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 TO 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) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days.
Yes x No o
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. See
the definitions of “large accelerated filer,” “accelerated filer” and “smaller
reporting company” in Rule 12b-2 of the Exchange Act.
Large
accelerated filer o
Accelerated filer o
Non-accelerated filer o (Do not check if
smaller reporting company) Smaller reporting company x
Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act):
Yes o No x
APPLICABLE
ONLY TO CORPORATE ISSUERS:
Indicate
the number of shares outstanding of each of the registrant’s classes of common
stock, as of the latest practicable date. The total shares outstanding at
February 12, 2009 were 10,351,448.
|
Page
|
PART
I - FINANCIAL INFORMATION
|
|
|
|
Item
1. Financial Statements
|
3
|
|
|
Consolidated
Balance Sheets as of December 31, 2008 (Unaudited) and June 30,
2008
|
3
|
|
|
Consolidated
Statements of Income and Other Comprehensive Income for the six months and
three months ended December 31, 2008 and 2007 (Unaudited)
|
4
|
|
|
Consolidated
Statements of Cash Flows for the six months ended December 31, 2008 and
2007 (Unaudited)
|
5
|
|
|
Notes
to Consolidated Financial Statements (Unaudited)
|
6
|
|
|
Item
2. Management’s Discussion and Analysis or Plan of
Operation
|
36
|
|
|
Item
3. Quantitative and Qualitative Disclosure About Market
Risk
|
44
|
|
|
Item
4T. Controls and Procedures
|
45
|
|
|
PART
II - OTHER INFORMATION
|
|
|
|
Item
1. Legal Proceedings
|
46
|
|
|
Item
2. Unregistered Sales of Equity Securities and Use of
Proceeds
|
48
|
|
|
Item
3. Defaults upon Senior Securities
|
48
|
|
|
Item
4. Submission of Matters to a Vote of Securities Holders
|
48
|
|
|
Item
5. Other Information
|
48
|
|
|
Item
6. Exhibits
|
49
|
GENESIS PHARMACEUTICALS ENTERPRISES,
INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE
SHEETS
A S S E T S
|
|
|
|
|
|
|
|
|
December
31,
|
|
June 30,
|
|
|
|
2008
|
|
|
2008
|
|
|
|
(Unaudited)
|
|
|
|
|
|
|
|
|
|
|
|
CURRENT
ASSETS:
|
|
|
|
|
|
|
Cash
|
|
$ |
76,379,860 |
|
|
$ |
48,195,798 |
|
Restricted
cash
|
|
|
6,580,962 |
|
|
|
7,839,785 |
|
Investments
|
|
|
532,724 |
|
|
|
2,055,241 |
|
Accounts receivable, net of
allowance for doubtful accounts of
|
|
$ 267,957 and $155,662,
respectively
|
|
|
26,101,618 |
|
|
|
24,312,077 |
|
Accounts receivable - related
parties
|
|
|
188,022 |
|
|
|
673,808 |
|
Inventories
|
|
|
4,978,846 |
|
|
|
3,906,174 |
|
Other
receivables
|
|
|
2,324,562 |
|
|
|
152,469 |
|
Other receivables-related
parties
|
|
|
237,343 |
|
|
|
- |
|
Advances to suppliers and other
assets
|
|
|
124,578 |
|
|
|
1,718,504 |
|
Total current
assets
|
|
|
117,448,515 |
|
|
|
88,853,856 |
|
|
|
|
|
|
|
|
|
|
PLANT AND EQUIPMENT,
net
|
|
|
11,125,526 |
|
|
|
11,225,844 |
|
|
|
|
|
|
|
|
|
|
OTHER
ASSETS:
|
|
|
|
|
|
|
|
|
Restricted
investments
|
|
|
600,075 |
|
|
|
2,481,413 |
|
Financing costs,
net
|
|
|
