|
|
14,315,158
|
|
|
|
|
|
|
|
|
|
Total
assets
|
|
$
|
123,948,290
|
|
$
|
114,394,858
|
|
|
|
|
|
|
|
|
|
LIABILITIES
AND SHAREHOLDERS' EQUITY
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
CURRENT
LIABILITIES:
|
|
|
|
|
|
|
|
Accounts
payable
|
|
$
|
2,536,337
|
|
$
|
2,341,812
|
|
Short
term bank loans
|
|
|
-
|
|
|
2,772,100
|
|
Notes
payable
|
|
|
7,894,348
|
|
|
5,843,295
|
|
Other
payables
|
|
|
4,583,078
|
|
|
3,671,703
|
|
Other
payables - related parties
|
|
|
391,723
|
|
|
164,137
|
|
Accrued
liabilities
|
|
|
954,231
|
|
|
334,439
|
|
Liabilities
assumed from reorganization
|
|
|
552,220
|
|
|
1,084,427
|
|
Taxes
payable
|
|
|
6,452,277
|
|
|
166,433
|
|
Total
current liabilities
|
|
|
23,364,214
|
|
|
16,378,346
|
|
|
|
|
|
|
|
|
|
CONVERTIBLE
DEBT, net of discount of $31,837,406 and $32,499,957
|
|
|
|
|
|
|
|
as
of September 30, 2008 and June 30, 2008, respectively
|
|
|
3,162,594
|
|
|
2,500,043
|
|
|
|
|
|
|
|
|
|
Total
Liabilities
|
|
|
26,526,808
|
|
|
18,878,389
|
|
|
|
|
|
|
|
|
|
COMMITMENTS
AND CONTINGENCIES
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
SHAREHOLDERS'
EQUITY:
|
|
|
|
|
|
|
|
Preferred
stock ($0.001 par value; 20,000,000 shares authorized;
|
|
|
-
|
|
|
-
|
|
none
issued, or outstanding)
|
|
|
|
|
|
|
|
Common
stock ($0.001 par value, 22,500,000 and 15,000,000 shares
|
|
|
|
|
|
|
|
authorized,
respectively; 9,771,448 and 9,767,844 shares issued
|
|
|
|
|
|
|
|
and
outstanding, respectively)
|
|
|
9,773
|
|
|
9,770
|
|
Paid-in-capital
|
|
|
73,392,365
|
|
|
45,554,513
|
|
Captial
contribution receivable
|
|
|
(27,845,000
|
)
|
|
(11,000
|
)
|
Retained
earnings
|
|
|
41,550,881
|
|
|
39,008,403
|
|
Statutory
reserves
|
|
|
3,844,884
|
|
|
3,253,878
|
|
Accumulated
other comprehensive income
|
|
|
6,468,579
|
|
|
7,700,905
|
|
Total
shareholders' equity
|
|
|
97,421,482
|
|
|
95,516,469
|
|
Total
liabilities and shareholders' equity
|
|
$
|
123,948,290
|
|
$
|
114,394,858
|
|
The
accompanying notes are an integral part of these consolidated financial
statements.
CONSOLIDATED
STATEMENTS OF INCOME AND OTHER COMPREHENSIVE INCOME
FOR
THE
THREE MONTHS ENDED SEPTEMBER 30, 2008 AND 2007
(UNAUDITED)
|
|
2008
|
|
2007
|
|
REVENUES:
|
|
|
|
|
|
|
|
Sales
|
|
$
|
27,320,750
|
|
$
|
15,262,789
|
|
Sales
- related parties
|
|
|
243,843
|
|
|
1,348,095
|
|
TOTAL
REVENUE
|
|
|
27,564,593
|
|
|
16,610,884
|
|
|
|
|
|
|
|
|
|
Cost
of sales
|
|
|
5,713,059
|
|
|
4,205,945
|
|
Cost
of sales - related parties
|
|
|
54,478
|
|
|
384,169
|
|
COST
OF SALES
|
|
|
5,767,537
|
|
|
4,590,114
|
|
|
|
|
|
|
|
|
|
GROSS
PROFIT
|
|
|
21,797,056
|
|
|
12,020,770
|
|
|
|
|
|
|
|
|
|
RESEARCH
AND DEVELOPMENT EXPENSE
|
|
|
1,097,925
|
|
|
264,920
|
|
|
|
|
|
|
|
|
|
SELLING,
GENERAL AND ADMINISTRATIVE EXPENSES
|
|
|
13,351,975
|
|
|
6,821,416
|
|
|
|
|
|
|
|
|
|
INCOME
FROM OPERATIONS
|
|
|
7,347,156
|
|
|
4,934,434
|
|
|
|
|
|
|
|
|
|
OTHER
(INCOME) EXPENSE:
|
|
|
|
|
|
|
|
Other
expense, net
|
|
|
914,970
|
|
|
12,678
|
|
Other
(income) - related parties
|
|
|
(143,950
|
)
|
|
(26,492
|
)
|
Non-operating
expense
|
|
|
74,621
|
|
|
59,903
|
|
Interest
expense, net
|
|
|
1,352,794
|
|
|
60,000
|
|
Loss
from discontinued operations
|
|
|
45,216
|
|
|
-
|
|
OTHER
EXPENSE, NET
|
|
|
2,243,651
|
|
|
106,089
|
|
|
|
|
|
|
|
|
|
INCOME
BEFORE PROVISION FOR INCOME TAXES
|
|
|
5,103,505
|
|
|
4,828,345
|
|
|
|
|
|
|
|
|
|
PROVISION
FOR INCOME TAXES
|
|
|
1,970,021
|
|
|
1,593,353
|
|
|
|
|
|
|
|
|
|
NET
INCOME
|
|
|
3,133,484
|
|
|
3,234,992
|
|
|
|
|
|
|
|
|
|
OTHER
COMPREHENSIVE INCOME:
|
|
|
|
|
|
|
|
Foreign
currency translation adjustment
|
|
|
330,641
|
|
|
417,346
|
|
Unrealized
holding (loss)
|
|
|
(1,562,967
|
)
|
|
-
|
|
|
|
|
|
|
|
|
|
COMPREHENSIVE
INCOME
|
|
$
|
1,901,158
|
|
$
|
3,652,338
|
|
|
|
|
|
|
|
|
|
BASIC
WEIGHTED AVERAGE NUMBER OF SHARES
|
|
|
9,769,329
|
|
|
7,494,740
|
|
|
|
|
|
|
|
|
|
BASIC
EARNINGS PER SHARE
|
|
$
|
0.32
|
|
$
|
0.43
|
|
|
|
|
|
|
|
|
|
DILUTED
WEIGHTED AVERAGE NUMBER OF SHARES
|
|
|
9,861,671
|
|
|
7,494,740
|
|
|
|
|
|
|
|
|
|
DILUTED
EARNINGS PER SHARE
|
|
$
|
0.32
|
|
$
|
0.43
|
|
The
accompanying notes are an integral part of these consolidated financial
statements.
CONSOLIDATED
STATEMENTS OF CASH FLOWS
FOR
THE
THREE MONTHS ENDED SEPTEMBER 30, 2008 AND 2007
(UNAUDITED)
|
|
2008
|
|
2007
|
|
CASH
FLOWS FROM OPERATING ACTIVITIES:
|
|
|
|
|
|
|
|
Net
income
|
|
$
|
3,133,484
|
|
$
|
3,234,992
|
|
Loss
from discontinued operations
|
|
|
(45,216
|
)
|
|
-
|
|
Income
from continuing operations
|
|
|
3,178,700
|
|
|
3,234,992
|
|
Adjustments
to reconcile net income to cash
|
|
|
|
|
|
|
|
provided
by (used in) operating activities:
|
|
|
|
|
|
|
|
Depreciation
|
|
|
146,694
|
|
|
111,356
|
|
Amortization
of intangible assets
|
|
|
73,540
|
|
|
31,521
|
|
Amortization
of debt issuance costs
|
|
|
170,076
|
|
|
-
|
|
Amortization
of debt discount
|
|
|
662,551
|
|
|
-
|
|
Bad
debt expense
|
|
|
63,350
|
|
|
-
|
|
Gain
on sale of marketable securities
|
|
|
(124,523
|
)
|
|
-
|
|
Unrealized
loss on trading securities
|
|
|
1,044,083
|
|
|
-
|
|
Other
non-cash settlement
|
|
|
(20,000
|
)
|
|
-
|
|
Stock-based
compensation
|
|
|
23,854
|
|
|
-
|
|
Change
in operating assets and liabilities
|
|
|
|
|
|
|
|
Accounts
receivable
|
|
|
(1,039,428
|
)
|
|
(3,173,544
|
)
|
Accounts
receivable - related parties
|
|
|
488,446
|
|
|
(1,213,279
|
)
|
Notes
receivables
|
|
|
-
|
|
|
19,046
|
|
Inventories
|
|
|
851,126
|
|
|
(354,330
|
)
|
Other
receivables
|
|
|
(48,205
|
)
|
|
(334,460
|
)
|
Other
receivables- related parties
|
|
|
(378,174
|
)
|
|
-
|
|
Advances
to suppliers and other assets
|
|
|
839,097
|
|
|
(3,858,910
|
)
|
Accounts
payable
|
|
|
188,211
|
|
|
(1,385,815
|
)
|
Other
payables
|
|
|
901,863
|
|
|
(1,091,944
|
)
|
Other
payables - related parties
|
|
|
227,135
|
|
|
-
|
|
Accrued
liabilities
|
|
|
138,310
|
|
|
55,947
|
|
Taxes
payable
|
|
|
6,289,257
|
|
|
4,719,062
|
|
Net
cash provided by (used in) operating activities
|
|
|
13,675,963
|
|
|
(3,240,358
|
)
|
|
|
|
|
|
|
|
|
CASH
FLOWS FROM INVESTING ACTIVITIES:
|
|
|
|
|
|
|
|
Procees
from sales of marketable securities
|
|
|
88,743
|
|
|
-
|
|
Acquisition
of equipment
|
|
|
(19,877
|
)
|
|
(20,723
|
)
|
Net
cash provided by (used in) investing activities
|
|
|
68,866
|
|
|
(20,723
|
)
|
|
|
|
|
|
|
|
|
CASH
FLOWS FINANCING ACTIVITIES:
|
|
|
|
|
|
|
|
Payments
for dividend
|
|
|
-
|
|
|
(10,596,800
|
)
|
Proceeds
from bank loans
|
|
|
-
|
|
|
3,179,040
|
|
Principal
payments on short term bank loans
|
|
|
(2,781,410
|
)
|
|
(2,649,200
|
)
|
Proceeds
from notes payable
|
|
|
2,036,285
|
|
|
-
|
|
Principal
payments on notes payable
|
|
|
-
|
|
|
(2,906,702
|
)
|
(Decrease)
increase in restricted cash
|
|
|
(39,795
|
)
|
|
2,906,702
|
|
Net
cash used in financing activities
|
|
|
(784,920
|
)
|
|
(10,066,960
|
)
|
|
|
|
|
|
|
|
|
EFFECTS
OF EXCHANGE RATE CHANGE IN CASH
|
|
|
114,229
|
|
|
161,697
|
|
|
|
|
|
|
|
|
|
INCREASE
(DECREASE) IN CASH
|
|
|
13,074,138
|
|
|
(13,166,344
|
)
|
|
|
|
|
|
|
|
|
CASH,
beginning of period
|
|
|
48,195,798
|
|
|
17,737,208
|
|
|
|
|
|
|
|
|
|
CASH,
end of period
|
|
$
|
61,269,936
|
|
$
|
4,570,864
|
|
The
accompanying notes are an integral part of these consolidated financial
statements.
GENESIS
PHARMACEUTICALS ENTERPRISES, INC. AND SUBSIDIARIES
NOTES
TO
CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER
30, 2008
(UNAUDITED)
Note
1 – Organization and business
Genesis
Pharmaceuticals Enterprises, Inc. (the “Company” or “Genesis”) was originally
incorporated in the state of Florida on August 15, 2001, under the name Genesis
Technology Group, Inc. with the principal business objective of operating as
a
business development and marketing firm that specializes in advising and
providing a turnkey solution for small and mid-sized Chinese companies entering
Western markets. On October 1, 2007, Genesis executed a Share Acquisition and
Exchange Agreement (“Exchange Agreement”) by and among Genesis, Karmoya
International Ltd. (“Karmoya”), a British Virgin Islands company, and the
shareholders of 100% of Karmoya’s capital stock (the “Karmoya Shareholders”).
After the closing of the Exchange Agreement, Karmoya became the Company’s wholly
owned subsidiary, and the Company’s primary operations now consist of the
business and operations of Karmoya and its subsidiaries. The following table
summarizes the estimated fair values of the assets acquired and liabilities
assumed at the date of the acquisition:
Cash
|
|
$
|
534,950
|
|
Prepaid
expenses
|
|
|
40,620
|
|
Marketable
equity securities
|
|
|
370,330
|
|
Other
assets
|
|
|
7,083
|
|
Restricted
marketable securities
|
|
|
1,746,809
|
|
Restricted
marketable securities held for short term loans
|
|
|
3,250,000
|
|
Accounts
payable and accrued liabilities
|
|
|
(1,085,323
|
)
|
Loan
payable
|
|
|
(515,000
|
)
|
Other
liabilities assumed from acquisition
|
|
|
(452,001
|
)
|
Minority
interest
|
|
|
(121,063
|
)
|
Net
assets acquired
|
|
$
|
3,776,405
|
|
Contemporaneous
with the Exchange Agreement in October 2007, the Company discontinued the
business development and marketing segment of the Company, which had been the
Company’s principal business objective prior to the reverse merger as described
in Note 5 (the business development and marketing segment represented 100%
of
the Company’s sales prior to October 1, 2007). Liabilities of the business
development and marketing segment are reclassified as liabilities assumed from
reorganization in the consolidated balance sheets. The results of operations
and
cash flows of the business development and marketing segment of the Company
have
been reflected as loss from discontinued operations in the consolidated
statements of income and cash flows, respectively, for the year ended June
30,
2008. Except for Genesis Pharmaceuticals Enterprises, Inc., all other entities
that were consolidated into the Company prior to October 1, 2007, have been
administratively dissolved.
Karmoya
was established on July 18, 2007, under the laws of the British Virgin Islands.
Karmoya was established as a “special purpose vehicle” for the foreign capital
raising activities of Laiyang Jiangbo Pharmaceuticals Co., Ltd. (“Laiyang
Jiangbo”), a limited liability company formed under the laws of the People’s
Republic of China (the “PRC” or “China”). China’s State Administration of
Foreign Exchange (“SAFE”) requires the shareholders of any Chinese companies to
obtain SAFE’s approval before establishing any offshore holding company
structure for foreign financing as well as subsequent acquisition matters under
an official notice known as “Circular 106” in the PRC. On September 19, 2007,
Karmoya was approved by the local Chinese SAFE as a “special purpose vehicle”
offshore company.
On
September 20, 2007, Karmoya acquired 100% of Union Well International Limited
(“Union Well”), a Cayman Islands corporation established on May 9, 2007. On
September 17, 2007, Union Well established a wholly owned subsidiary, Genesis
Jiangbo (“Laiyang”) Biotech Technology Co., Ltd. (“GJBT”), in the PRC as a
wholly owned foreign limited liability company (“WOFE”) with an original
registered capital of $12 million. GJBT develops, manufactures, and sells health
medicines. The Company increased its registered capital in GJBT to $30,000,000
in June 2008. In August 2008, the PRC government approved GJBT to increase
its
registered capital from $30 million to $59.8 million. The PRC laws require
Union
Well, the 100% owner of GJBT to contribute at least 20% of the registered
capital within 30 days of the approval and the remaining balance is required
to
be contributed within two years of the approval date. In August 2008,
GJBT’s
board of directors approved an increase of additional registered capital in
the
amount of $29,800,000 of which $1,966,000 was paid as of September 30, 2008,
and
the remaining balance of $27,834,000 was recorded as a capital contribution
receivable as of September 30, 2008.
Laiyang
Jiangbo was formed under laws of the PRC in August 2003, with registered capital
of $1,210,000 (RMB 10,000,000). On December 1, 2006, Laiyang Jiangbo’s
registered capital increased to $6,664,000 (RMB 50,000,000), and on December
22,
2006, the registered capital was funded by the contribution of certain buildings
to the Company. Laiyang Jiangbo produces and sells western pharmaceutical
products in China and focuses on developing innovative medicines to address
various medical needs for patients worldwide. Laiyang Jiangbo operates in 26
provinces in the PRC, and is headquartered in Laiyang City, Shandong province,
China.