1,576,793 |
|
|
|
1,916,944 |
|
Intangible assets,
net
|
|
|
9,823,785 |
|
|
|
9,916,801 |
|
Total other
assets
|
|
|
12,000,653 |
|
|
|
14,315,158 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
assets
|
|
$ |
140,574,694 |
|
|
$ |
114,394,858 |
|
|
|
|
|
|
|
|
|
|
L I A B I L I T I E S A N
D S H A R E H O L D E R S' E Q U I T
Y
|
|
|
|
|
|
|
|
|
|
CURRENT
LIABILITIES:
|
|
|
|
|
|
|
|
|
Accounts
payable
|
|
$ |
2,924,891 |
|
|
$ |
2,341,812 |
|
Short term bank
loans
|
|
|
2,200,500 |
|
|
|
2,772,100 |
|
Notes
payable
|
|
|
6,580,962 |
|
|
|
5,843,295 |
|
Other
payables
|
|
|
5,613,441 |
|
|
|
3,671,703 |
|
Other payables - related
parties
|
|
|
391,793 |
|
|
|
324,972 |
|
Accrued
liabilities
|
|
|
231,715 |
|
|
|
173,604 |
|
Liabilities assumed from
reorganization
|
|
|
1,771,650 |
|
|
|
1,084,427 |
|
Taxes
payable
|
|
|
14,014,450 |
|
|
|
166,433 |
|
Total current
liabilities
|
|
|
33,729,402 |
|
|
|
16,378,346 |
|
|
|
|
|
|
|
|
|
|
CONVERTIBLE DEBT, net of discount
$31,364,174 and $32,499,957
|
as of December 31, 2008 and June
30, 2008, respectively
|
|
|
3,986,278 |
|
|
|
2,500,043 |
|
|
|
|
|
|
|
|
|
|
Total
liabilities
|
|
|
37,715,680 |
|
|
|
18,878,389 |
|
|
|
|
|
|
|
|
|
|
COMMITMENTS AND
CONTINGENCIES
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
SHAREHOLDERS'
EQUITY:
|
|
|
|
|
|
|
|
|
Preferred stock Series ($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;
9,791,448 and 9,767,844 shares issued
|
|
and outstanding,
respectively)
|
|
|
9,792 |
|
|
|
9,770 |
|
Paid-in-capital
|
|
|
73,566,519 |
|
|
|
45,554,513 |
|
Captial contribution
receivable
|
|
|
(27,845,000 |
) |
|
|
(11,000 |
) |
Retained
earnings
|
|
|
46,109,412 |
|
|
|
39,008,403 |
|
Statutory
reserves
|
|
|
4,685,539 |
|
|
|
3,253,878 |
|
Accumulated other comprehensive
income
|
|
|
6,332,752 |
|
|
|
7,700,905 |
|
Total shareholders'
equity
|
|
|
102,859,014 |
|
|
|
95,516,469 |
|
Total liabilities and
shareholders' equity
|
|
$ |
140,574,694 |
|
|
$ |
114,394,858 |
|
The accompanying notes are an integral
part of these consolidated financial statements.
GENESIS PHARMACEUTICALS ENTERPRISES,
INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME AND
OTHER COMPREHENSIVE INCOME
|
|
For the Three Months
Ended
|
|
|
For the Six Months
Ended
|
|
|
|
December
31,
|
|
|
December
31,
|
|
|
|
2008
|
|
|
2007
|
|
|
2008
|
|
|
2007
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
REVENUES:
|
|
|
|
|
|
|
|
|
|
|
|
|
Sales
|
|
$ |
32,944,809 |
|
|
$ |
25,154,071 |
|
|
$ |
60,265,493 |
|
|
$ |
40,416,860 |
|
Sales-
related parties
|
|
|
- |
|
|
|
1,394,662 |
|
|
|
243,909 |
|
|
|
2,742,757 |
|
TOTAL
REVENUE
|
|
|
32,944,809 |
|
|
|
26,548,733 |
|
|
|
60,509,402 |
|
|
|
43,159,617 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of
sales
|
|
|
7,138,166 |
|
|
|
6,524,403 |
|
|
|
12,851,210 |
|
|
|
10,730,348 |
|
Cost of sales -related
parties
|
|
|
- |
|
|
|
292,040 |
|
|
|
54,493 |
|
|
|
676,209 |
|
COST OF
SALES
|
|
|
7,138,166 |
|
|
|
6,816,443 |
|
|
|
12,905,703 |
|
|
|
11,406,557 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
GROSS
PROFIT
|
|
|
25,806,643 |
|
|
|
19,732,290 |
|
|
|
47,603,699 |
|
|
|
31,753,060 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
RESEARCH AND DEVELOPMENT
EXPENSE
|
|
|
1,098,525 |
|
|
|
937,390 |
|
|
|
2,196,450 |
|
|
|
1,202,310 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
SELLING, GENERAL AND
ADMINISTRATIVE EXPENSES
|
|
|
13,282,421 |
|
|
|
10,311,750 |
|
|
|
26,634,396 |
|
|
|
17,133,166 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
INCOME FROM
OPERATIONS
|
|
|
11,425,697 |
|
|
|
8,483,150 |
|
|
|
18,772,853 |
|
|
|
13,417,584 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
OTHER (INCOME)
EXPENSE:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other (income) expense,
net
|
|
|
429,559 |
|
|
|
(40,185 |
) |
|
|
1,344,529 |
|
|
|
(27,507 |
) |
Other (income)-related
parties
|
|
|
(92,774 |
) |
|
|
(26,944 |
) |
|
|
(236,724 |
) |
|
|
(53,436 |
) |
Non-operating (income)
expense
|
|
|
(225,558 |
) |
|
|
(59,606 |
) |
|
|
(150,937 |
) |
|
|
297 |
|
Interest expense,
net
|
|
|
1,549,331 |
|
|
|
339,484 |
|
|
|
2,902,125 |
|
|
|
399,484 |
|
Loss from discontinued
operations
|
|
|
1,545,607 |
|
|
|
112,931 |
|
|
|
1,590,823 |
|
|
|
112,931 |
|
OTHER EXPENSE ,
NET
|
|
|
3,206,165 |
|
|
|
325,680 |
|
|
|
5,449,816 |
|
|
|
431,769 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
INCOME BEFORE PROVISION FOR INCOME
TAXES
|
|
|
8,219,532 |
|
|
|
8,157,470 |
|
|
|
13,323,037 |
|
|
|
12,985,815 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
PROVISION FOR INCOME
TAXES
|
|
|
2,820,346 |
|
|
|
3,004,007 |
|
|
|
4,790,367 |
|
|
|
4,597,360 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
NET INCOME
|
|
$ |
5,399,186 |
|
|
$ |
5,153,463 |
|
|
$ |
8,532,670 |
|
|
$ |
8,388,455 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
OTHER COMPREHENSIVE
INCOME:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Unrealized
holding (loss) gain
|
|
$ |
(384,650 |
) |
|
$ |
1,618,203 |
|
|
$ |
(1,947,617 |
) |
|
$ |
1,618,203 |
|
Foreign
currency translation adjustment
|
|
|
248,823 |
|
|
|
1,050,485 |
|
|
|
579,464 |
|
|
|
1,467,831 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
COMPREHENSIVE
INCOME
|
|
$ |
5,263,359 |
|
|
$ |
7,822,151 |
|
|
$ |
7,164,517 |
|
|
$ |
11,474,489 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
BASIC WEIGHTED AVERAGE NUMBER OF
SHARES
|
|
|
9,771,883 |
|
|
|
9,641,742 |
|
|
|
9,770,615 |
|
|
|
5,907,192 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
BASIC EARNINGS PER
SHARE
|
|
$ |
0.55 |
|
|
$ |
0.53 |
|
|
$ |
0.87 |
|
|
$ |
1.42 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
DILUTED WEIGHTED AVERAGE NUMBER OF
SHARES
|
|
|
10,418,317 |
|
|
|
10,206,553 |
|
|
|
10,443,463 |
|
|
|
6,472,003 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
DILUTED EARNINGS PER
SHARE
|
|
$ |
0.11 |
|
|
$ |
0.02 |
|
|
$ |
0.41 |
|
|
$ |
0.53 |
|
The accompanying notes are an integral
part of these consolidated financial statements.