On
September 21, 2007, GJBT entered into a series of contractual arrangements
(“Contractual Arrangements”) with Laiyang Jiangbo and its shareholders. Under
the terms of the Contractual Arrangements, GJBT took control over the management
of the business activities of Laiyang Jiangbo and holds a 100% variable interest
in Laiyang Jiangbo. The Contractual Arrangements are comprised of a series
of
agreements, including a Consulting Services Agreement and an Operating
Agreement, through which GJBT has the right to advise, consult, manage, and
operate Laiyang Jiangbo, and collect and own all of their respective net
profits. Additionally, Laiyang Jiangbo’s shareholders have granted their voting
rights over Laiyang Jiangbo to GJBT. In order to further reinforce GJBT’s rights
to control and operate Laiyang Jiangbo, Laiyang Jiangbo and its shareholders
have granted GJBT the exclusive right and option to acquire all of their equity
interests in Laiyang Jiangbo or, alternatively, all of the assets of Laiyang
Jiangbo. Further, Laiyang Jiangbo’s shareholders have pledged all of their
rights, titles, and interests in Laiyang Jiangbo to GJBT. As both companies
are
under common control, this has been accounted for as a reorganization of
entities and the accompanying consolidated financial statements have been
prepared as if the reorganization occurred retroactively. The Company
consolidates Laiyang Jiangbo’s results of operations, assets and liabilities in
its financial statements.
Karmoya
used the contractual arrangements to gain control of Laiyang Jiangbo, instead
of
using a complete acquisition of Laiyang Jiangbo’s assets or equity to make
Laiyang Jiangbo a wholly owned subsidiary of Karmoya, due to the following:
(i)
PRC laws governing share exchanges with foreign entities, which became effective
on September 8, 2006, make the consequences of such acquisitions uncertain
and
(ii) other than by share exchange, PRC’s laws would require Karmoya to acquire
Laiyang Jiangbo in cash, and at the time of the acquisition, Karmoya was unable
to raise sufficient funds to pay the full appraised cash fair value for Laiyang
Jiangbo’s assets or shares as required under PRC laws.
Note
2 - Summary of significant accounting policies
Basis
of presentation
The
consolidated financial statements have been prepared in accordance with
accounting principles generally accepted in the United States of America ("US
GAAP") for interim financial information and pursuant to the requirements for
reporting on Form 10-Q. Accordingly, they do not include all the information
and
footnotes required by US GAAP for complete financial statements. In the opinion
of management, the accompanying balance sheets, and related interim statements
of income, shareholders’ equity and cash flows include all adjustments,
consisting only of normal recurring items, however, these consolidated financial
statements are not indicative of a full year of operations.
Principles
of consolidation
The
accompanying consolidated financial statements include the accounts of the
following entities, and all significant intercompany transactions and balances
have been eliminated in consolidation:
Consolidated
entity name:
|
|
Percentage of ownership
|
|
Karmoya
International Ltd.
|
|
|
100
|
%
|
Union
Well International Limited
|
|
|
100
|
%
|
Genesis
Jiangbo (Laiyang) Biotech Technology Co., Ltd.
|
|
|
100
|
%
|
Laiyang
Jiangbo Pharmaceuticals Co., Ltd.
|
|
|
Variable Interest Entity
|
|
Financial
Accounting Standards Board (“FASB”) Interpretation Number (“FIN”) 46 (revised
December 2003), “Consolidation of Variable Interest Entities, an Interpretation
of ARB No.51” (“FIN 46R”), addresses whether certain types of entities, referred
to as variable interest entities (“VIEs”), should be consolidated in a company’s
consolidated financial statements. In accordance with the provisions of FIN
46R,
the Company has determined that Laiyang Jiangbo is a VIE and that the Company
is
the primary beneficiary, and accordingly, the financial statements of Laiyang
Jiangbo are consolidated into the financial statements of the
Company.
Reverse
stock split
In
July
2008, the Company approved a 40-to-1 reverse stock split, effective September
4,
2008, and a new trading symbol “GNPH” also became effective on that day. The
accompanying consolidated financial statements have been retroactively adjusted
to reflect the reverse stock split. All share representations are on a
post-split basis.
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”). In accordance
with Statement of Financial Accounting Standards (“SFAS”) No. 52, “Foreign
Currency Translation,” results of operations and cash flows are translated at
average exchange rates during the period, assets and liabilities are translated
at the unified exchange rates as quoted by the People’s Bank of China at the end
of the period, and equity is translated at historical exchange rates. As a
result, amounts related to assets and liabilities reported on the consolidated
statements of cash flows will not necessarily agree with changes in the
corresponding balances on the consolidated balance sheets. 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.
Translation
adjustments amounted to $6,683,694 and $6,353,053 as of September 30, 2008
and
June 30, 2008, respectively. Asset and liability accounts at September 30,
2008
were translated at 6.835RMB to $1.00 USD as compared to 6.851RMB at June 30,
2008. Equity accounts were stated at their historical rates. The average
translation rates applied to statements of income for the three months ended
September 30, 2008 and 2007 were 6.8311 RMB and 7.55 RMB to $1.00
USD.
In
accordance with SFAS 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 consolidated statements of cash flows will not necessarily
agree
with changes in the corresponding balances on the consolidated balance
sheets.
Use
of
estimates
The
preparation of financial statements in conformity with US GAAP requires
management to make estimates and assumptions that affect the reported amounts
of
assets and liabilities, and disclosure of contingent assets and liabilities
at
the date of the financial statements, and the reported amounts of revenues
and
expenses during the reporting period. The significant estimates made in the
preparation of the Company’s consolidated financial statements relate to the
assessment of the carrying values of accounts receivable and related allowance
for doubtful accounts, allowance for obsolete inventory, sales returns, fair
value of warrants and beneficial conversion features related to the convertible
notes, and fair value of options granted to employees. Actual results could
be
materially different from these estimates upon which the carrying values were
based.
Revenue
recognition
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 SFAS No. 48 (“SFAS 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 collectibility is reasonably
assured.
The
Company is generally not contractually obligated to accept returns. However,
on
a case by case negotiated basis, the Company permits customers to return their
products. In accordance with SFAS 48, revenue is recorded net of an allowance
for estimated returns. Such reserves are based upon management's evaluation
of
historical experience and estimated costs. The amount of the reserves ultimately
required could differ materially in the near term from amounts included in
the
accompanying consolidated statements of income.
Financial
instruments
SFAS
No.
107 (“SFAS 107”), “Disclosures about Fair Value of Financial Instruments,”
requires disclosure of the fair value of financial instruments held by the
Company. SFAS 107 defines the fair value of financial instruments as the amount
at which the instrument could be exchanged in a current transaction between
willing parties. The Company considers the carrying values of cash, accounts
receivable, notes receivable, other receivables,
prepayments, accounts payable, other payables, accrued liabilities, customer
deposits, taxes payable, and loans to approximate their fair values because
of
the short period of time between the origination of such instruments and their
expected realization and their current market rate of interest.
Stock-based
compensation
The
Company records stock-based compensation expense pursuant to SFAS No. 123R
(SFAS
123R”), "Share Based Payment.” SFAS 123R requires companies to measure
compensation cost for stock-based employee compensation plans at fair value
at
the grant date and recognize the expense over the employee's requisite service
period. The Company estimates the fair value of the awards using the
Black-Scholes Option Pricing Model. Under SFAS 123R, the Company’s expected
volatility assumption is based on the historical volatility of Company’s stock
or the expected volatility of similar entities. The expected life assumption
is
primarily based on historical exercise patterns and employee post-vesting
termination behavior. The risk-free interest rate for the expected term of
the
option is based on the U.S. Treasury yield curve in effect at the time of grant.
Stock-based
compensation expense is recognized based on awards expected to vest, and there
were no estimated forfeitures as the Company has a short history of issuing
options. SFAS 123R requires forfeitures to be estimated at the time of grant
and
revised in subsequent periods, if necessary, if actual forfeitures differ from
those estimates.
Comprehensive
income
SFAS
No.
130 (“SFAS 130”), “Reporting Comprehensive Income,” establishes standards for
reporting and display of comprehensive income and its components in financial
statements. It requires that all items that are required to be recognized under
accounting standards as components of comprehensive income be reported in a
financial statement that is displayed with the same prominence as other
financial statements. The accompanying consolidated financial statements include
the provisions of SFAS 130.
Cash
and cash equivalents
Cash
and
cash equivalents include cash on hand and demand deposits in accounts maintained
with state-owned banks within the PRC. The Company considers all highly liquid
instruments with original maturities of three months or less, and money market
accounts to be cash and cash equivalents.
The
Company maintains cash deposits in financial institutions that exceed the
amounts insured by the U.S. government. Balances at financial institutions
or
state-owned banks within the PRC are not covered by insurance. Non-performance
by these institutions could expose the Company to losses for amounts in excess
of insured balances. As of September 30, 2008 and June 30, 2008, the Company’s
bank balances, including restricted cash balances, exceeded government-insured
limits by approximately $68,933,520 and $55,576,446, respectively.
Restricted
cash
Restricted
cash represent amounts set aside by the Company in accordance with the Company’s
debt agreements with certain financial institutions. These cash amounts are
designated for the purpose of paying down the principal amounts owed to the
financial institutions, and these amounts are held at the same financial
institutions with which the Company has debt agreements. Due to the short-term
nature of the Company’s debt obligations to these banks, the corresponding
restricted cash balances have been classified as current in the consolidated
balance sheets.
As
of
September 30, 2008 and June 30, 2008, the Company had restricted cash of
$7,894,348 and $7,839,785, respectively, of which $7,894,348 and $5,843,295,
respectively, were maintained as security deposits for bank acceptance related
to the Company’s notes payable.
Investment
and restricted investments
Investments
are comprised primarily of equity securities and are stated fair value. Certain
of these investments are classified as trading securities based on the Company’s
intent to sell them within the year. Further, certain of these securities are
classified as available-for-sale and are reflected as restricted, noncurrent
investments, based on the Company’s intent to hold them beyond one year.
Restricted investments are securities that were acquired through the reverse
acquisition which contained certain restrictions on the securities. For trading
securities, realized and unrealized gains and losses are included in the
accompanying consolidated statements of income. For available-for-sale
securities, realized gains and losses are included in the consolidated
statements of income. Unrealized gains and losses for these available-for-sale
securities are reported in other comprehensive income, net of tax, in the
consolidated statements of shareholders’ equity. The Company has no investments
that are considered to be held-to-maturity securities.
For
the
three months ended September 30, 2008 and 2007, realized gain on trading
securities amounted to $124,523 and $0, respectively. Unrealized loss on trading
securities amounted to $1,044,083 for the three months ended September 2008.
There were no unrealized losses on trading securities for the three months
ended
September 30, 2007.
For
the
three months ended September 30, 2008 and 2007, unrealized loss on
available-for-sales securities amounted to $215,115 and $0, respectively.
Accounts
receivable
In
the
normal course of business, the Company extends credit to its customers without
requiring collateral or other security interests. Management reviews its
accounts receivables at each reporting period to provide for an allowance
against accounts receivable for an amount that could become uncollectible.
This
review process may involve the identification of payment problems with specific
customers. The Company estimates this allowance based on the aging of the
accounts receivable, historical collection experience, and other relevant
factors, such as changes in the economy and the imposition of regulatory
requirements that can have an impact on the industry. These factors continuously
change, and can have an impact on collections and the Company’s estimation
process. These impacts may be material.
Certain
accounts receivable amounts are charged off against allowances after
unsuccessful collection efforts. Subsequent cash recoveries are recognized
as
income in the period when they occur.
The
activities in the allowance for doubtful accounts are as follows for the periods
ended September 30, 2008 and June 30, 2008:
|
|
September 30, 2008
|
|
June 30, 2008
|
|
|
|
(Unaudited)
|
|
|
|
Beginning
allowance for doubtful accounts
|
|
$
|
155,662
|
|
$
|
166,696
|
|
Bad
debt additions (recovery of previously reserved amount)
|
|
|
63,298
|
|
|
(27,641
|
)
|
Foreign
currency translation adjustments
|
|
|
440
|
|
|
16,607
|
|
Ending
allowance for doubtful accounts
|
|
$
|
219,400
|
|
$
|
155,662
|
|
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. The Company reviews its inventory periodically for possible
obsolete goods or to determine if any reserves are necessary. As of September
30, 2008 and June 30, 2008, the Company has determined that no reserves were
necessary.
Advance
to suppliers
Advances
to suppliers represent partial payments or deposits for future inventory and
equipment purchases. These advances to suppliers are non-interest bearing and
unsecured. From time to time, vendors require a certain amount of money to
be
deposited with them as a guarantee that the Company will receive their purchase
on a timely basis. As of September 30, 2008 and June 30, 2008, advances to
suppliers amounted to $891,489 and $1,718,504, respectively.
Plant
and equipment
Plant
and
equipment are stated at cost less accumulated depreciation. Additions and
improvements to plant and equipment accounts are recorded at cost. 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 the results
of operations in the year of disposition. Maintenance, repairs, and minor
renewals are charged directly to expense as incurred. Major additions and
betterments to plant and equipment accounts are capitalized. Depreciation is
computed using the straight-line method over the estimated useful lives of
the
assets. The estimated useful lives of the assets are as follows:
|
|
Useful
Life
|
|
Building
and building improvements
|
|
|
5 – 40 Years
|
|
Manufacturing
equipment
|
|
|
5
– 20 Years
|
|
Office
equipment and furniture
|
|
|
5
– 10 Years
|
|
Vehicle
|
|
|
5
Years
|
|
Intangible
assets
All
land
in the PRC is owned by the PRC government and cannot be sold to any individual
or company. The Company has recorded the amounts paid to the PRC government
to
acquire long-term interests to utilize land underlying the Company’s facilities
as land use rights. This type of arrangement is common for the use of land
in
the PRC. Land use rights are amortized on the straight-line method over the
terms of the land use rights, which range from 20 to 50 years. The Company
acquired land use rights in August 2004 and October 2007 in the amounts of
approximately $879,000 and $8,871,000, respectively, which are included in
intangible assets.
Patents
and licenses include purchased technological know-how, secret formulas,
manufacturing processes, technical, procedural manuals, and the certificate
of
drugs production and is amortized using the straight-line method over the
expected useful economic life of 5 years, which reflects the period over which
those formulas, manufacturing processes, technical and procedural manuals are
kept secret to the Company as agreed between the Company and the selling
parties.
The
estimated useful lives of intangible assets are as follows:
|
|
Useful
Life
|
|
Land
Use Rights
|
|
|
50 Years
|
|
Patents
|
|
|
5
Years
|
|
Licenses
|
|
|
5
Years
|
|
Impairment
of long-lived assets
Long-lived
assets of the Company are reviewed periodically or more often if circumstances
dictate, to determine whether their carrying values have become impaired. The
Company considers assets to be impaired if the carrying values exceed the future
projected cash flows from related operations. The Company also re-evaluates
the
periods of depreciation to determine whether subsequent events and circumstances
warrant revised estimates of useful lives. As of September 30, 2008, the Company
expects these assets to be fully recoverable.
Beneficial
conversion feature of convertible notes
The
Company accounted for the $5,000,000 and $30,000,000 secured convertible notes
issued pursuant to the subscription agreements discussed in Note 14 under
Emerging Issues Task Force (“EITF”) 00-27, ‘‘Application of Issue 98-5 to
Certain Convertible Instruments.” In accordance with EITF 00-27, the Company has
determined that the convertible notes contained beneficial conversion feature
because on November 6, 2007, the effective conversion price of the $5,000,000
convertible note was $5.48 when the market value per share was $16.00, and
on
May 30, 2008, the effective conversion price of the $30,000,000 convertible
note
was $4.69 when the market value per share was $12.00. Total value of beneficial
conversion feature of $2,742,714 for the November 6, 2007 convertible
note and $17,572,910 for the May 30, 2008 convertible debt was discounted
from the carrying value of the convertible notes. The beneficial conversation
feature is amortized using the effective interest method over the term of the
note. As of September 30, 2008 and June 30, 2008, total of $18,628,786 and
$19,069,054, respectively, remained unamortized for the beneficial conversion
feature.
Income
taxes
The
Company accounts for income taxes in accordance with SFAS No. 109 (“SFAS 109”),
“Accounting for Income Taxes.” Under the asset and liability method as required
by SFAS 109, deferred income taxes are recognized for the tax consequences
of
temporary differences by applying enacted statutory tax rates applicable to
future years to differences between the financial statement carrying amounts
and
the tax bases of existing assets and liabilities. Under SFAS 109, the effect
on
deferred income taxes of a change in tax rates is recognized in income in the
period that includes the enactment date. A valuation allowance is recognized
if
it is more likely than not that some portion, or all of, a deferred tax asset
will not be realized. As of September 30, 2008 and June 30, 2008, the Company
did not have any deferred tax assets or liabilities, and as such, no valuation
allowances were recorded at September 30, 2008 and June 30, 2008.
In
July
2006, the Financial Accounting Standards Board (“FASB”) issued FASB
Interpretation No. 48 (“FIN 48”), "Accounting for Uncertainty in Income Taxes -
an interpretation of FASB Statement No. 109," which clarifies the accounting
and
disclosure for uncertain tax positions. This interpretation is effective for
fiscal years beginning after December 15, 2006, and the Company has implemented
this interpretation as of July 1, 2007. FIN 48 prescribes a recognition
threshold and measurement attribute for recognition and measurement of a tax
position taken or expected to be taken in a tax return. FIN 48 also provides
guidance on de-recognition, classification, interest and penalties, accounting
in interim periods, disclosure and transition.