GENESIS PHARMACEUTICALS ENTERPRISES,
INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH
FLOWS
|
|
For the six months
ended
|
|
|
|
December
31,
|
|
|
|
2008
|
|
|
2007
|
|
CASH FLOWS FROM OPERATING
ACTIVITIES:
|
|
|
|
|
Net income
|
|
$ |
8,532,670 |
|
|
$ |
8,388,455 |
|
Loss from discontinued
operations
|
|
|
1,590,823 |
|
|
|
112,931 |
|
Income from continuing
operations
|
|
|
10,123,493 |
|
|
|
8,501,386 |
|
Adjustments to reconcile net
income to cash
|
|
|
|
|
|
|
|
|
provided by (used in) operating
activities:
|
|
|
|
|
|
|
|
|
Depreciation
|
|
|
289,749 |
|
|
|
241,282 |
|
Amortization of intangible
assets
|
|
|
147,120 |
|
|
|
58,289 |
|
Amortization of deferred debt
issuance costs
|
|
|
340,151 |
|
|
|
18,049 |
|
Amortization of debt
discount
|
|
|
1,646,235 |
|
|
|
254,630 |
|
Bad debt
expense
|
|
|
111,237 |
|
|
|
- |
|
Gain on sale of marketable
securities
|
|
|
(115,128 |
) |
|
|
(64,742 |
) |
Unrealized loss (gain) on trading
securities
|
|
|
1,459,656 |
|
|
|
(8,893 |
) |
Other non-cash
setlement
|
|
|
(20,000 |
) |
|
|
- |
|
Stock-based
compensation
|
|
|
38,028 |
|
|
|
28,750 |
|
Changes in operating assets and
liabilities
|
|
|
|
|
|
|
|
|
Accounts
receivable
|
|
|
(1,764,421 |
) |
|
|
(5,314,103 |
) |
Accounts receivable - related
parties
|
|
|
488,580 |
|
|
|
(1,093,483 |
) |
Notes
receivables
|
|
|
- |
|
|
|
58,893 |
|
Inventories
|
|
|
(1,049,318 |
) |
|
|
738,910 |
|
Other
receivables
|
|
|
(2,175,378 |
) |
|
|
(84,925 |
) |
Other receivables- related
parties
|
|
|
(236,724 |
) |
|
|
- |
|
Advances to suppliers and other
assets
|
|
|
1,608,131 |
|
|
|
(2,129,298 |
) |
Accounts
payable
|
|
|
569,601 |
|
|
|
(453,390 |
) |
Accrued
liabilities
|
|
|
153,587 |
|
|
|
311,785 |
|
Other
payables
|
|
|
1,815,563 |
|
|
|
(879,701 |
) |
Other payables - related
parties
|
|
|
66,028 |
|
|
|
13,359 |
|
Liabilities assumed from
reorganization
|
|
|
(903,600 |
) |
|
|
(689,022 |
) |
Taxes
payable
|
|
|
13,821,621 |
|
|
|
3,363,650 |
|
Net cash provided by operating
activities
|
|
|
26,414,211 |
|
|
|
2,871,426 |
|
|
|
|
|
|
|
|
|
|
CASH FLOWS FROM INVESTING
ACTIVITIES:
|
|
|
|
|
|
Proceeds from sale of marketable
securities
|
|
|
117,614 |
|
|
|
376,205 |
|
Prepayment for land use
right
|
|
|
- |
|
|
|
(2,544,100 |
) |
Cash receipt from reverse
acquisiion
|
|
|
- |
|
|
|
534,950 |
|
Purchase of
equipment
|
|
|
(128,179 |
) |
|
|
(293,487 |
) |
Net cash used in investing
activities
|
|
|
(10,565 |
) |
|
|
(1,926,432 |
) |
|
|
|
|
|
|
|
|
|
CASH FLOWS FINANCING
ACTIVITIES:
|
|
|
|
|
|
|
|
|
Decrease in restricted
cash
|
|
|
1,292,162 |
|
|
|
4,270,071 |
|
Proceeds from sale of common stock
and options exercised
|
|
|
- |
|
|
|
180,000 |
|
Proceeds from convertible
debt
|
|
|
- |
|
|
|
5,000,000 |
|
Payments on debt issuance
costs
|
|
|
- |
|
|
|
(354,408 |
) |
Payments for
dividends
|
|
|
- |
|
|
|
(10,596,800 |
) |
Proceeds from short term bank
loans
|
|
|
2,196,450 |
|
|
|
3,183,560 |
|
Principal payments on short term
bank loans
|
|
|
(2,782,170 |
) |
|
|
(2,649,200 |
) |
Payment to escrow
account
|
|
|
- |
|
|
|
(325,000 |
) |
Increase (Decrease) in notes
payable
|
|
|
704,328 |
|
|
|
(4,270,071 |
) |
Net cash provided (used) in
financing activities
|
|
|
1,410,770 |
|
|
|
(5,561,848 |
) |
|
|
|
|
|
|
|
|
|
EFFECTS OF EXCHANGE RATE CHANGE IN
CASH
|
|
|
369,646 |
|
|
|
513,427 |
|
|
|
|
|
|
|
|
|
|
INCREASE (DECREASE) INCREASE
IN CASH
|
|
|
28,184,062 |
|
|
|
(4,103,427 |
) |
|
|
|
|
|
|
|
|
|
CASH, beginning of the
period
|
|
|
48,195,798 |
|
|
|
17,737,208 |
|
|
|
|
|
|
|
|
|
|
CASH, end of the
period
|
|
$ |
76,379,860 |
|
|
$ |
13,633,781 |
|
The accompanying notes are an integral
part of these consolidated financial statements.
GENESIS
PHARMACEUTICALS ENTERPRISES, INC. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
December
31, 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. 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
(“BVI”). 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 $12,000,000. 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 $30,000,000 to $59,800,000. 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 December 31, 2008, and
the remaining balance of $27,834,000 was recorded as a capital contribution
receivable as of December 31, 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 consolidated balance sheets, and related interim
consolidated statements of income, 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. The information
included in this Form 10-Q should be read in conjunction with information
included in the 2008 annual report filed on Form 10-K.
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”) 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 approximately $6,932,000 and $6,353,000 as of December
31, 2008 and June 30, 2008, respectively. Asset and liability accounts at
December 31, 2008 were translated at 6.85 RMB to $1.00 as compared to 6.87 RMB
at June 30, 2008. Equity accounts were stated at their historical rates. The
average translation rates applied to statements of income for the six months
ended December 31, 2008 and 2007 were 6.83 RMB and 7.49 RMB to
$1.00.
In
accordance with SFAS 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 stock 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 48 “Revenue Recognition When Right of
Return Exists.” SAB 104 states that revenue should not be
recognized until it is realized or realizable and earned. In general, the
Company records revenue when persuasive evidence of an arrangement exists,
services have been rendered or product delivery has occurred, the sales price to
the customer is fixed or determinable, and collectability is reasonably
assured.
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 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 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. 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.
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.
Comprehensive
income
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 financial statements 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 December 31, 2008 and June 30, 2008, the Company’s
bank balances, including restricted cash balances, exceeded government-insured
limits by approximately $82,926,000 and $55,576,000, 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
December 31, 2008 and June 30, 2008, the Company had restricted cash of
approximately $6,581,000 and $7,840,000, respectively, of which approximately
$6,581,000 and $5,843,000, 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. The Company
has no investments that are considered to be held-to-maturity
securities.
For the
three months ended December 31, 2008 and 2007, realized loss on trading
securities amounted to approximately $5,000 and $0 respectively, and for the six
months ended December 31, 2008 and 2007, realized gains on trading securities
amounted to approximately $115,000 and $9,000, respectively. Unrealized losses
on trading securities amounted to approximately $416,000 and $76,000 for the
three months ended December 31 2008 and 2007, and amounted to approximately
$1,460,000 and $76,000 for the six months ended December 31, 2008 and 2007,
respectively.
For the
three and six months ended December 31, 2008, unrealized losses on
available-for-sales securities amounted to $385,000 and $1,948,000,
respectively. There was $1,618,000 and $1,618,000 in unrealized gains
on available-for-sale securities for the three and six months ended December 31,
2007, which has been reflected as a component of accumulated other comprehensive
income in shareholders’ equity.
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 a material impact on collections and the Company’s
estimation process.
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.
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 December 31,
2008 and June 30, 2008, the Company has determined that no reserves were
necessary.
Advances 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 monies to be
deposited with them as a guarantee that the Company will receive their purchases
on a timely basis. As of December 31, 2008 and June 30, 2008, advances to
suppliers amounted to approximately $124,000 and $1,719,000,
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 period of disposition. Maintenance, repairs, and minor
renewals are charged directly to operations 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
|
Vehicles
|
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 and 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 at least annually, 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 and amortization to determine whether
subsequent events and circumstances warrant revised estimates of useful lives.
As of December 31, 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 $2,904,092 for the November
6, 2007 convertible note and $19,111,323 for the May 30, 2008 convertible
debt was discounted from the carrying value of the convertible notes. The
beneficial conversion feature is amortized using the effective interest method
over the term of the note. As of December 31, 2008 and June 30, 2008,
$19,742,865 and $20,453,441, respectively, remained unamortized relating to the
beneficial conversion features.
Income
taxes
The
Company accounts for income taxes in accordance with 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. Since the Company’s operations are domiciled in the PRC, and the
taxable income mirrors that of GAAP income, there are no temporary differences
that would result in deferred tax assets or liabilities. As such, no valuation
allowances were necessary at December 31, 2008 and June 30, 2008.