Under
FIN
48, evaluation of a tax position is a two-step process. The first step is to
determine whether it is more-likely-than-not that a tax position will be
sustained upon examination, including the resolution of any related appeals
or
litigation based on the technical merits of that position. The second step
is to
measure a tax position that meets the more-likely-than-not threshold to
determine the amount of benefit to be recognized in the financial statements.
A
tax position is measured at the largest amount of benefit that is greater than
50 percent likely of being realized upon ultimate settlement. Tax positions
that
previously failed to meet the more-likely-than-not recognition threshold should
be recognized in the first subsequent period in which the threshold is met.
Previously recognized tax positions that no longer meet the more-likely-than-not
criteria should be de-recognized in the first subsequent financial reporting
period in which the threshold is no longer met.
The
adoption of FIN 48 at July 1, 2007, did not have a material effect on the
Company's consolidated financial statements.
The
Company’s operations are subject to income and transaction taxes in the United
States and in the PRC jurisdictions. Significant estimates and judgments are
required in determining the Company’s worldwide provision for income taxes. Some
of these estimates are based on interpretations of existing tax laws or
regulations, and as a result the ultimate amount of tax liability may be
uncertain. However, the Company does not anticipate any events that would lead
to changes to these uncertainties.
Value
added tax
The
Company is subject to value added tax (“VAT”) for manufacturing products and
business tax for services provided. The applicable VAT rate is 17% for products
sold in the PRC. The amount of VAT liability is determined by applying the
applicable tax rate to the invoiced amount of goods sold (output VAT) less
VAT
paid on purchases made with the relevant supporting invoices (input VAT). Under
the commercial practice of the PRC, the Company paid VAT
based
on tax invoices issued. The tax invoices may be issued subsequent to the date
on
which revenue is recognized, and there may be a considerable delay between
the
date on which the revenue is recognized and the date on which the tax invoice
is
issued. In the event that the PRC tax authorities dispute the date on which
revenue is recognized for tax purposes, the PRC tax office has the right to
assess a penalty, which can range from zero to five times the amount of the
taxes which are determined to be late or deficient, and will be charged to
operations in the period if and when a determination is been made by the taxing
authorities that a penalty is due.
VAT
on
sales and VAT on purchases amounted to $4,683,100 and $374,264 for the three
months ended September 30, 2008, respectively, and $2,915,293 and $57,370 for
the three months ended September 30, 2007, respectively. Sales and purchases
are
recorded net of VAT collected and paid as the Company acts as an agent for
the
government. VAT taxes are not impacted by the income tax
holiday.
Shipping
and handling
Shipping
and handling costs related to costs of goods sold are included in selling,
general and administrative expenses. Shipping and handling costs amounted to
$121,864 and $48,373, respectively, for the three months ended September 30,
2008, and 2007, respectively.
Advertising
Expenses
incurred in the advertising of the Company and the Company’s products are
charged to operations currently. Advertising expenses amounted to $904,444
and
$2,767,459 for the three months ended September 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 to assist in such efforts. Research
and
development costs amounted to $1,097,925 and $264,920 for the three months
ended
September 30, 2008 and 2007, respectively.
Recently
adopted accounting pronouncements
On
July 1, 2008, the Company adopted SFAS No. 157 (“SFAS 157”), “Fair
Value Measurements,” for all financial assets and liabilities and nonfinancial
assets and liabilities that are recognized or disclosed at fair value in the
financial statements on a recurring basis (at least annually). SFAS 157
defines fair value, establishes a framework for measuring fair value in
accordance with generally accepted accounting principles, and expands
disclosures about fair value measurements. This statement does not require
any
new fair value measurements, but provides guidance on how to measure fair value
by providing a fair value hierarchy used to classify the source of the
information
SFAS
157
defines fair value as the price that would be received to sell an asset or
paid
to transfer a liability (i.e., the “exit price”) in an orderly transaction
between market participants at the measurement date. SFAS 157 establishes a
three-level valuation hierarchy for disclosures of fair value measurement and
enhances disclosures requirements for fair value measures. The carrying amounts
reported in the balance sheets for receivables and current liabilities each
qualify as financial instruments and are a reasonable estimate of fair value
because of the short period of time between the origination of such instruments
and their expected realization and their current market rate of interest. The
three levels are defined as follow:
|
·
|
Level
1 inputs
to the valuation methodology are quoted prices (unadjusted) for
identical
assets or liabilities in active
markets.
|
|
·
|
Level
2 inputs
to the valuation methodology include quoted prices for similar
assets and
liabilities in active markets, and inputs that are observable for
the
asset or liability, either directly or indirectly, for substantially
the
full term of the financial
instrument.
|
|
·
|
Level
3 inputs
to the valuation methodology are unobservable and significant to
the fair
value measurement.
|
The
Company analyzes all financial instruments with features of both liabilities
and
equity under SFAS 150, “Accounting for Certain Financial Instruments with
Characteristics of Both Liabilities and Equity,” SFAS 133, “Accounting for
Derivative Instruments and Hedging Activities” and EITF 00-19, “Accounting for
Derivative Financial Instruments Indexed to, and Potentially Settled in, a
Company’s Own Stock.”
As
required by SFAS 157, financial assets and liabilities are classified in their
entirety based on the lowest level of input that is significant to the fair
value measurement. Depending on the product and the terms of the transaction,
the fair value of our notes payable and derivative liabilities were modeled
using a series of techniques, including closed-form analytic formula, such
as
the Black-Scholes option-pricing model, which does
not
entail material subjectivity because the
methodology employed do not necessitate significant judgment, and the pricing
inputs are observed from actively quoted markets.
The
following table sets forth by level within the fair value hierarchy our
financial assets and liabilities that were accounted for at fair value on a
recurring basis as of September 30, 2008.
|
|
Carrying Value at
|
|
Fair Value Measurements at
|
|
|
|
September 30, 2008
|
|
September 30, 2008 Using
|
|
|
|
|
|
Level
1
|
|
Level
2
|
|
Level
3
|
|
|
|
|
|
|
|
|
|
|
|
$5M
Convertible Debt (November 2007)
|
|
$
|
686,939
|
|
$
|
-
|
|
$ |
|
|
$
|
5,000,523
|
|
$30M
Convertible Debt (May 2008)
|
|
|
2,475,655
|
|
|
-
|
|
|
|
|
|
30,380,159
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
3,162,594
|
|
$
|
-
|
|
$ |
|
|
$
|
35,380,682
|
|
The
Company did not identify any other non-recurring assets and liabilities that
are
required to be presented on the balance sheet at fair value in accordance with
SFAS 157.
SFAS
No. 159 (“SFAS 159”), “The Fair Value Option for Financial Assets and
Financial Liabilities – Including an amendment of FASB Statement No. 115,”
became effective for the Company on July 1, 2008. SFAS 159 provides the
Company with the irrevocable option to elect fair value for the initial and
subsequent measurement for certain financial assets and liabilities on a
contract-by-contract basis with the difference between the carrying value before
election of the fair value option and the fair value recorded upon election
as
an adjustment to beginning retained earnings. The Company chose not to elect
the
fair value option.
Recent
accounting pronouncements
In
December 2007, the FASB issued SFAS No. 141(R) (“SFAS 141R”), “Business
Combinations,” which replaces SFAS No. 141. SFAS 141R retains the purchase
method of accounting for acquisitions, but requires a number of changes,
including changes in the way assets and liabilities are recognized in the
purchase accounting as well as requiring the expensing of acquisition-related
costs as incurred. Furthermore, SFAS 141R provides guidance for recognizing
and
measuring the goodwill acquired in the business combination and determines
what
information to disclose to enable users of the financial statements to evaluate
the nature and financial effects of the business combination. SFAS 141R is
effective for fiscal years beginning on or after December 15, 2008. Earlier
adoption is prohibited. The Company is evaluating the impact, if any, that
the
adoption of this statement will have on its consolidated results of operations
or consolidated financial position.
In
December 2007, the FASB issued SFAS No. 160 (“SFAS 160”), “Noncontrolling
Interests in Consolidated Financial Statements — An Amendment of ARB No. 51.”
SFAS 160 amends ARB No. 51 to establish accounting and reporting standards
for
the noncontrolling interest in a subsidiary and for the deconsolidation of
a
subsidiary. It is intended to eliminate the diversity in practice regarding
the
accounting for transactions between equity and noncontrolling interests by
requiring that they be treated as equity transactions. Further, it requires
consolidated net income to be reported at amounts that include the amounts
attributable to both the parent and the noncontrolling interest. SFAS 160 also
establishes a single method of accounting for changes in a parent’s ownership
interest in a subsidiary that do not result in deconsolidation, requires that
a
parent recognize a gain or loss in net income when a subsidiary is
deconsolidated, requires expanded disclosures in the consolidated financial
statements that clearly identify and distinguish between the interests of the
parent’s owners and the interests of the noncontrolling owners of a subsidiary,
among others. SFAS 160 is effective for fiscal years beginning on or after
December 15, 2008, with early adoption permitted, and it is to be applied
prospectively. SFAS 160 is to be applied prospectively as of the beginning
of
the fiscal year in which it is initially applied, except for the presentation
and disclosure requirements, which must be applied retrospectively for all
periods presented. The Company has not yet evaluated the impact that SFAS 160
will have on its consolidated financial position or consolidated results of
operations.
In
February 2008, the FASB issued FASB Staff Position No. 157-1 ("FSP 157-1"),
"Application of FASB Statement No. 157 to FASB Statement No. 13 and Other
Accounting Pronouncements That Address Fair Value Measurements for Purposes
of
Lease Classification or Measurement under Statement 13." FSP 157-1 indicates
that it does not apply under FASB Statement No. 13 (“SFAS 13”), "Accounting for
Leases," and other accounting pronouncements that address fair value
measurements for purposes of lease classification or measurement under SFAS
13.
This scope exception does not apply to assets acquired and liabilities assumed
in a business combination that are required to be measured at fair value under
SFAS No. 141 or SFAS No. 141R, regardless of whether those assets and
liabilities are related to leases.
Also
in
February 2008, the FASB issued FASB Staff Position No. 157-2 ("FSP 157-2"),
"Effective Date of FASB Statement No. 157." With the issuance of FSP 157-2,
the
FASB agreed to: (a) defer the effective date in SFAS No. 157 for one year for
certain nonfinancial assets and nonfinancial liabilities, except those that
are
recognized or disclosed at fair value in the financial statements on a recurring
basis (at least annually), and (b) remove certain leasing transactions from
the
scope of SFAS No. 157. The deferral is intended to provide the FASB time to
consider the effect of certain implementation issues that have arisen from
the
application of SFAS No. 157 to these assets and liabilities.
In
March
2008, the FASB issued SFAS No. 161 ("SFAS 161"), "Disclosures about Derivative
Instruments and Hedging Activities." SFAS 161 is intended to improve financial
reporting of derivative instruments and hedging activities by requiring enhanced
disclosures to enable financial statement users to better understand the effects
of derivatives and hedging on an entity's financial position, financial
performance and cash flows. The provisions of SFAS 161 are effective for interim
periods and fiscal years beginning after November 15, 2008, with early adoption
encouraged. The Company does not anticipate that the adoption of SFAS 161 will
have a material impact on its consolidated results of operations or consolidated
financial position.
In
May
2008, the FASB issued SFAS No. 162 (“SFAS 162”), "The Hierarchy of Generally
Accepted Accounting Principles." SFAS 162 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 GAAP for nongovernmental entities. SFAS 162 is
effective 60 days following the SEC's approval of the Public Company Accounting
Oversight Board (“PCAOB”) amendments to AU Section 411, "The Meaning of Present
Fairly in Conformity with Generally Accepted Accounting Principles." The Company
does not expect the adoption of SFAS 162 will have a material impact on its
consolidated results of operations or consolidated financial
position.
In
May
2008, the FASB issued SFAS No. 163 (“SFAS 163”), “Accounting for Financial
Guarantee Insurance Contracts, an interpretation of FASB Statement No. 60.” The
scope of SFAS 163 is limited to financial guarantee insurance (and reinsurance)
contracts issued by enterprises included within the scope of FASB Statement
No.
60. Accordingly, SFAS 163 does not apply to financial guarantee contracts issued
by enterprises excluded from the scope of FASB Statement No. 60 or to some
insurance contracts that seem similar to financial guarantee insurance contracts
issued by insurance enterprises (such as mortgage guaranty insurance or credit
insurance on trade receivables). SFAS 163 also does not apply to financial
guarantee insurance contracts that are derivative instruments included within
the scope of FASB Statement No. 133, “Accounting for Derivative Instruments and
Hedging Activities.” The Company does not expect the adoption of SFAS 163 will
have a material impact on its consolidated results of operations or consolidated
financial position.
On
May 9,
2008, the FASB issued FASB Staff Position No. APB 14-1 ("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 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 APB14-1 is effective
for
financial statements issued for fiscal years beginning after December 15, 2008,
and interim periods within those fiscal years. The Company is currently
evaluating the impact that FSP APB 14-1 will have on its consolidated results
of
operations or consolidated financial position.
On
June
16, 2008, the FASB issued FASB Staff Position No. EITF 03-6-1 (“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. FSP EITF 03-6-1 indicates 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. The Company is currently evaluating the
requirements of FSP No. EITF 03-6-1 and the impact that its adoption will have
on the consolidated results of operations or consolidated financial
position.
In
June
2008, the FASB issued Emerging Issues Task Force Issue 07-5 (“EITF 07-5”),
“Determining whether an Instrument (or Embedded Feature) is indexed to an
Entity’s Own Stock.” EITF No. 07-5 is effective for financial statements issued
for fiscal years beginning after December 15, 2008, and interim periods within
those fiscal years. Early application is not permitted. Paragraph 11(a) of
SFAS
No. 133 “Accounting for Derivatives and Hedging Activities,” specifies that a
contract that would otherwise meet the definition of a derivative but is both
(a) indexed to the Company’s own stock and (b) classified in stockholders’
equity in the statement of financial position would not be considered a
derivative financial instrument. EITF 07-5 provides a new two-step model to
be
applied in determining whether a financial instrument or an embedded feature
is
indexed to an issuer’s own stock and thus able to qualify for the SFAS No. 133
paragraph 11(a) scope exception. This standard triggers liability accounting
on
all options and warrants exercisable at strike prices denominated in any
currency other than the functional currency of the operating entity in the
PRC
(Renminbi). The Company is currently evaluating the impact of the adoption
of
EITF 07-5 on the accounting for related warrants transactions.
In
June
2008, FASB issued EITF Issue No. 08-4 (“EITF No. 08-4”), “Transition Guidance
for Conforming Changes to Issue No. 98-5.” The objective of EITF No.08-4 is
to provide transition guidance for conforming changes made to EITF No. 98-5,
“Accounting for Convertible Securities with Beneficial Conversion Features or
Contingently Adjustable Conversion Ratios,” that result from EITF No. 00-27
“Application of Issue No. 98-5 to Certain Convertible Instruments,” and SFAS No.
150, “Accounting for Certain Financial Instruments with Characteristics of both
Liabilities and Equity.” EITF No. 08-4 is effective for financial statements
issued for fiscal years ending after December 15, 2008. Early application is
permitted. The Company is currently evaluating the impact of adoption of EITF
No. 07-5 on the accounting for the convertible notes and related warrants
transactions.
On
October 10, 2008, the FASB issued FSP 157-3 (“FSP 157-3”), “Determining the Fair
Value of a Financial Asset When the Market for That Asset Is Not Active,” which
clarifies the application of SFAS 157 in a market that is not active and
provides an example to illustrate key considerations in determining the fair
value of a financial asset when the market for that financial asset is not
active. FSP 157-3 became effective on October 10, 2008, and its adoption did
not
have a material impact on the Company’s consolidated results of operations or
consolidated financial position for the three months ended September 30,
2008.
Reclassifications
Certain
amounts in the prior period’s consolidated financial statements have been
reclassified to conform to the current period presentation with no impact on
the
previously reported net income or cash flows.
Note
3 - Earnings per share
The
Company reports earnings per share in accordance with the provisions of SFAS
128, “Earnings Per Share.” SFAS 128 requires presentation of basic and diluted
earnings per share in conjunction with the disclosure of the methodology used
in
computing such earnings per share. Basic earnings per share excludes dilution
and is computed by dividing income available to common stockholders by the
weighted average common shares outstanding during the period. Diluted earnings
per share takes into account the potential dilution that could occur if
securities or other contracts to issue common stock were exercised and converted
into common stock.
All
share
and per share amounts used in the Company’s financial statements and notes
thereto have been retroactively restated to reflect the 40-to-1 reverse stock
split, which occurred on September 4, 2008.