In July
2006, the 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 approximately $5,603,000 and $781,000, respectively,
for the three months ended December 31, 2008, and approximately $4,615,000 and
$136,000, respectively, for the three months ended December 31, 2007. VAT on
sales and VAT on purchases amounted to approximately $10,287,000 and $1,155,000,
respectively, for the six months ended December 31, 2008, and approximately
$7,530,000 and $194,000, respectively, for the six months ended December 31,
2007. Sales and purchases are recorded net of VAT collected and paid as the
Company acts as an agent for the government. VAT is 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
approximately $130,000 and $99,000 for the three months ended December 31, 2008,
and 2007, respectively. Shipping and handling costs amounted to approximately
$252,000 and $147,000
for the six months ended December 31, 2008, and 2007, respectively.
Advertising
Expenses incurred in the advertisement
of the Company and the Company’s products are charged to operations currently.
Advertising expenses amounted to approximately $24,000 and $1,539,000 for the
three months ended December 31, 2008 and 2007, respectively. Advertising expenses amounted to
approximately $928,000 and $4,129,000 for the six months ended
December 31, 2008 and 2007, respectively.
Research and
development
Research
and development costs are expensed as incurred. These costs primarily consist of
cost of materials 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 approximately $1,099,000 and $937,000 for the
three months ended December 31, 2008 and 2007, respectively. Research and
development costs amounted to approximately $2,196,000 and $1,202,000 for the
six months ended December 31, 2008 and 2007, respectively.
Recently adopted accounting
pronouncements
On
July 1, 2008, the Company adopted 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 on 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 of valuation hierarchy are defined as follows:
|
·
|
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 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 does 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 the
financial assets and liabilities that were accounted for at fair value on a
recurring basis as of December 31, 2008.
|
|
Carrying Value at
December 31, 2008
|
|
|
Fair Value Measurements at December
31, 2008 Using
|
|
|
|
|
|
|
Level
1
|
|
Level
2
|
|
|
Level
3
|
|
$5M
Convertible Debt (November 2007)
|
$
|
865,276
|
|
$
|
-
|
|
$
|
|
$
|
5,021,998
|
|
$30M
Convertible Debt (May 2008)
|
|
3,121,002
|
|
|
-
|
|
|
|
|
30,326,363
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
$
|
3,986,278
|
|
$
|
-
|
|
$
|
|
$
|
35,348,361
|
|
The
Company did not identify any other non-recurring assets and liabilities that are
required to be presented on the consolidated balance sheets at fair value in
accordance with SFAS 157.
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 141(R), “Business Combinations,”
which replaces SFAS 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 160, “Noncontrolling Interests in
Consolidated Financial Statements — An Amendment of ARB No. 51.” SFAS 160
amends ARB 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 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
141 or SFAS 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 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 157 to these assets and liabilities.
In March
2008, the FASB issued 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 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 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 SFAS 60.
Accordingly, SFAS 163 does not apply to financial guarantee contracts issued by
enterprises excluded from the scope of SFAS 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 SFAS 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 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
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 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 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 08-4, “Transition Guidance for Conforming
Changes to Issue No. 98-5.” The objective of EITF 08-4 is to provide
transition guidance for conforming changes made to EITF 98-5, “Accounting for Convertible
Securities with Beneficial Conversion Features or Contingently Adjustable
Conversion Ratios,” that result from EITF 00-27 “Application of Issue No. 98-5 to
Certain Convertible Instruments,” and SFAS 150, “Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity.” EITF
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 08-4 on the accounting for the
convertible notes and related warrants transactions.
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 the Company’s consolidated results of operations or consolidated
financial position for the six months ended December 31, 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 December 31, 2008 and 2007:
Basic
earning per share
|
|
2008
|
|
|
2007
|
|
For
the three months ended December 31, 2008 and 2007
|
|
|
|
|
|
|
Net
income for basic earnings per share
|
|
$ |
5,399,186 |
|
|
$ |
5,153,463 |
|
|
|
|
|
|
|
|
|
|
Weighted
average shares used in basic computation
|
|
|
9,771,883 |
|
|
|
9,641,782 |
|
|
|
|
|
|
|
|
|
|
Earnings
per share-Basic
|
|
$ |
0.55 |
|
|
$ |
0.53 |
|
Diluted
earning per share
|
|
2008
|
|
2007
|
For
the three months ended December 31, 2008 and 2007
|
|
|
|
|
Net
income for basic earnings per share
|
|
$ |
5,399,186 |
|
|
$ |
5,153,463 |
|
Add:
Interest expense
|
|
|
76,667 |
|
|
|
46,667 |
|
Add:
Note discount amortization
|
|
|
178,338 |
|
|
|
342,392 |
|
Subtract:
Loan issuance cost
|
|
|
(218,223 |
) |
|
|
(336,359 |
) |
Subtract:
Debt discount if converted
|
|
|
(4,313,060 |
) |
|
|
(5,000,000 |
) |
Net
income for diluted EPS
|
|
|
1,122,908 |
|
|
|
206,163 |
|
|
|
|
|
|
|
|
|
|
Weighted
average shares used in basic computation
|
|
|
9,771,883 |
|
|
|
9,641,742 |
|
Diluted
effect of stock options and warrants
|
|
|
646,434 |
|
|
|
564,811 |
|
Weighted
average shares used in diluted computation
|
|
|
10,418,317 |
|
|
|
10,206,553 |
|
|
|
|
|
|
|
|
|
|
Earnings
per share-Diluted
|
|
$ |
0.11 |
|
|
|
0.02 |
|
The
following is a reconciliation of the basic and diluted earnings per share
computations for the six months ended December 31, 2008 and 2007:
Basic
earning per share
|
|
2008
|
|
|
2007
|
|
For
the six months ended December 31, 2008 and 2007
|
|
|
|
|
|
|
Net
income for basic earnings per share
|
|
$ |
8,532,670 |
|
|
$ |
8,388,455 |
|
|
|
|
|
|
|
|
|
|
Weighted
average shares used in basic computation
|
|
|
9,770,615 |
|
|
|
5,907,192 |
|
|
|
|
|
|
|
|
|
|
Earnings
per share – Basic
|
|
$ |
0.87 |
|
|
$ |
1.42 |
|
Diluted
earnings per share
|
|
2008
|
|
|
2007
|
|
For
the six months ended December 31, 2008 and 2007
|
|
|
|
|
|
|
Net
income for basic earnings per share
|
|
$ |
8,532,670 |
|
|
$ |
8,388,455 |
|
Add:
Interest expense
|
|
$ |
153,333 |
|
|
|
46,667 |
|
Add: Note
discount amortization
|
|
|
319,916 |
|
|
|
342,392 |
|
Subtract:
Loan issuance cost
|
|
|
(218,223 |
) |
|
|
(336,359 |
) |
Subtract:
Debt discount if converted
|
|
|
(4,454,641 |
) |
|
|
(5,000,000 |
) |
|
|
|
|
|
|
|
|
|
Net
income for diluted EPS
|
|
|
4,333,055 |
|
|
|
3,441,155 |
|
|
|
|
|
|
|
|
|
|
Weighted
average shares used in basic computation
|
|
|
9,770,615 |
|
|
|
5,907,192 |
|
Diluted
effect of stock options and warrants
|
|
|
672,848 |
|
|
|
564,811 |
|
Weighted
average shares used in diluted computation
|
|
|
10,443,463 |
|
|
|
6,472,003 |
|
|
|
|
|
|
|
|
|
|
Earnings
per share-Diluted
|
|
$ |
0.41 |
|
|
$ |
0.53 |
|
For the
three and six months ended December 31, 2008, 2,000 stock options and 1,875,000
warrants with an average exercise price of $12.00 and $10.00, respectively, were
not included in the diluted earnings per share calculation because of the
anti-dilutive effect. For the three and six months ended December 31, 2007,
74,084 and 250,000 stock options and warrants at an exercise price of $10.00 and
$12.80, respectively, were not included in the diluted earnings per share
calculation because of the anti-dilutive effect.
Note
4 - Supplemental disclosure of cash flow information
Cash paid
for income taxes amounted to $128,329 and $3,434,140 for the six months ended
December 31, 2008 and 2007, respectively. Cash paid for income taxes amounted to
$65,386 and $3,351,133 for the three months ended December 31, 2008 and 2007,
respectively.
Cash paid
for interest amounted to $1,110,572 and $205,729 for the six month ended
December 31, 2008 and 2007, respectively. Cash paid for interest amounted to
$1,051,922 and $115,463 for the three month ended December 31, 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 and its
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 amounted to $1,771,650 and $1,084,427 as of December 31,
2008 and June 30, 2008, respectively.