The
following is a reconciliation of the basic and diluted earnings per share
computations for the three months ended September 30, 2008 and
2007:
|
|
2008
|
|
2007
|
|
|
|
|
|
|
|
Net
income for basic and diluted earnings per share
|
|
$
|
3,133,484
|
|
$
|
3,234,992
|
|
|
|
|
|
|
|
|
|
Weighted
average shares used in basic computation
|
|
|
9,769,329
|
|
|
7,494,740
|
|
Diluted
effect of stock options and warrants
|
|
|
92,342
|
|
|
-
|
|
Weighted
average shares used in diluted computation
|
|
|
9,861,671
|
|
|
7,494,740
|
|
|
|
|
|
|
|
|
|
Earnings
per share:
|
|
|
|
|
|
|
|
Basic
|
|
$
|
0.32
|
|
$
|
0.43
|
|
Diluted
|
|
$
|
0.32
|
|
$
|
0.43
|
|
For
the
three months ended September 30, 2008,
2,000
stock options and 1,875,000 warrants with an average exercise price of $12
and
$10.00, respectively, were not included in the diluted earnings per share
calculation because of the anti-diluted effect. For the three months ended
September 30, 2007, all options and warrants were excluded in the diluted
earnings per share calculation due to the anti-diluted effect.
Note
4 - Supplemental disclosure of cash flow information
Cash
paid
for income taxes amounted to $62,943 and $59,251 for the three month periods
ended September 30, 2008 and 2007, respectively.
Cash
paid
for interest amounted to $58,650 and $89,501 for the three month periods ended
September 30, 2008 and 2007, respectively.
Note
5 - Discontinued operations
In
connection with the reverse merger with Karmoya on October 1, 2007, the Company
determined to discontinue its operations of business development and marketing,
as it no longer supported its core business strategy. The discontinuance of
these operations did not involve any sale of assets or assumption of liabilities
by another party. In conjunction with the discontinuance of operations, the
Company determined that the assets related to the Company’s business development
and marketing operations were subject to the recognition of impairment. However,
since the related assets are continuing to be used by the Company’s Karmoya and
subsidiaries, the Company determined that there had been no impairment. The
remaining liabilities of the discontinued operations are reflected in the
consolidated balance sheets under the caption "liabilities assumed from
reorganization" which totaled $552,220 as of September 30, 2008.
In
accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of
Long-Lived Assets,” the results of operations of a component of entity that has
been disposed of or is classified as held for sale shall be reported in
discontinued operations. Accordingly, the results of operations of the business
development and marketing operation segment are reported as discontinued
operations in the accompanying consolidated statements of income for the three
months ended September 30, 2008. As the accompanying consolidated statements
of
income for the three months ended September 30, 2008 reflect the results of
operations for Karmoya and its subsidiaries, the discontinued operations of
the
Company did not have any impact on the consolidated statements of income for
the
period presented.
The
following is a summary of the components of the loss from discontinued
operations for the three months ended September 30, 2008 and 2007:
|
|
2008
|
|
2007
|
|
Revenues
|
|
$
|
-
|
|
$
|
-
|
|
Cost
of sales
|
|
|
-
|
|
|
-
|
|
Gross
profit
|
|
|
-
|
|
|
-
|
|
Operating
and other non-operating expenses
|
|
|
45,216
|
|
|
-
|
|
Loss
from discontinued operations before other expenses and income
taxes
|
|
|
45,216
|
|
|
-
|
|
Income
tax benefit
|
|
|
-
|
|
|
|
|
Loss
from discontinued operations
|
|
$
|
45,216
|
|
$
|
-
|
|
Note
6 - Inventories
Inventories
consisted of the following:
|
|
September 30, 2008
|
|
June 30, 2008
|
|
|
|
(Unaudited)
|
|
|
|
Raw
materials
|
|
$
|
1,060,443
|
|
$
|
2,164,138
|
|
Work-in-process
|
|
|
76,512
|
|
|
531,076
|
|
Packing
materials
|
|
|
772,992
|
|
|
204,763
|
|
Finished
goods
|
|
|
1,156,333
|
|
|
1,006,197
|
|
Total
|
|
$
|
3,066,280
|
|
$
|
3,906,174
|
|
Note
7 - Plant and equipment
Plant
and
equipment consisted of the following:
|
|
September 30, 2008
|
|
June 30, 2008
|
|
|
|
(Unaudited)
|
|
|
|
Buildings
and building improvements
|
|
$
|
10,956,321
|
|
$
|
10,926,369
|
|
Manufacturing
equipment
|
|
|
1,204,659
|
|
|
1,188,643
|
|
Office
equipment and furniture
|
|
|
305,948
|
|
|
298,137
|
|
Vehicles
|
|
|
381,529
|
|
|
380,485
|
|
Total
|
|
|
12,848,457
|
|
|
12,793,634
|
|
Less:
accumulated depreciation
|
|
|
(1,718,579
|
)
|
|
(1,567,790
|
)
|
Total
|
|
$
|
11,129,878
|
|
$
|
11,225,844
|
|
For
the
three months ended September 30, 2008 and 2007, depreciation expense amounted
to
$146,694 and $111,356, respectively.
Note
8 - Intangible assets
Intangible
assets consisted of the following:
|
|
September 30, 2008
|
|
June 30, 2008
|
|
|
|
(Unaudited)
|
|
|
|
Land
use rights
|
|
$
|
9,957,382
|
|
$
|
9,930,157
|
|
Patents
|
|
|
541,310
|
|
|
539,830
|
|
Licenses
|
|
|
23,335
|
|
|
23,271
|
|
Total
|
|
|
10,522,027
|
|
|
10,493,258
|
|
Less:
accumulated amortization
|
|
|
(651,533
|
)
|
|
(576,457
|
)
|
Total
|
|
$
|
9,870,494
|
|
$
|
9,916,801
|
|
Amortization
expense for the three months ended September 30, 2008, and 2007 amounted to
$73,540, and $31,521, respectively.
Note
9 - Debt
Short
term bank loan
Short
term bank loan represents an amount due to a bank that is due within one year.
This loan can be renewed with the bank upon maturity. The Company’s short term
bank loan consisted of the following:
|
|
September ,2008
(Unaudited)
|
|
June 30,2008
|
|
Loan
from Communication Bank; due September 2008; interest rate of 8.64%
per
annum; monthly interest payment; guaranteed by related party, Jiangbo
Chinese-Western Pharmacy.
|
|
$
|
-
|
|
$
|
2,772,100
|
|
Total
|
|
$
|
-
|
|
$
|
2,772,100
|
|
In
September 2008, the Company repaid the outstanding balance on the short term
bank loan in the amount of $2,772,100, in satisfaction of its obligation
outstanding as of June 30, 2008.
Interest
expense related to the short term bank loans amounted to $58,650 and $58,273
for
three months ended September 30, 2008 and 2007, respectively.
Notes
Payable
Notes
payable represent amounts due to a bank which are normally secured and are
typically renewed. All notes payable are secured by the Company’s restricted
cash. The Company’s notes payables consist of the following:
|
|
September 30, 2008
|
|
June 30, 2008
|
|
|
|
(Unaudited)
|
|
|
|
Commercial
Bank, various amounts, due from October 2008 to March 2009.
|
|
$
|
7,894,348
|
|
$
|
5,843,295
|
|
Total
|
|
$
|
7,894,348
|
|
$
|
5,843,295
|
|
Note
10 - Related party transactions
Accounts
receivable - related parties
The
Company is engaged in business activities with three related parties, Jiangbo
Chinese-Western Pharmacy, Laiyang Jiangbo Medicals, Co., Ltd, and Yantai Jiangbo
Pharmaceuticals Co., Ltd. The Company’s Chief Executive Officer and other
majority shareholders have 100% ownership of these entities. At September 30,
20008 and June 30, 2008, accounts receivable from sales of the Company’s
products to these related entities were $187,509 and $673,808, respectively.
Accounts receivable due from related parties are receivable in cash and due
within 3 to 6 months. For the three months ended September 30, 2008 and 2007,
the Company recorded sales to related parties as follows:
Name
of Related Party
|
|
Relationship
|
|
September 30, 2008
(Unaudited)
|
|
September 30, 2007
(Unaudited)
|
|
|
|
|
|
|
|
|
|
Jiangbo
Chinese-Western Pharmacy
|
|
90%
owned by Chief Executive Officer |
|
$
|
108,094
|
|
$
|
395,848
|
|
|
|
|
|
|
|
|
|
|
|
Laiyang
Jiangbo Medicals Co., Ltd.
|
|
60%
owned by Chief Executive Officer |
|
|
-
|
|
|
134,280
|
|
|
|
|
|
|
|
|
|
|
|
Yantai
Jiangbo Pharmaceuticals Co., Ltd.
|
|
Owned
by Other Related Party |
|
|
135,749
|
|
|
817,967
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
|
$
|
243,843
|
|
$
|
1,348,095
|
|
Other
receivable - related parties
The
Company leases two of its buildings to Jiangbo Chinese-Western Pharmacy. For
the
three months ended September 30, 2008 and 2007, the Company recorded other
income of $143,950 and $26,492 from leasing the two buildings to this related
party. As of September 30, 2008, amount due from this related party was
$565,450.
Other
payable - related parties
Other
payable-related parties primarily consist of accrued salary payable to the
Company’s officers and directors, and advances from the Company’s Chief
Executive Officer. These advances are short-term in nature and bear no interest.
The amounts are expected to be repaid in the form of cash.
Other
payable - related parties consisted of the following:
|
|
September 30,
|
|
June 30,
|
|
|
|
2008
|
|
2008
|
|
|
|
(Unaudited)
|
|
|
|
Payable
to Cao Wubo, Chief Executive Officer and Chairman of the Board
|
|
$
|
320,588
|
|
$
|
164,137
|
|
|
|
|
|
|
|
|
|
Payable
to Haibo Xu, Chief Operating Officer and Director
|
|
|
60,635
|
|
|
-
|
|
|
|
|
|
|
|
|
|
Payable
to Elsa Sung, Chief Financial Officer
|
|
|
8,000
|
|
|
-
|
|
|
|
|
|
|
|
|
|
Payable
to John Wang, Director
|
|
|
2,500
|
|
|
-
|
|
|
|
|
|
|
|
|
|
Total
other payable - related parties
|
|
$
|
391,723
|
|
$
|
164,137
|
|
Note
11 – Concentration of major customers, suppliers, and
products
For
the
three months ended September 30, 2008, three products accounted for 36%, 35%,
and 27% of the Company’s total sales. For the three months ended September 30,
2007, three products accounted for 65%, 16%, and 12% of the Company’s total
sales.
For
the
three months ended September 30, 2008 and 2007, five customers accounted for
approximately 17.4% and 29.1%, respectively, of the Company's sales. These
five
customers represented 11.0 % and 25.9% of the Company's total accounts
receivable as of September 30, 2008 and June 30, 2008,
respectively.
For
the
three months ended September 30, 2008 and 2007, five suppliers accounted for
approximately 76.5% and 89.6%, respectively, of the Company's purchases. These
five suppliers represented 81.6% and 65.82% of the Company's total accounts
payable as of September 30, 2008 and June 30, 2008,
respectively.
Note
12- Taxes payable
The
Company is subject to the United States federal income tax at a tax rate of
34%.
No provision for U.S. income taxes has been made as the Company had no U.S.
taxable income during the three months ended September 30, 2008 and
2007.
The
Company’s wholly owned subsidiaries Karmoya International Ltd. and Union Well
International Ltd. were incorporated in the British Virgin Island (“BVI”) and
the Cayman Islands. Under the current laws of the BVI and Cayman Islands, the
two entities are not subject to income taxes.
Before
January 1, 2008, companies established in the PRC were generally subject to
an
enterprise income tax ("EIT") rate of 33.0%, which included a 30.0% state income
tax and a 3.0% local income tax. The PRC local government has provided various
incentives to companies in order to encourage economic development. Such
incentives include reduced tax rates and other measures. On March 16, 2007,
the
National People's Congress of China passed the new Enterprise Income Tax Law
("EIT Law"), and on November 28, 2007, the State Council of China passed the
Implementing Rules for the EIT Law ("Implementing Rules") which took effect
on
January 1, 2008. The EIT Law and Implementing Rules impose a unified EIT rate
of
25.0% on all domestic-invested enterprises and FIEs, unless they qualify under
certain limited exceptions. Therefore, nearly all FIEs are subject to the new
tax rate alongside other domestic businesses rather than benefiting from the
FEIT, and its associated preferential tax treatments, beginning January 1,
2008.
In
addition to the changes to the current tax structure, under the EIT Law, an
enterprise established outside of China with "de facto management bodies" within
China is considered a resident enterprise and will normally be subject to an
EIT
of 25.0% on its global income. The Implementing Rules define the term "de facto
management bodies" as "an establishment that exercises, in substance, overall
management and control over the production, business, personnel, accounting,
etc., of a Chinese enterprise." If the PRC tax authorities subsequently
determine that the Company should be classified as a resident enterprise, then
the organization's global income will be subject to PRC income tax of 25.0%.
Laiyang Jiangbo and GJBT were subject to 25% income tax rate since January
1,
2008 and 33% income tax rate prior to January 1, 2008.
The
table
below summarizes the differences between the U.S. statutory federal rate and
the
Company’s effective tax rate for the three months ended September 30, 2008 and
2007:
|
|
2008
|
|
2007
|
|
|
|
(Unaudited)
|
|
(Unaudited)
|
|
U.S.
Statutory rates
|
|
|
34.0
|
%
|
|
34.0
|
%
|
Foreign
income not recognized in the U.S
|
|
|
(34.0
|
)%
|
|
(34.0
|
)%
|
China
income taxes
|
|
|
25.0
|
%
|
|
33.0
|
%
|
Total
provision for income taxes
|
|
|
25.0
|
%
|
|
33.0
|
%
|
Taxes
payable are as follows:
|
|
September 30,
|
|
June 30,
|
|
|
|
2008
|
|
2008
|
|
|
|
(Unaudited)
|
|
|
|
Value
added taxes
|
|
$
|
4,031,320
|
|
$
|
83,775
|
|
Income
taxes
|
|
|
1,968,810
|
|
|
62,733
|
|
Other
taxes
|
|
|
452,147
|
|
|
19,924
|
|
Total
|
|
$
|
6,452,277
|
|
$
|
166,432
|
|
Note
13 - Convertible Debt
November
2007 Convertible Debentures
On
November 7, 2007, the Company entered into a Securities Purchase Agreement
(the
“November 2007 Purchase Agreement”) with Pope Investments, LLC (“Pope”) (the
“November 2007 Investor”). Pursuant to the November 2007 Purchase Agreement, the
Company issued and sold to the November 2007 Investor, $5,000,000 principal
amount of our 6% convertible subordinated debentures due November 30, 2010
(the
“November 2007 Debenture”) and a three-year warrant to purchase 250,000 shares
of the Company’s common stock, par value $0.001 per share, exercisable at $12.80
per share, subject to adjustment as provided therein. The November 2007
Debenture bears interest at the rate of 6% per annum and the initial conversion
price of the debentures is $10 per share. In connection with the offering,
the
Company placed in escrow 500,000 shares of its common stock. In connection
with
the May 2008 financing, the November 2007 Debenture conversion price was
subsequently adjusted to $8 per share (Post 40-to-1 reverse split).
The
Company evaluated the application of EITF 98-5, “Accounting for Convertible
Securities with Beneficial Conversion Features or Contingently Adjustable
Conversion Ratios,” and EITF 00-27, “Application of Issue No. 98-5 to Certain
Convertible Instruments,” and concluded that the convertible debenture has a
beneficial conversion feature. The Company estimated the intrinsic
value of the beneficial conversion feature of the November 2007 Debenture at
$2,904,093. The fair value of the warrants was estimated at $2,095,907. The
two
amounts are recorded together as debt discount and amortized using the effective
interest method over the three-year term of debentures.
The
fair
value of the warrants granted with this private placement was computed using
the
Black-Scholes option-pricing model. Variables used in the option-pricing model
include (1) risk-free interest rate at the date of grant (4.5%),
(2) expected warrant life of 3 years, (3) expected volatility of
197%, and (4) zero expected dividends. The total estimated fair value of
the warrants granted and beneficial conversion feature of the November 2007
Debenture should not exceed the $5,000,000 November 2007 Debenture, and the
calculated warrant value was used to determine the allocation between the fair
value of the beneficial conversion feature of the November 2007 Debenture and
the fair value of the warrants.
In
connection with the private placement, the Company paid the placement agents
a
fee of $250,000 and incurred other expenses of $104,408, which were capitalized
as deferred debt issuance costs and are being amortized to interest expense
over
the life of the debentures. For the three months ended September 30, 2008,
amortization of debt issuance costs related to the November 2007 Purchase
Agreement was $29,534, which has been included in interest expense. The
remaining balance of unamortized debt issuance costs of the November 2007
Purchase Agreement at September 30, 2008 was $247,757. The amortization of
debt
discounts was $141,580 for the three months ended September 30, 2008, which
has
been included in interest expense on the accompanying consolidated statements
of
income. The balance of the debt discount was $4,313,061 at September 30,
2008.
The
Company evaluated whether or not the secured convertible debentures contain
embedded conversion options, which meet the definition of derivatives under
SFAS
No. 133 and related interpretations. The Company concluded that since the
secured convertible debentures had a fixed conversion rate of $10, the secured
convertible debt was not a derivative instrument.
The
November 2007 Debenture bears interest at the rate of 6% per annum, payable
in
semi-annual installments on May 31 and November 30 of each year, with the first
interest payment due on May 31, 2008. The initial conversion price (“November
2007 Conversion Price”) of the November 2007 Debentures is $10 per share. If the
Company issues common stock at a price that is less than the effective November
2007 Conversion Price, or common stock equivalents with an exercise or
conversion price less than the then effective November 2007 Conversion Price,
the November 2007 Conversion Price of the November 2007 Debenture and the
exercise price of the warrants will be reduced to such price. The November
2007
Debenture may not be prepaid without the prior written consent of the Holder,
as
defined. In connection with the Offering, the Company placed in escrow 500,000
shares of common stock issued by the Company in the name of the escrow agent.
In
the event the Company’s consolidated Net Income Per Share (as defined in the
November 2007 Purchase Agreement), for the year ended June 30, 2008, is less
than $1.52, the escrow agent shall deliver the 500,000 shares to the November
2007 Investor. The Company determined that its fiscal 2008 Net Income Per Share
met the required amount and no shares were delivered to the November 2007
Investor.
Pursuant
to the November 2007 Purchase Agreement, the Company entered into a Registration
Rights Agreement. In accordance with the Registration Rights Agreement, the
Company must file on each Filing Date (as defined in the Registration Rights
Agreement) a registration statement to register the portion of the Registrable
Securities (as defined therein) as permitted by the Securities and Exchange
Commission’s guidance. The initial registration statement must be filed within
90 days of the closing date and declared effective within 180 days following
such closing date. Any subsequent registration statements that are required
to
be filed on the earliest practical date on which the Company is permitted by
the
Securities and Exchange Commission’s guidance to file such additional
registration statements, these statements must be effective 90 days following
the date on which it is required to be filed. In the event that the registration
statement is not timely filed or declared effective, the Company will be
required to pay liquidated damages. Such liquidated damages shall be, at the
investor’s option, either $1,643.83 or 164 shares of common stock per day that
the registration statement is not timely filed or declared effective as required
pursuant to the Registration Rights Agreement, subject to an amount of
liquidated damages not exceeding either $600,000, and 60,000 shares of common
stock, or a combination thereof based upon 12% liquidated damages in the
aggregate. In December 2006, the FASB issued FSP EITF 00-19-2, "Accounting
for
Registration Payments," which was effective immediately. FSP EITF 00-19-2
amended EITF 00-19 to require potential registration payment arrangements be
treated as a contingency pursuant to SFAS No. 5, “Accounting for Contingencies,”
rather than at fair value. The November 2007 Investor has subsequently agreed
to
allow the Company to file the November 2007 registration statement in
conjunction with the Company’s financing in May 2008 and, as such, no liquidated
damages were incurred for the year ended June 30, 2008.
The
financing was completed through a private placement to accredited investors
and
is exempt from registration pursuant to Section 4(2) of the Securities Act
of
1933 ("Securities Act"), as amended.
May
2008 Convertible Debentures
On
May
30, 2008, the “Company entered into a Securities Purchase Agreement (the “May
2008 Securities Purchase Agreement”) with certain investors (the “May 2008
Investors”), pursuant to which, on May 30, 2008, the Company sold to the May
2008 Investors 6% convertible debentures (the “May 2008 Notes”) and warrants to
purchase 1,875,000 shares of the Company’s common stock (“May 2008 Warrants”),
for an aggregate amount of $30,000,000 (the “May 2008 Purchase Price”), in
transactions exempt from registration under the Securities Act (the “May 2008
Financing”). Pursuant to the terms of the May 2008 Securities Purchase
Agreement, the Company will use the net proceeds from the Financing for working
capital purposes. Also pursuant to the terms of the May 2008 Securities Purchase
Agreement, the Company must, among other things, increase the number of its
authorized shares of common stock to 22,500,000 by August 31, 2008, and is
prohibited from issuing any “Future Priced Securities” as such term is described
by NASD IM-4350-1 for one year following the closing of the May 2008 Financing.
The Company has satisfied the increase in the number of its authorized shares
of
common stock in August 2008 (post 40-to-1 reverse split).
The
May
2008 Notes are due May 30, 2011, and are convertible into shares of the
Company’s common stock at a conversion price equal to $8 per share, subject to
adjustment pursuant to customary anti-dilution provisions and automatic downward
adjustments in the event of certain sales or issuances by the Company of common
stock at a price per share less than $8. Interest on the outstanding principal
balance of the May 2008 Notes is payable at a rate of 6% per annum, in
semi-annual installments payable on November 30 and May 30 of each year, with
the first interest payment due on November 30, 2008. At any time after the
issuance of the May 2008 Note, any May 2008 Investor may convert its May 2008
Note, in whole or in part, into shares of the Company’s common stock, provided
that such May 2008 Investor shall not effect any conversion if immediately
after
such conversion, such May 2008 Investor and its affiliates would, in the
aggregate, beneficially own more than 9.99% of the Company’s outstanding common
stock. The May 2008 Notes are convertible at the option of the Company if the
following four conditions are met: (i) effectiveness of a registration statement
with respect to the shares of the Company’s common stock underlying the May 2008
Notes and the Warrants; (ii) the Volume Weighted Average Price (“VWAP” of the
common stock has been equal to or greater than 250% of the conversion price,
as
adjusted, for 20 consecutive trading days on its principal trading market;
(iii)
the average dollar trading volume of the common stock exceeds $500,000 on its
principal trading market for the same 20 days; and (iv) the Company achieves
2008 Guaranteed EBT (as hereinafter defined) and 2009 Guaranteed EBT (as
hereinafter defined). A holder of a May 2008 Note may require the Company to
redeem all or a portion of such May 2008 Note for cash at a redemption price
as
set forth in the May 2008 Notes, in the event of a change in control of the
Company, an event of default or if any governmental agency in the PRC challenges
or takes action that would adversely affect the transactions contemplated by
the
Securities Purchase Agreement. The May 2008 Warrants are exercisable for a
five-year period beginning on May 30, 2008, at an initial exercise price of
$10
per share.
The
Company evaluated the application of EITF 98-5, “Accounting for Convertible
Securities with Beneficial Conversion Features or Contingently Adjustable
Conversion Ratios,” and EITF 00-27, “Application of Issue No. 98-5 to Certain
Convertible Instruments” and concluded that the convertible debenture has a
beneficial conversion feature. The Company estimated the intrinsic
value of the beneficial conversion feature of the May 2008 Note at $17,572,910.
The fair value of the warrants was estimated at $12,427,090. The two amounts
are
recorded together as debt discount and amortized using the effective interest
method over the three-year term of the debentures.
The
fair
value of the warrants granted with this private placement was computed using
the
Black-Scholes option-pricing model. Variables used in the option-pricing model
include (1) risk-free interest rate at the date of grant (4.2%),
(2) expected warrant life of 5 years, (3) expected volatility of
95%, and (4) zero expected dividends. The total estimated fair value of the
warrants granted and beneficial conversion feature of the May 2008 Note should
not exceed the $30,000,000 debenture, and the calculated warrant value was
used
to determine the allocation between the fair value of the beneficial conversion
feature of the May 2008 debenture and the fair value of the
warrants.
In
connection with the private placement, the Company paid the placement agents
a
fee of $1,500,000 and incurred other expenses of $186,500, which were
capitalized as deferred debt issuance costs and are being amortized to interest
expense over the life of the debenture. During the three months ended September
30, 2008, amortization of debt issuance costs related to the May 2008 Purchase
Agreement was $140,542. The remaining balance of unamortized debt issuance
costs
of the May 2008 Purchase Agreement at September 30, 2008 was $1,499,111. The
amortization of debt discounts was $520,971 for the three months ended September
30, 2008, which has been included in interest expense on the accompanying
consolidated statements of income. The balance of the debt discount was
$27,524,345 at September 30, 2008.
The
Company evaluated whether or not the secured convertible debentures contain
embedded conversion options, which meets the definition of derivatives under
SFAS No. 133 and related interpretations. The Company concluded that since
the
secured convertible debentures had a fixed conversion rate of $8 per share,
the
secured convertible debt was not a derivative instrument.
In
connection with the May 2008 Financing, the Company entered into a holdback
escrow agreement (the “Holdback Escrow Agreement”) dated May 30, 2008, with the
May 2008 Investors and Loeb & Loeb LLP, as Escrow Agent, pursuant to which
$4,000,000 of the May 2008 Purchase Price was deposited into an escrow account
with the Escrow Agent at the closing of the Financing. Pursuant to the terms
of
the Holdback Escrow Agreement, (i) $2,000,000 of the escrowed funds will be
released to the Company upon the Company’s satisfaction no later than 120 days
following the closing of the Financing of an obligation that the board of
directors be comprised of at least five members (at least two of whom are to
be
fluent English speakers who possess necessary experience to serve as a director
of a public company), a majority of whom will be independent directors
acceptable to Pope and (ii) $2,000,000 of the escrowed funds will be released
to
the Company upon the Company’s satisfaction no later than six months following
the closing of the Financing of an obligation to hire a qualified full-time
chief financial officer (as defined in the May 2008 Securities Purchase
Agreement). In the event that either or both of these obligations are not so
satisfied, the applicable portion of the escrowed funds will be released pro
rata to the Investors. The Company has satisfied both requirement and the
holdback money was released to the Company in full.
In
connection with the May 2008 Financing, Mr. Cao, the Company’s Chief Executive
Officer and Chairman of the Board, placed 3,750,000 shares of common stock
of
the Company owned by him into an escrow account pursuant to a make good escrow
agreement, dated May 30, 2008 (the “Make Good Escrow Agreement”). In the event
that either (i) the Company’s adjusted 2008 earnings before taxes is less than
$26,700,000 (“2008 Guaranteed EBT”) or (ii) the Company’s 2008 adjusted fully
diluted earnings before taxes per share is less than $1.60 (“2008 Guaranteed
Diluted EBT”), 1,500,000 of such shares (the “2008 Make Good Shares”) are to be
released pro rata to the May 2008 Investors. In the event that either (i) the
Company’s adjusted 2009 earnings before taxes is less than $38,400,000 (“2009
Guaranteed EBT”) or (ii) the Company’s adjusted fully diluted earnings before
taxes per share is less than $2.32 (or $2.24 if the 500,000 shares of common
stock held in escrow in connection with the November 2007 private placement
have
been released from escrow) (“2009 Guaranteed Diluted EBT”), 2,250,000 of such
shares (the “2009 Make Good Shares”) are to be released pro rata to the May 2008
Investors. Should the Company successfully satisfy these respective financial
milestones, the 2008 Make Good Shares and 2009 Make Good Shares will be returned
to Mr. Cao. In addition, Mr. Cao is required to deliver shares of common stock
owned by him to the Investors on a pro rata basis equal to the number of shares
(the “Settlement Shares”) required to satisfy all costs and expenses associated
with the settlement of all legal and other matters pertaining to the Company
prior to or in connection with the completion of the Company’s October 2007
share exchange in accordance with formulas set forth in the May 2008 Securities
Purchase Agreement (post 40-to-1 reverse split).
The
security purchase agreement set forth permitted indebtedness which the Company’s
lease obligations and purchase money indebtedness is limited up to $1,500,000
per year in connection with new acquisition of capital assets and lease
obligations. Permitted investment set forth with the security purchase agreement
limits capital expenditure of the Company not to exceed $5,000,000 in any
rolling 12 months.
Pursuant
to a Registration Rights Agreement, the Company agreed to file a registration
statement covering the resale of the shares of common stock underlying the
May
2008 Notes and Warrants, (ii) the 2008 Make Good Shares, (iii) the 2009 Make
Good Shares, and (iv) the Settlement Shares. The Company must file an initial
registration statement covering the shares of common stock underlying the Notes
and Warrants no later than 45 days from the closing of the Financing and to
have
such registration statement declared effective no later than 180 days from
the
closing of the Financing. If the Company does not timely file such registration
statement or cause it to be declared effective by the required dates, then
the
Company will be required to pay liquidated damages to the Investors equal to
1.0% of the aggregate May 2008 Purchase Price paid by such Investors for each
month that the Company does not file the registration statement or cause it
to
be declared effective. Notwithstanding the foregoing, in no event shall
liquidated damages exceed 10% of the aggregate amount of the May 2008 Purchase
Price.
The
above two convertible debenture liabilities are as follows at September
30, 2008:
|
|
|
|
|
|
|
|
November
2007 convertible debenture note payable
|
|
$
|
5,000,000
|
|
May
2008 convertible debenture note payable
|
|
|
30,000,000
|
|
Total
convertible debenture note payable
|
|
|
35,000,000
|
|
Less:
Unamortized discount on November 2007 convertible debenture note
payable
|
|
|
(4,313,061
|
)
|
Less:
Unamortized discount on May 2008 convertible debenture note
payable
|
|
|
(27,524,345
|
)
|
Convertible
debentures, net
|
|
$
|
3,162,594
|
|
Note
14 - Shareholders’ equity
Common
Stock
In
July
2008, the Board of Directors approved a 40-to-1 reverse stock split that became
effective on September 4, 2008, and a new trading symbol “GNPH” also became
effective on that day. Those holding fractional shares were rounded up the
next
whole share. Subsequent to the stock split, the Company had approximately
9,768,000 shares issued and outstanding. The total number of authorized shares
became 22,500,000. These consolidated financial statements have been
retroactively adjusted to reflect the reverse split. Additionally, all share
representations are on a post-split basis.
In
July
2008, in connection with the settlement with Mr. Fernando Praca (Fernando Praca,
Plaintiff vs. EXTREMA, LLC and Genesis Pharmaceuticals Enterprises, Inc.- Case
No. 50 2005 CA 005317, Circuit Court of the 15th Judicial Circuit in and for
Palm Beach County, Florida), the Company cancelled 2,500 shares of its common
stock (post 40-to-1 reverse split) and the cancelled shares were valued at
fair
market value on the date of cancellation at $8 per share or $20,000 in total,
based on the trading price of the common stock. For the three months ended
September 30, 2008, the Company recorded settlement income of $20,000 related
to
the settlement.
In
July
2008, the Company issued 2,500 shares of common stock to two of the Company’s
current and ex-directors as part of their compensation for services. The Company
valued these shares at the fair market value on the date of grant of $8 per
share, or $20,000 in total, based on the trading price of common stock (post
40-to-1 reverse split). In September 2008, the Company issued 2,500 shares
of
common stock to two of the Company’s current and ex-directors as part of
compensation for services. The Company valued these shares at the fair market
value on the date of grant of $9 per share, or $22,500 in total, based on the
trading price of common stock. (post 40-to-1 reverse split) For the three months
ended September 30, 2008, the Company recorded stock based compensation of
$23,854 and deferred compensation of $18,646 accordingly.
Registered
capital contribution receivable
At
inception, Karmoya issued 1,000 shares of common stock to its founder. The
shares were valued at par value. On September 20, 2007, the Company issued
9,000
shares of common stock to nine individuals at par value. The balance of $10,000
is shown in capital contribution receivable on the accompanying consolidated
financial statements. As part of its agreements with shareholders, the Company
was to receive the entire $10,000 in October 2007. As of September 30, 2008,
the
Company has not received the $10,000.
Union
Well was established on May 9, 2007, with a registered capital of $1,000. In
connection with Karmoya’s acquisition of Union Well, the registered capital of
$1,000 is reflected as capital contribution receivable on the accompanying
consolidated financial statements. The $1,000 was due in October 2007, however,
as of September 30, 2008, the Company has not received the $1,000.
On
September 17, 2007, Union Well established GJBT in PRC as a 100% wholly owned
foreign limited liability subsidiary (“WOFE”) with registered capital of $12
million. PRC laws require the owner of the WOFE to contribute at least 15%
of
the registered capital within 90 days of its business license issuance date
and
the remaining balance is required to be contributed within two years of the
business license issuance date. In June 2008, the PRC government approved for
GJBT to increase its registered capital from $12 million to $30 million. By
June
30, 2008, the Company had funded GJBT the entire registered capital required
in
accordance with PRC laws. In August 2008, the PRC government approved for GJBT
to increase its registered capital from $30 million to $59.8 million. The PRC
laws require Union Well, the 100% owner of GJBT to contribute at least 20%
of
the registered capital within 30 days of the approval, and the remaining balance
is required to be contributed within two years of the approval date. In August
2008, GJBT received additional registered capital in the amount of approximately
$1,966,000. As of September 30, 2008, the Company has not received the remaining
contribution receivable in the amount of $27,834,000.
Note
15 - Warrants
In
connection with the May 2008 financing, the exercise price of outstanding
warrants issued in 2004 to purchase 74,085 shares of common stock was reduced
to
$8 per share. The 2004 warrants contain full ratchet anti-dilution provisions
to
the exercise price, in which due to the Company’s May 2008 financing, resulted
in the 2004 warrants to be exercisable at $8 per share. The provisions of the
2004 warrants, which result in the reduction of the exercise price, remain
in
place. Of the 2004 warrants, 16,455 shares are exercisable through January
15,
2009, and 57,630 are exercisable through March 29, 2009.
In
connection with the $5,000,000, 6% convertible subordinated debentures note,
the
Company issued a three-year warrant to purchase 250,000 shares of common stock,
at an exercise price of $12.80 per share. The calculated fair value of the
warrants granted with this private placement was computed using the
Black-Scholes option-pricing model. Variables used in the option-pricing model
include (1) risk-free interest rate at the date of grant (4.5%),
(2) expected warrant life of 3 years, (3) expected volatility of
197%, and (4) zero expected dividends. In connection with the May 2008
financing, the exercise price of outstanding warrants issued in November 2007
was reduced to $8 per share and the total number of warrants to purchase common
stock was increased to 400,000.
In
connection with the $30,000,000, 6% convertible subordinated debentures note,
the Company issued a five-year warrant to purchase 1,875,000 shares of common
stock, at an exercise price of $10 per share. The calculated fair value of
the
warrants granted with this private placement was computed using the
Black-Scholes option-pricing model. Variables used in the option-pricing model
include (1) risk-free interest rate at the date of grant (4.5%),
(2) expected warrant life of 5 years, (3) expected volatility of
95%, and (4) zero expected dividends.
The
Company had 2,349,085 warrants outstanding and exercisable at an average
exercise price of $9.60 per share as of September 30, 2008.
A
summary
of the warrants as of September 30, 2008, and changes during the period are
presented below:
|
|
Number of warrants
|
|
Outstanding
as of July 1, 2007
|
|
|
74,085
|
|
Granted
|
|
|
2,275,000
|
|
Forfeited
|
|
|
-
|
|
Exercised
|
|
|
-
|
|
Outstanding
as of June 30, 2008
|
|
|
2,349,085
|
|
Granted
|
|
|
-
|
|
Forfeited
|
|
|
-
|
|
Exercised
|
|
|
-
|
|
Outstanding
as of September 30, 2008
|
|
|
2,349,085
|
|
The
following is a summary of the status of warrants outstanding at September 30,
2008:
|
Outstanding Warrants
|
|
Exercisable Warrants
|
|
Exercise Price
|
|
Number
|
|
Average
Remaining
Contractual Life
(Years)
|
|
Average
Exercise Price
|
|
Number
|
|
Average Remaining
Contractual Life
(Years)
|
|
$ |
8.00
|
|
|
474,085
|
|
|
2.16
|
|
$
|
8.00
|
|
|
474,085
|
|
|
2.16
|
|
$ |
10.00
|
|
|
1,875,000
|
|
|
4.67
|
|
$
|
10.00
|
|
|
1,875,000
|
|
|
4.67
|
|
|
Total
|
|
|
2,349,085
|
|
|
|
|
|
|
|
|
2,349,085
|
|
|
|
|
Note
16 - Stock options
The
Company uses the Black-Scholes option-pricing model which was developed for
use
in estimating the fair value of options. Option pricing models require the
input
of highly complex and subjective variables including the expected life of
options granted and the Company’s expected stock price volatility over a period
equal to or greater than the expected life of the options. Because changes
in
the subjective assumptions can materially affect the estimated value of the
Company’s employee stock options, it is management’s opinion that the
Black-Scholes option-pricing model may not provide an accurate measure of the
fair value of the Company’s employee stock options. Although the fair value of
employee stock options is determined in accordance with SFAS 123R using an
option-pricing model, that value may not be indicative of the fair value
observed in a willing buyer/willing seller market transaction.
On
July
1, 2007, 133,400 options were granted and the fair value of these options was
estimated on the date of the grant using the Black-Scholes option-pricing model
with the following weighted-average assumptions:
|
|
Expected
|
|
Expected
|
|
Dividend
|
|
Risk Free
|
|
Grant Date
|
|
|
|
Life
|
|
Volatility
|
|
Yield
|
|
Interest Rate
|
|
Fair Value
|
|
Former
officers
|
|
|
3.50 years
|
|
|
195
|
%
|
|
0
|
%
|
|
4.50
|
%
|
$
|
5.20
|
|
On
June
10, 2008, 7,500 options were granted and the fair value of these options was
estimated on the date of the grant using the Black-Scholes option-pricing model
with the following weighted-average assumptions:
|
|
|
|
|
|
|
|
|
|
Grant Date
|
|
|
|
Expected
|
|
Expected
|
|
Dividend
|
|
Risk Free
|
|
Average Fair
|
|
|
|
Life
|
|
Volatility
|
|
Yield
|
|
Interest Rate
|
|
Value
|
|
Current
officer
|
|
|
5
years
|
|
|
95
|
%
|
|
0
|
%
|
|
2.51
|
%
|
$
|
8.00
|
|
As
of
September 2008, of the 7,500 options held by the Company’s executives,
directors, and employees, 2,000 were vested.
The
following is a summary of the option activity:
|
|
Number of options
|
|
Outstanding
as of July 1, 2007
|
|
|
194,436
|
|
Granted
|
|
|
7,500
|
|
Forfeited
|
|
|
(23,536
|
)
|
Exercised
|
|
|
(37,500
|
)
|
Outstanding
as of June 30, 2008
|
|
|
140,900
|
|
Granted
|
|
|
-
|
|
Forfeited
|
|
|
-
|
|
Exercised
|
|
|
-
|
|
Outstanding
as of September 30, 2008
|
|
|
140,900
|
|
Following
is a summary of the status of options outstanding at September 30,
2008:
|
Outstanding options
|
|
Exercisable options
|
|
Average
Exercise price
|
|
Number
|
|
Average
remaining
contractual life
(years)
|
|
Average
exercise price
|
|
Number
|
|
Weighted
average
exercise price
|
|
$ |
4.20
|
|
|
133,400
|
|
|
2.25
|
|
$
|
4.20
|
|
|
133,400
|
|
$
|
4.20
|
|
|
12.00
|
|
|
2,000
|
|
|
4.75
|
|
|
12.00
|
|
|
2,000
|
|
|
12.00
|
|
|
16.00
|
|
|
1,750
|
|
|
4.75
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
20.00
|
|
|
1,875
|
|
|
4.75
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
24.00
|
|
|
1,875
|
|
|
4.75
|
|
|
-
|
|
|
-
|
|
|
-
|
|
$ |
4.93
|
|
|
140,900
|
|
|
|
|
$
|
-
|
|
|
135,400
|
|
$
|
4.32
|
|
As
of
September 30, 2008, there was $44,941 of total unrecognized compensation expense
related to nonvested share-based compensation arrangements. That cost is
expected to be recognized over a weighted-average period of 2.5
years.
Note
17 - Employee pension
The
employee pension in the Company generally includes two parts: the first part
to
be paid by the Company is 30.6% of $128 for each qualified employee each month.
The other part, paid by the employees, is 11% of $128 each month. For the three
months ended September 30, 2008 and 2007, the Company made pension contributions
in the amount of $9,661 and $7,738, respectively.
Note
18 - Statutory reserves
The
Company is required to make appropriations to reserve funds, comprising the
statutory surplus reserve and discretionary surplus reserve, based on after-tax
net income determined in accordance with generally accepted accounting
principles of the People's Republic of China ("PRC GAAP"). Appropriations to
the
statutory surplus reserve is required to be at least 10% of the after tax net
income determined in accordance with PRC GAAP until the reserve is equal to
50%
of the entities' registered capital. Appropriations to the discretionary surplus
reserve are made at the discretion of the Board of Directors.
The
statutory surplus reserve fund is non-distributable other than during
liquidation and can be used to fund previous years' losses, if any, and may
be
utilized for business expansion or converted into share capital by issuing
new
shares to existing shareholders in proportion to their shareholding or by
increasing the par value of shares currently held by them, provided that the
remaining reserve balance after such issue is not less than 25% of the
registered capital.
The
discretionary surplus fund may be used to acquire fixed assets or to increase
the working capital to expend on production and operation of the business.
The
Company's Board of Directors decided not to make an appropriation to this
reserve for 2008.
Pursuant
to the Company's articles of incorporation, the Company is to appropriate 10%
of
its net profits as statutory surplus reserve. For the three months ended
September 30, 2008 and 2007, the Company appropriated to the statutory surplus
reserve the amount of $591,006 and $323,498, respectively.
Note
19 - Accumulated other comprehensive income
The
components of accumulated other comprehensive income is as follows:
Balance,
June 30, 2008
|
|
$
|
7,700,905
|
|
Foreign
currency translation gain
|
|
|
330,641
|
|
Unrealized
loss on marketable securities
|
|
|
(1,562,967
|
)
|
Balance,
September 30, 2008
|
|
$
|
6,468,579
|
|
Note
20 - Commitments and Contingencies
Operations
based in PRC
The
Company's operations are carried out in the PRC. Accordingly, the Company's
business, financial condition, and results of operations may be influenced
by
the political, economic, and legal environments in the PRC, and by the general
state of PRC's economy.
The
Company's operations in the PRC are subject to specific considerations and
significant risks not typically associated with companies in North America
and
Western Europe. These include risks associated with, among others, the
political, economic, and legal environments, and foreign currency exchange.
The
Company's results may be adversely affected by changes in governmental policies
with respect to laws and regulations, anti-inflationary measures, currency
conversion and remittance abroad, and rates and methods of taxation, among
others.
R&D
Agreement
In
September 2007, the Company entered into a three year Cooperative Research
and
Development Agreement (“CRADA”) with a provincial university. Under the CRADA,
the university is responsible for designing, researching and developing
designated pharmaceutical projects for the Company. Additionally, the university
will also provide technical services and trainings to the Company. As part
of the CRADA, the Company will pay approximately $3.2 million (RMB 24,000,000)
plus out-of-pocket expenses to the university annually and provide internship
opportunities for students of the university. The Company will have the
primary ownership of the designated research and development project results.
In
November 2007, the Company entered into a five year CRADA with a research
institute. Under this CRADA, the institute is responsible for designing,
researching and developing designated pharmaceutical projects for the Company.
Additionally, the university will also provide technical services and trainings
to the Company. As part of the CRADA, the Company will pay approximately
$814,000 (RMB 6,000,000) to the institute annually. The Company will have
the primary ownership of the designated research and development project
results. As of September 30, 2008, the Company’s future estimated payments to
CRADA amounted to $8,929,790.
For
the
three months ended September 30, 2008, approximately $1,098,000 was incurred
as
research and development expense.
Legal
proceedings
The
Company is involved in various legal matters arising in the ordinary course
of
business. After taking into consideration the Company’s legal counsel’s
evaluation of such matters, the Company’s management is of the opinion that the
outcome of these matters will not have a significant effect on the Company’s
consolidated financial position as of September 30, 2008.
The
following summarizes the Company’s pending and settled legal proceedings as of
September 30, 2008:
Fernando
Praca, Plaintiff v.s. EXTREMA, LLC and Genesis Pharmaceuticals Enterprises,
Inc.- Case No. 50 2005 CA 005317, Circuit Court of the 15
th
Judicial Circuit in and for Palm Beach County, Florida
Fernando
Praca, former Director and former President of the Company’s discontinued
subsidiary, Extrema LLC, filed an action in Dade County, Florida against
Extrema, LLC and the Company in June 2005 relating to damages arising from
the
sale of Extrema LLC to Genesis Technology Group, Inc. Fernando Praca had filed
a
Motion of Temporary Injunction but had not proceeded to move this case forward.
The plaintiff has decided to reinitiate the legal action in March 2008. In
July
2008, the Company and Fernando Praca entered into a Settlement Agreement whereby
Fernando Praca agreed to dismiss this action against the Company and to
surrender to the Company for cancellation, 100,000 shares of common stock in
the
Company held by him. The Company agreed to provide Fernando Praca with a legal
opinion of its counsel removing the restrictive legend on the 1,269,607 shares
of common stock held by Fernando Praca.
CRG
Partners, Inc. and Capital Research Group, Inc. and Genesis Technology Group,
Inc., n/k/a Genesis Pharmaceuticals Enterprises, Inc. (Arbitration) - Case
No.
32 145 Y 00976 07, American Arbitration Association, Southeast Case Management
Center
On
December 4, 2007, CRG Partners, Inc. (“CRGP”), a former consultant of the
Company, filed a demand for arbitration against the Company alleging breach
of
contract and seeking damages of approximately $10 million as compensation for
consulting services rendered to the Company. The amount of damages sought by
the
claimant is equal to the dollar value of 29,978,900 shares of the Company’s
common stock (Pre 40-to-1 reverse split) on November 2, 2007, in which the
claimant alleges are due and owing to CRGP. On December 5, 2007, the Company
gave notice of termination of the relationship with CRG under the consulting
agreement. CRGP subsequently filed an amendment to the demand for arbitration
to
include Capital Research Group, Inc. (“CRG”) as an added claimant and increased
the damage amount sought under this matter to approximately $10.9 million.
The
Company subsequently filed counter claims in reference to the aforementioned
allegations of breach of contract. The hearing date for the arbitration is
set
for December 1, 2008, in Miami, Florida. The Company’s management believes this
matter will not have a material impact on the Company’s consolidated results of
operations or consolidated financial position.
China
West II, LLC and Genesis Technology Group, Inc., n/k/a Genesis Pharmaceuticals
Enterprises, Inc. (Arbitration)
In
June
2008, China West II, LLC (“CW II”) filed a Demand For Arbitration with the
American Arbitration Association the case of
CW
II and Genesis Technology Group, Inc. n/k/a Genesis Pharmaceuticals Enterprises,
Inc. and Joshua Tan.
In that
matter, CW II seeks breach of contract damages in connection with the Company’s
October 2007 reverse merger from the Company and Joshua Tan, former director
of
the Company, jointly and severally for approximately $6.7 million estimated
by
CW II. As of the date of these consolidated financial statements, the Company
is
unable to estimate a loss, if any, the Company may incur related expenses to
this lawsuit. The Company believes CW II’s demand is without merit and plans to
vigorously defend its position.
China
West, LLC and Genesis Technology Group, Inc., n/k/a Genesis Pharmaceuticals
Enterprises, Inc. (Arbitration)
In
November 2008, China West, LLC (“CW”) filed a Demand For Arbitration with the
American Arbitration Association the case of
CW
and Genesis Technology Group, Inc. n/k/a Genesis Pharmaceuticals Enterprises,
Inc. and Joshua Tan.
In that
matter, CW seeks from the Company in the amount of approximately $7.5 million
for breach of contract and fiduciary duty damages in connection with the
Company’s October 2007 reverse. As of the date of these consolidated financial
statements, the Company is unable to estimate a loss, if any, the Company may
incur related expenses to this lawsuit. The Company believes CW demand is
without merit and plans to vigorously defend its position. Therefore, no amounts
have been provided for in the accompanying consolidated financial
statements.
Note
21- Subsequent event
In
November 2008, the Board of the Directors of the Company authorized a share
buyback program to purchase the Company’s common stock in the open market with a
two million dollar limitation. As of November 13, 2008, the Company has not
purchased any shares in the open market.
CAUTIONARY
NOTICE REGARDING FORWARD-LOOKING INFORMATION
All
statements contained in this Quarterly Report on Form 10-Q (“Form 10-Q”) for
Genesis Pharmaceuticals Enterprises, Inc., other than statements of historical
facts, that address future activities, events or developments are
forward-looking statements, including, but not limited to, statements containing
the words “believe,” “anticipate,” “expect” and words of similar import. These
statements are based on certain assumptions and analyses made by us in light
of
our experience and our assessment of historical trends, current conditions
and
expected future developments as well as other factors we believe are appropriate
under the circumstances. However, whether actual results will conform to the
expectations and predictions of management is subject to a number of risks
and
uncertainties that may cause actual results to differ materially.
Such
risks include, among others, the following: international, national and local
general economic and market conditions; our ability to sustain, manage or
forecast our growth; raw material costs and availability; new product
development and introduction; existing government regulations and changes in,
or
the failure to comply with, government regulations; adverse publicity;
competition; the loss of significant customers or suppliers; fluctuations and
difficulty in forecasting operating results; changes in business strategy or
development plans; business disruptions; the ability to attract and retain
qualified personnel; the ability to protect technology; and other factors
referenced in this and previous filings.
Consequently,
all of the forward-looking statements made in this Form 10-Q are qualified
by
these cautionary statements and there can be no assurance that the actual
results anticipated by management will be realized or, even if substantially
realized, that they will have the expected consequences to or effects on our
business operations. As used in this Form 10-Q, unless the context requires
otherwise, “we” or “us” or “Genesis” or the “Company” means Genesis
Pharmaceuticals Enterprises, Inc. and its subsidiaries.
Item
2. Management’s
Discussion and Analysis or Plan of Operation
The
following discussion and analysis of the results of operations and financial
condition of Genesis Pharmaceuticals Enterprises, Inc. for the three months
ended September 30, 2008 and 2007 should be read in conjunction with Genesis’
financial statements and the notes to those financial statements that are
included elsewhere in this Quarterly Report on Form 10-Q. Our discussion
includes forward-looking statements based upon current expectations that involve
risks and uncertainties, such as our plans, objectives, expectations and
intentions. Actual results and the timing of events could differ materially
from
those anticipated in these forward-looking statements as a result of a number
of
factors, including those set forth under the Risk Factors, and Cautionary Notice
Regarding Forward-Looking Statements in this Form 10-Q. We use words such as
“anticipate,” “estimate,” “plan,” “project,” “continuing,” “ongoing,” “expect,”
“believe,” “intend,” “may,” “will,” “should,” “could,” and similar expressions
to identify forward-looking statements.
OVERVIEW
We
were
incorporated on August 15, 2001, in the State of Florida under the name Genesis
Technology Group, Inc. On October 12, 2001, we consummated a merger with
NewAgeCities.com, an Idaho public corporation formed in 1969. We were the
surviving entity after the merger. On October 1, 2007, we completed a share
exchange transaction by and among us, Karmoya International Ltd. (“Karmoya”), a
British Virgin Islands company, and Karmoya’s shareholders. As a result of the
share exchange transaction, Karmoya, a company which was established as a
“special purpose vehicle” for the foreign capital raising activities of its
Chinese subsidiaries, became our wholly-owned subsidiary and our new operating
business. Karmoya was incorporated under the laws of the British Virgin Islands
on July 17, 2007, and owns 100% of the capital stock of Union Well International
Limited (“Union Well”), a Cayman Islands company. Karmoya conducts its business
operations through Union Well’s wholly-owned subsidiary, Genesis Jiangbo
(Laiyang) Biotech Technology Co., Ltd. (“GJBT”). GJBT was incorporated under the
laws of the People’s Republic of China ("PRC") on September 16, 2007, and
registered as a wholly foreign owned enterprise (“WOFE”) on September 19, 2007.
GJBT has entered into consulting service agreements and equity-related
agreements with Laiyang Jiangbo Pharmaceutical Co., Ltd. (“Laiyang Jiangbo”), a
PRC limited liability company incorporated on August 18, 2003.
As
a
result of the share exchange transaction, our primary operations consist of
the
business and operations of Karmoya and its subsidiaries, which are conducted
by
Laiyang Jiangbo in the PRC. Laiyang Jiangbo produces and sells western
pharmaceutical products in China and focuses on developing innovative medicines
to address various medical needs for patients worldwide.
RESULTS
OF OPERATIONS
Comparison
of three months ended September 30, 2008 and 2007
The
following table sets forth the results of our operations for the periods
indicated as a percentage of total net sales ($ in thousands):
|
|
Three Month
Period Ended
September 30,
|
|
% of
|
|
Three Month
Period Ended
September 30,
|
|
% of
|
|
|
|
2008
|
|
Revenue
|
|
2007
|
|
Revenue
|
|
SALES
|
|
$
|
27,321
|
|
|
99.12
|
%
|
$
|
15,263
|
|
|
91.88
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
SALES
- RELATED
PARTIES
|
|
|
244
|
|
|
0.88
|
%
|
|
1,348
|
|
|
8.12
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
COST
OF SALES
|
|
|
5,713
|
|
|
20.73
|
%
|
|
4,206
|
|
|
25.32
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
COST
OF SALES- RELATED PARTIES
|
|
|
55
|
|
|
0.2
|
%
|
|
384
|
|
|
2.31
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
GROSS
PROFIT
|
|
|
21,797
|
|
|
79.07
|
%
|
|
12,021
|
|
|
72.37
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
SELLING,
GENERAL AND ADMINISTRATIVE EXPENSES
|
|
|
13,352
|
|
|
48.48
|
%
|
|
6,822
|
|
|
41.07
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
RESEARCH
AND DEVELOPMENT
|
|
|
1,098
|
|
|
3.98
|
%
|
|
265
|
|
|
1.59
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
INCOME
FROM OPERATIONS
|
|
|
7,347
|
|
|
26.42
|
%
|
|
4,934
|
|
|
29.71
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
OTHER
EXPENSES, NET
|
|
|
2,244
|
|
|
8.10
|
%
|
|
106
|
|
|
0.64
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
INCOME
BEFORE PROVISION FOR INCOME TAXES
|
|
|
5,103
|
|
|
18.31
|
%
|
|
4,828
|
|
|
29.07
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
PROVISION
FOR INCOME TAXES
|
|
|
1,970
|
|
|
7.02
|
%
|
|
1,593
|
|
|
9.59
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
NET
INCOME
|
|
|
3,133
|
|
|
11.30
|
%
|
|
3,235
|
|
|
19.48
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
OTHER
COMPREHENSIVE (LOSS) INCOME
|
|
|
(1,232
|
)
|
|
(5.59)
|
%
|
|
418
|
|
|
2.51
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
COMPREHENSIVE
INCOME
|
|
$
|
1,901
|
|
|
5.71
|
%
|
$
|
3,653
|
|
|
21.99
|
%
|
REVENUES.
Our revenues include revenues from sales and revenues from sales to related
party of $27.3 million and $0.2 million, respectively, for the three months
ended September 30, 2008. During the three months ended September 30, 2008,
we
had revenues from sales of $27.3 million as compared to revenues from sales
of
$15.3 million for the three months ended September 30, 2007, an increase
of
$12.1 million or approximately 79.0%. During the three months ended September
30, 2008, we had revenues from sales to related party of $0.2 million as
compared to revenues from sales to related party of $1.3 million for the
three
months ended September 30, 2007, a decrease of $1.1 million or approximately
81.9%. The overall increase in total revenue was due to the increase of sales
volume of our strong selling product, Itopride Hydrochloride Granules and
a new
product, Baobaole Chewable Tablets, and partially offset by the decrease
in
sales of Clarithromycin Sustained-release Tablets. Itopride Hydrochloride
Granules sales increased by over 90% were primarily due to the strong market
demand for this product. Baobaole was released in the second quarter of fiscal
year 2008 and the product has been very popular in the market since.
Additionally, we also had a loss of production time for approximately five
weeks
in the three months ended September 30, 2007, due to a previously scheduled
maintenance project implemented by management to comply with Chinese drug
production industry standards, which affected our production and related
sales
in 2007. We believe that our sales will have improvements and growth in
remaining of fiscal year 2009 as our new product Baobaole Chewable Tablets
continues generating strong sales and we began selling another new product,
Radix Isatidis Dispersible Tablets, in October 2008. We will also continue
strengthening our sales force, improving the quality of our products and
developing new products that will be well accepted in the
market.
COST
OF SALES.
Cost of
sales and cost of sales – related parties for the three months ended September
30, 2008 increased $1.2 million or 25.6%, from $ 4.6 million for the three
months ended September 30, 2007 to $5.8 million for the three months ended
September 30, 2008. The increase in cost of sales and cost of sales - related
parties was primarily due to increase in sales. There was a decrease in cost
of
sales as a percentage of net revenues for the three months ended September
30,
2008, which was approximately 20.9% as compared to 27.6% for the three months
ended September 30, 2007. The decrease was attributable to more sales being
generated from high-profit-margin products, included highly profitable new
product Baobaole Chewable Tables, more efficient producing processes and our
ability to better manage raw material purchase prices.
GROSS
PROFIT.
Gross
profit was $21.8 million for the three months ended September 30, 2008, as
compared to $12.0 million for the three months ended September 30, 2007,
representing gross margins of approximately 79% and 72%, respectively. The
increase in our gross profits was primarily due to the higher volume of sales
with higher margin products.
SELLING,
GENERAL AND ADMINISTRATIVE EXPENSES.
Selling,
general and administrative expenses totaled $13.4 million for the three months
ended September 30, 2008, as compared to $ 6.8 million for the three months
ended September 30, 2007, an increase of $6.6 million or approximately 97%
as
summarized below ($ in thousands):
|
|
Three months ended September 30,
|
|
|
|
2008
|
|
2007
|
|
Advertisement,
marketing and promotion spending
|
|
$
|
3,229
|
|
$
|
2,874
|
|
Travel
and entertainment - sales related
|
|
|
642
|
|
|
195
|
|
Depreciation
and amortization
|
|
|
151
|
|
|
89
|
|
Shipping
and handling
|
|
|
122
|
|
|
48
|
|
Salaries,
wages and related benefits
|
|
|
8,638
|
|
|
3,225
|
|
Travel
and entertainment - non sales related
|
|
|
82
|
|
|
50
|
|
Other
|
|
|
488
|
|
|
341
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
13,352
|
|
$
|
6,822
|
|
The
changes in these expenses from the three months ended September 30, 2008, as
compared to the three months ended September 30, 2007, included the
following:
·
|
An
increase of $0.4 million or approximately 12.3% in advertisement,
marketing and promotion spending primarily due to increase in our
marketing and promotional activities to promote our current products,
new
product Radix Isatidis Dispersible Tablets, and brand name.
|
·
|
Travel
and entertainment - sales related expenses increased by $0.4 million
or
approximately 229% primarily due to the increase in our sales activities
related to promoting our products and establishing the distribution
network for them.
|
·
|
Shipping
and handling expenses increased by $0.1 million or approximately
154%
primarily due to increase in our sales volume and fuel prices.
|
·
|
Depreciation
and amortization increased by $0.1 million due to more fixed and
intangible assets being depreciated and
amortized.
|
·
|
An
increase of $5.4 million or approximately 168 % in salaries, wages
and
related benefits was primarily due to the increase in commission
payments
as a percentage of sales to sales representatives, as well as an
increase
in number of employees and sales representatives as a result of expanding
our distribution network from 26 provinces and regions to 30 provinces
and
regions.
|
·
|
Travel
and entertainment – non-sales related expenses increased $32,000 or
approximately 64% for the three months ended September 30, 2008,
as
compared to the prior corresponding period.
|
·
|
Other
selling, general and administrative expenses, which include utilities,
office supplies and expenses, increased by $148,000 or 43.5% primarily
due
to more professional fees and other expenses related to being a publicly
traded company.
|
RESEARCH
AND DEVELOPMENT COSTS.
Research
and development costs, which consist of fees paid to third parties for research
and development related activities conducted for the Company and cost of
material used and salaries paid for the development of the Company’s products,
totaled $1.1 million for the three months ended September 30, 2008, as compared
to $0.3 million for the three months ended September 30, 2007, an increase
of
$0.8 million or approximately 314%. The increase in research and development
expenses was mainly due to two new R&D cooperative agreements being signed
in the latter part of fiscal 2008, and we began making monthly payments to
the
designated university research and development projects, plus expenses incurred.
OTHER
EXPENSES.
Our
other expenses consisted of valued added tax and various other tax exemptions
from the government, financial expenses and non-operating expenses. We had
net
other expense of $2.2 million for the three months ended September 30, 2008
as
compared to $0.1 million for the three months September 30, 2007. The increase
in net other expenses was due to increases in realized and unrealized losses
on
our security investments of $1.0 million, and the increase in interest expenses
related to our financing in November 2007 and May 2008 of $1.3 million, of
which
we did not incur in the prior corresponding period.
NET
INCOME.
Our net
income for the three months ended September 30, 2008 was $3.1 million as
compared to $3.2 million for the three months ended September 30, 2007. Although
we had a $2.4 million or 48.9 % increase in our income from operations, the
amount was largely offset by the significant increase of $2.1 million in other
expenses. Management believes that net income will have improvements in the
remainder of fiscal year 2009, as we will continue to strengthen our sales
efforts and offer better and more products to gain market share, improve our
manufacturing efficiency, and control our spending.
LIQUIDITY
AND CAPITAL RESOURCES
Net
cash
provided by operating activities for the three months ended September 30, 2008
was $13.7 million as compared to net cash used by operating activities of $3.2
million for the three months ended September 30, 2007. The significant increase
in cash provided by operating activities included the following: 1) decrease
in
inventory of $0.9 million 2) an add-back of amortization on debt discount and
deferred debt costs of $0.8 million, 3) an add-back of unrealized loss on
marketable securities of $1.0 million, 4) increase in other payables and other
payable related parties of $1.1 million and 5) an increased in accrued
liabilities of $0.7 million 6) an increase in taxes payable of $6.3million
7) an
increase in advances to suppliers of $0.8 million, partially offset by the
increase in accounts receivable and accounts receivable related parties of
$0.6
million.
Net
cash
provided by investing activities for the three months ended September 30, 2008,
was mainly attributable to proceeds from sale of marketable securities which
remained materially consistent with the three months ended September 30, 2007.
Net
cash
used in financing activities was $0.7 million for the three months ended
September, 30, 2008 was primarily attributable to payments for bank loans of
$2.8 million and an increase in notes payable of $2.0 million.
We
reported a net decrease in cash for the three months ended September 30, 2008
of
$13.1 million as compared to a net decrease in cash of $13.2 million for the
three months ended September 30, 2007.
We
have
historically financed our operations and capital expenditures principally
through private placements of debt and equity offerings, bank loans, and cash
provided by operations. At September 30, 2008, the majority of our liquid assets
were held in RMB denominations deposited in banks within the PRC. The PRC has
strict rules for converting RMB to other currencies and for movement of funds
from the PRC to other countries. Consequently, in the future, we may face
difficulties in moving funds deposited within the PRC to fund working capital
requirements in the U.S. The management is currently evaluating the situation.
Our working capital position improved by $4.3 million to $76.8 million at
September 30, 2008 from $72.5 million at June 30, 2008. This increase in working
capital is primarily attributable to an increase in cash of $13.1 million,
an
increase in accounts receivable of approximately $1.0 million, and an increase
in other receivables – related parties of $0.4 million, decrease in short-term
bank loans of $2.8 million, and liabilities assumed from discontinued operations
of $0.5 million, offset by a decrease in investments of $1.2 million, accounts
receivables – related parties of $0.5 million, a decrease in advances to
suppliers of $1.1 million, an increase in notes payable of $2.1 million, an
increase of other payables of $0.9 million and an increase in tax payable of
$6.3 million.
We
anticipate that our working capital requirements may increase as a result of
our
anticipated business expansion plan, continued increase in sales, potential
increases in the price of our raw materials, competition and our relationship
with suppliers or customers. We believe that our existing cash, cash equivalents
and cash flows from operations will be sufficient to meet our present
anticipated future cash needs for at least the next 12 months. We may, however,
require additional cash resources due to changed business conditions or other
future developments, including any investments or acquisitions we may decide
to
pursue.
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 amount of payments.
Off-balance
Sheet Arrangements
We
have
not entered into any other financial guarantees or other commitments to
guarantee the payment obligations of any third parties. We have not entered
into
any derivative contracts that are indexed to our shares and classified as
shareholder’s equity or that are not reflected in our consolidated financial
statements. Furthermore, we do not have any retained or contingent interest
in
assets transferred to an unconsolidated entity that serves as credit, liquidity
or market risk support to such entity. We do not have any variable interest
in
any unconsolidated entity that provides financing, liquidity, market risk or
credit support to us or engages in leasing, hedging or research and development
services with us.
Risk
Factors
Interest
Rates.
Our
exposure to market risk for changes in interest rates primarily relates to
our
short-term investments and short-term obligations; thus, fluctuations in
interest rates would not have a material impact on the fair value of these
securities. At September 30, 2008, we had approximately $61,269,936 in cash
and
cash equivalents. A hypothetical 2 % increase or decrease in interest rates
would not have a material impact on our earnings or loss, or the fair market
value or cash flows of these instruments.
Foreign
Exchange Rates.
All of
our sales are denominated in the Chinese Renminbi (“RMB”). As a result, changes
in the relative values of U.S. Dollars and RMB affect our reported levels of
revenues and profitability as the results are translated into U.S. Dollars
for
reporting purposes. In particular, fluctuations in currency exchange rates
could
have a significant impact on our financial stability due to a mismatch among
various foreign currency-denominated sales and costs. Fluctuations in exchange
rates between the U.S. dollar and RMB affect our gross and net profit
margins and could result in foreign exchange and operating losses.
Our
exposure to foreign exchange risk primarily relates to currency gains or losses
resulting from timing differences between signing of sales contracts and
settling of these contracts. Furthermore, we translate monetary assets and
liabilities denominated in other currencies into RMB, the functional currency
of
our operating business. Our results of operations and cash flows are translated
at average exchange rates during the period, and assets and liabilities are
translated at the unified exchange rate as quoted by the People’s Bank of China
at the end of the period. Translation adjustments resulting from this process
are included in accumulated other comprehensive income in our statements of
shareholders’ equity. We recorded net foreign currency gains of $330,641 and
$417,346 for the three months ended September 30, 2008 and 2007, respectively.
We have not used any forward contracts, currency options or borrowings to hedge
our exposure to foreign currency exchange risk. We cannot predict the impact
of
future exchange rate fluctuations on our results of operations and may incur
net
foreign currency losses in the future. As our sales denominated in foreign
currencies, such as RMB and Euros, continue to grow, we will consider using
arrangements to hedge our exposure to foreign currency exchange
risk.
Our
financial statements are expressed in U.S. dollars but the functional
currency of our operating subsidiary is the RMB. The value of your investment
in
our stock will be affected by the foreign exchange rates between the
U.S. dollar and the RMB. To the extent we hold assets denominated in
U.S. dollars, any appreciation of the RMB against the U.S. dollar
could result in a change to our statements of operations and a reduction in
the
value of our U.S. dollar denominated assets. On the other hand, a decline
in the value of RMB against the U.S. dollar could reduce the
U.S. dollar equivalent amounts of our financial results, the value of your
investment in our company and the dividends we may pay in the future, if any,
all of which may have a material adverse effect on the price of our
stock.
Credit
Risk. We
have
not experienced significant credit risk, as most of our customers are long-term
customers with excellent payment records. We review our accounts receivable
on a
regular basis to determine if the allowance for doubtful accounts is adequate
at
each quarter-end. We typically extend 30 to 90 day trade credit to our largest
customers and we have not seen any of our major customers’ accounts receivable
go uncollected beyond the extended period of time or experienced any material
write-off of accounts receivable in the past.
Inflation
Risk.
In
recent years, China has not experienced significant inflation, and thus
inflation has not had a material impact on our results of operations. According
to the National Bureau of Statistics of China (“NBS”) (www.stats.gov.cn), the
change in Consumer Price Index (“CPI”) in China was 3.9%, 1.8% and 1.5% in 2004,
2005 and 2006, respectively. However, in 2007, according to NBS, CPI rose
significantly at a monthly average rate of 4.8%. Especially during the months
of
August, September, October, November, and December, CPI was up 6.5%, 6.2%,
6.5%,
6.9%, and 6.5%, respectively. Inflationary factors, such as increases in the
cost of our products and overhead costs, could impair our operating results.
Although we do not believe that inflation has had a material impact on our
financial position or results of operations to date, a high rate of inflation
may have an adverse effect on our ability to maintain current levels of gross
margin and selling, general and administrative expenses as a percentage of
sales
revenue if the selling prices of our products do not increase with these
increased costs.
Related
Party Transactions
Accounts
receivable - related parties
The
Company is engaged in business activities with three related parties, Jiangbo
Chinese-Western Pharmacy, Laiyang Jiangbo Medicals, Co., Ltd, and Yantai Jiangbo
Pharmaceuticals Co., Ltd. The Company’s Chief Executive Officer and other
majority shareholders have 100% ownership of these entities. As of September
30,
2008 and June 30, 2008, accounts receivable from sales of the Company’s products
to these related entities were $187,509 and $673,808, respectively. Accounts
receivable due from related parties are receivable in cash and due within 3
to 6
months. For the three months ended September 30, 2008 and 2007, the Company
recorded sales to related parties as follows:
Name
of Related Party
|
|
Relationship
|
|
September
30,
2008
|
|
September
30,
2007
|
|
|
|
|
|
|
|
|
|
|
|
Jiangbo
Chinese-Western Pharmacy
|
|
90%
owned by Chief Executive Officer |
|
$
|
108,094
|
|
$
|
395,848
|
|
|
|
|
|
|
|
|
|
|
|
Laiyang
Jiangbo Medicals, Co. Ltd.
|
|
60%
owned by Chief Executive Officer |
|
|
-
|
|
|
134,280
|
|
|
|
|
|
|
|
|
|
|
|
Yantai
Jiangbo Pharmaceuticals Co., Ltd.
|
|
Owned
by Other Related Party |
|
|
135,749
|
|
|
817,967
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
|
$
|
243,843
|
|
$
|
1,348,095
|
|
Other
receivable - related parties
The
Company leases two of its buildings to Jiangbo Chinese-Western Pharmacy. For
the
three months ended September 30, 2008 and 2007, the Company recorded other
income of $143,950 and $26,492, respectively, from leasing the two buildings
to
this related party. As of September 30, 2008, amount due from this related
party
was $565,450.
Other
payable - related parties
Other
payable-related parties primarily consist of accrued salary payable to the
Company’s officers and directors, and advances from the Company’s Chief
Executive Officer. These advances are short-term in nature and bear no interest.
The amounts are expected to be repaid in the form of cash.
At
September 30, 2008 and June 30, 2008, other payable - related parties consisted
of the following:
|
|
September 30,
|
|
June 30,
|
|
|
|
2008
|
|
2008
|
|
|
|
(Unaudited)
|
|
|
|
Payable
to Cao Wubo, Chief Executive Officer and Chairman of the Board
|
|
$
|
320,588
|
|
$
|
164,137
|
|
|
|
|
|
|
|
|
|
Payable
to Haibo Xu, Chief Operating Officer and Director
|
|
|
60,635
|
|
|
-
|
|
|
|
|
|
|
|
|
|
Payable
to Elsa Sung, Chief Financial Officer
|
|
|
8,000
|
|
|
-
|
|
|
|
|
|
|
|
|
|
Payable
to John Wang, Director
|
|
|
2,500
|
|
|
-
|
|
|
|
|
|
|
|
|
|
Total
other payable - related parties
|
|
$
|
391,723
|
|
$
|
164,137
|
|
CRITICAL
ACCOUNTING POLICIES AND ESTIMATES
We
believe that the application of the following accounting policies, which
are
important to our financial position and results of operations, require
significant judgments and estimates on the part of management. Our critical
accounting policies and estimates present an analysis of the uncertainties
involved in applying a principle, while the accounting policies note to the
financial statements (Note 2) describe the method used to apply the accounting
principle.
Recent
Accounting Pronouncements
In
June 2008, the FASB issued Emerging Issues Task Force Issue 07-5 “Determining
whether an Instrument (or Embedded Feature) is indexed to an Entity’s Own Stock”
(“EITF 07-5”). This Issue is effective for financial statements issued for
fiscal years beginning after December 15, 2008, and interim periods within
those
fiscal years. Early application is not permitted. Paragraph 11(a) of Statement
of Financial Accounting Standard No 133 “Accounting for Derivatives and Hedging
Activities” (“SFAS 133”) specifies that a contract that would otherwise meet the
definition of a derivative but is both (a) indexed to the Company’s own stock
and (b) classified in stockholders’ equity in the statement of financial
position would not be considered a derivative financial instrument. EITF
07-5
provides a new two-step model to be applied in determining whether a financial
instrument or an embedded feature is indexed to an issuer’s own stock and thus
able to qualify for the SFAS 133 paragraph 11(a) scope exception. The Company
believes adopting statement will have a material impact on the financial
statements because among other things, any option or warrant previously issued
and all new issuances denominated is US dollars will be required to be carried
as a liability and marked to market each reporting
period.
On
October 10, 2008, the FASB issued FSP 157-3, “Determining the Fair Value of a
Financial Asset When the Market for That Asset Is Not Active,” which clarifies
the application of SFAS 157 in a market that is not active and provides an
example to illustrate key considerations in determining the fair value of
a
financial asset when the market for that financial asset is not active. FSP
157-3 became effective on October 10, 2008, and its adoption did not have
a
material impact on our financial position or results for the quarter ended
September 30, 2008.
Item
3. Quantitative
and Qualitative Disclosures About Market Risk
Not
required for smaller reporting companies.
Item
4T: Controls and Procedures
(a) 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 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, for the following two reasons:
1. Accounting
and Finance Personnel Weaknesses - US
GAAP expertise - The current staff in the accounting department does not have
extensive experience with US GAAP, and needs substantial training so as to
meet
the higher demands of being a publicly-traded company in the US. The accounting
skills and understanding necessary to fulfill the requirements of US GAAP-based
reporting, including the skills of subsidiary financial statement consolidation,
were inadequate and the personnel were inadequately supervised. The lack of
sufficient and adequately trained accounting and finance personnel resulted
in
an ineffective segregation of duties relative to key financial reporting
functions.
2. Lack
of internal audit function–
The
Company lacks qualified resources to perform the internal audit functions
properly, which resulted in the inability to prevent and detect control lapses
and errors in the accounting of certain key areas such as revenue recognition,
inter-company transactions, cash receipt and cash disbursement authorizations,
inventory safeguard and proper accumulation for cost of products, in accordance
with the appropriate costing method used by the Company. In addition, the scope
and effectiveness of the internal audit function are yet to be
developed.
In
order
to correct the foregoing deficiencies, we have taken the following remediation
actions:
1.
We
have started training our internal accounting staff on US GAAP and financial
reporting requirements. Additionally, we are also taking steps to hire
additional accounting personnel to ensure we have adequate resources to meet
the
requirements of segregation of duties.
2. We
plan on involving both internal accounting and operations personnel and outside
consultants with US GAAP technical accounting expertise, as needed, early in
the
evaluation of a complex, non-routine transaction to obtain additional guidance
as to the application of generally accepted accounting principles to such a
proposed transaction. During the three months ended September 30, 2008, our
senior management has started interviewing and selecting outside internal
control consultants. The internal consultants will be working with our internal
audit department to implement new policies and procedures within the financial
reporting process with adequate review and approval procedures.
3. We
have continued to evaluate the internal audit function in relation to the
Company’s financial resources and requirements. During the three months ended
September 30, 2008, we have established an internal audit department and the
department have started evaluating the Company’s current internal control over
financial reporting process. 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 significant deficiencies
identified above, and we will continue to monitor the effectiveness of these
steps and make any changes that our management deems appropriate to insure
that
the foregoing do not become material weaknesses. We plan to fully implement
the
above remediation plan by June 30, 2009.
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.
Our
management is not aware of any material weaknesses in our internal control
over
financial reporting, and nothing has come to the attention of management that
causes them to believe that any material inaccuracies or errors exist in our
financial statements as of September 30, 2008. The reportable
conditions and other areas of our internal control over financial reporting
identified by us as needing improvement have not resulted in a material
restatement of our financial statements. Nor are we aware of any
instance where such reportable conditions or other identified areas of weakness
have resulted in a material misstatement or omission in any report we have
filed
with or submitted to the Commission.
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.
(b) Changes
in internal controls over financial reporting.
During
the fiscal quarter covered by this quarterly report, there was no change in
our
internal control over financial reporting that has materially affected, or
is
reasonably likely to materially affect, our internal control over financial
reporting.
A
control
system, no matter how well conceived and operated, can provide only reasonable,
not absolute, assurance that the objectives of the control systems are met.
Because of the inherent limitations in all control systems, no evaluation of
controls can provide absolute assurance that all control issues, if any, within
a company have been detected. Such limitations include the fact that human
judgment in decision-making can be faulty and that breakdowns in internal
control can occur because of human failures, such as simple errors or mistakes
or intentional circumvention of the established process.
PART
II
Item
1. Legal
Proceedings
The
Company is involved in various legal matters arising in the ordinary course
of
business. After taking into consideration the Company’s legal counsel’s
evaluation of such matters, the Company’s management is of the opinion that the
outcome of these matters will not have a significant effect on the Company’s
consolidated financial position as of September 30, 2008.
The
following summarizes the Company’s pending and settled legal proceedings as of
September 30, 2008:
Fernando
Praca, Plaintiff v.s. EXTREMA, LLC and Genesis Pharmaceuticals Enterprises,
Inc.- Case No. 50 2005 CA 005317, Circuit Court of the 15
th
Judicial Circuit in and for Palm Beach County, Florida
Fernando
Praca, former Director and former President of the Company’s discontinued
subsidiary, Extrema LLC, filed an action in Dade County, Florida against
Extrema, LLC and the Company in June 2005 relating to damages arising from
the
sale of Extrema LLC to Genesis Technology Group, Inc. Fernando Praca had filed
a
Motion of Temporary Injunction but had not proceeded to move this case forward.
The plaintiff has decided to reinitiate the legal action in March 2008. In
July
2008, the Company and Fernando Praca entered into a Settlement Agreement whereby
Fernando Praca agreed to dismiss this action against the Company and to
surrender to the Company for cancellation, 100,000 shares of common stock in
the
Company held by him. The Company agreed to provide Fernando Praca with a legal
opinion of its counsel removing the restrictive legend on the 1,269,607 shares
of common stock held by Fernando Praca.
CRG
Partners, Inc. and Capital Research Group, Inc. and Genesis Technology Group,
Inc., n/k/a Genesis Pharmaceuticals Enterprises, Inc. (Arbitration) - Case
No.
32 145 Y 00976 07, American Arbitration Association, Southeast Case Management
Center
On
December 4, 2007, CRG Partners, Inc. (“CRGP”), a former consultant of the
Company, filed a demand for arbitration against the Company alleging breach
of
contract and seeking damages of approximately $10 million as compensation for
consulting services rendered to the Company. The amount of damages sought by
the
claimant is equal to the dollar value of 29,978,900 shares of the Company’s
common stock (Pre 40-to-1 reverse split) on November 2, 2007, in which the
claimant alleges are due and owing to CRGP. On December 5, 2007, the Company
gave notice of termination of the relationship with CRG under the consulting
agreement. CRGP subsequently filed an amendment to the demand for arbitration
to
included Capital Research Group, Inc. (“CRG”) as an added claimant and increased
the damage amount sought under this matter to approximately $10.9 million.
The
Company subsequently filed counter claims in reference to the aforementioned
allegations of breach of contract. The hearing date for the arbitration is
set
for December 1, 2008, in Miami, Florida.
China
West II, LLC and Genesis Technology Group, Inc., n/k/a Genesis Pharmaceuticals
Enterprises, Inc. (Arbitration)
In
June
2008, China West II, LLC (“CW II”) filed a Demand For Arbitration with the
American Arbitration Association the case of
CW
II and Genesis Technology Group, Inc. n/k/a Genesis Pharmaceuticals Enterprises,
Inc. and Joshua Tan.
In that
matter, CW II seeks breach of contract damages in connection with the Company’s
October 2007 reverse merger from the Company and Joshua Tan, former director
of
the Company, jointly and severally for approximately $6.7 million estimated
by
CW II. As of the date of these consolidated financial statements, the Company
is
unable to estimate a loss, if any, the Company may incur related expenses to
this lawsuit. The Company believes CW II’s demand is without merit and plans to
vigorously defend its position.
China
West, LLC and Genesis Technology Group, Inc., n/k/a Genesis Pharmaceuticals
Enterprises, Inc. (Arbitration)
In
November 2008, China West, LLC (“CW”) filed a Demand For Arbitration with the
American Arbitration Association the case of
CW
and Genesis Technology Group, Inc. n/k/a Genesis Pharmaceuticals Enterprises,
Inc. and Joshua Tan.
In that
matter, CW seeks breach of contract and fiduciary duty damages in connection
with the Company’s October 2007 reverse merger from the Company for
approximately $7.5 million estimated by CW. As of the date of these consolidated
financial statements, the Company is unable to estimate a loss, if any, the
Company may incur related expenses to this lawsuit. The Company believes CW
demand is without merit and plans to vigorously defend its position. Therefore,
no amounts have been provided for in the accompanying consolidated financial
statements.
Item
2. Unregistered
Sales of Equity Securities and Use of Proceeds
In
July
2008, we issued 2,500 shares of restricted common stock as compensation to
two
of our former and current directors. We valued the shares at the fair market
value on the date of the grant at $8 per share or $20,000 in total. We recorded
related stock-based compensation expenses of $11,667 and deferred compensation
of $8,333 for the three months ended September 30, 2008, accordingly. The shares
were issued to accredited investors, without any general solicitation and,
accordingly, was exempt from Securities Act registration pursuant to Section
4(2) thereof.
In
September 2008, we issued 2,500 shares of restricted common stock to two of
our
ex-and current directors for director compensation. We valued these common
shares at the fair market value on the date of the grant at $9 per share or
$22,500 in total. We recorded related stock-based compensation expenses of
$12,188 and deferred compensation of $10,312 for the three months ended
September 30, 2008, accordingly. The shares were issued to accredited investors,
without any general solicitation and, accordingly, was exempt from Securities
Act registration pursuant to Section 4(2) thereof.
Item
3. Defaults Upon Senior Securities
None.
Item
4. Submissions of Matters to a Vote of Security Holders
None.
Item
5. Other
Information.
None.
Item
6. Exhibits
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 and Chief Financial
Officer
|
SIGNATURES
In
accordance with the requirements of the Exchange Act, the registrant caused
this
report to be signed on its behalf by the undersigned, thereunto duly
authorized.
|
|
|
|
GENESIS
PHARMACEUTICALS ENTERPRISES,
INC.
|
|
|
|
Date:
November 14, 2008
|
By: |
/s/ Cao
Wubo |
|
|
|
Cao
Wubo
Chief
Executive Officer and President
|
42