In
accordance with SFAS 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 six months ended December 31, 2008. As the accompanying consolidated
statements of income for the six months ended December 31, 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 six months ended December 31, 2008 and 2007:
|
|
2008
|
|
|
2007
|
|
Revenues
|
|
$ |
- |
|
|
$ |
- |
|
Cost
of sales
|
|
|
- |
|
|
|
- |
|
Gross
profit
|
|
|
- |
|
|
|
- |
|
Operating
and other non-operating expenses
|
|
|
1,590,823 |
|
|
|
112,931 |
|
Loss
from discontinued operations before other expenses and income
taxes
|
|
|
1,590,823 |
|
|
|
112,931 |
|
Income
tax benefit
|
|
|
- |
|
|
|
- |
|
Loss
from discontinued operations
|
|
$ |
1,590,823 |
|
|
$ |
112,931 |
|
The
following is a summary of the components of the loss from discontinued
operations for the three months ended December 31, 2008 and 2007:
|
|
2008
|
|
|
2007
|
|
Revenues
|
|
$ |
- |
|
|
$ |
- |
|
Cost
of sales
|
|
|
- |
|
|
|
- |
|
Gross
profit
|
|
|
- |
|
|
|
- |
|
Operating
and other non-operating expenses
|
|
|
1,545,607 |
|
|
|
112,931 |
|
Loss
from discontinued operations before other expenses and income
taxes
|
|
|
1,545,607 |
|
|
|
112,931 |
|
Income
tax benefit
|
|
|
- |
|
|
|
- |
|
Loss
from discontinued operations
|
|
$ |
1,545,607 |
|
|
$ |
112,931 |
|
Note
6 - Inventories
Inventories
consisted of the following:
|
|
December31, 2008
|
|
|
June 30, 2008
|
|
|
|
(Unaudited)
|
|
|
|
|
Raw
materials
|
|
$ |
2,295,316 |
|
|
$ |
2,164,138 |
|
Work-in-process
|
|
|
- |
|
|
|
531,076 |
|
Packing
materials
|
|
|
611,336 |
|
|
|
204,763 |
|
Finished
goods
|
|
|
2,072,194 |
|
|
|
1,006,197 |
|
Total
|
|
$ |
4,978,846 |
|
|
$ |
3,906,174 |
|
Note
7 - Plant and equipment
Plant and
equipment consisted of the following:
|
|
December
31, 2008
|
|
|
June 30, 2008
|
|
|
|
(Unaudited)
|
|
|
|
|
Buildings
and building improvements
|
|
$ |
10,986,277 |
|
|
$ |
10,926,369 |
|
Manufacturing
equipment
|
|
|
1,171,399 |
|
|
|
1,188,643 |
|
Office
equipment and furniture
|
|
|
317,806 |
|
|
|
298,137 |
|
Vehicles
|
|
|
475,462 |
|
|
|
380,485 |
|
Total
|
|
|
12,950,944 |
|
|
|
12,793,634 |
|
Less:
accumulated depreciation
|
|
|
(1,825,418
|
) |
|
|
(1,567,790
|
) |
Total
|
|
$ |
11,125,526 |
|
|
$ |
11,225,844 |
|
For the
three months ended December 31, 2008 and 2007, depreciation expense amounted to
approximately $147,000 and $130,000, respectively. For the six months ended
December 31, 2008 and 2007, depreciation expense amounted to approximately
$294,000 and $241,000, respectively.
Note
8 - Intangible assets
Intangible
assets consisted of the following:
|
|
December
31, 2008
|
|
|
June 30, 2008
|
|
|
|
(Unaudited)
|
|
|
|
|
Land
use rights
|
|
$ |
9,984,606 |
|
|
$ |
9,930,157 |
|
Patents
|
|
|
542,790 |
|
|
|
539,830 |
|
Licenses
|
|
|
23,399 |
|
|
|
23,271 |
|
Total
|
|
|
10,550,795 |
|
|
|
10,493,258 |
|
Less:
accumulated amortization
|
|
|
(727,010 |
) |
|
|
(576,457
|
) |
Total
|
|
$ |
9,823,785 |
|
|
$ |
9,916,801 |
|
Total
amortization expense for the three months ended December 31, 2008 and 2007
amounted to approximately $74,000 and $27,000, respectively. Total amortization
expense for the six months ended December 31, 2008 and 2007 amounted to
approximately $147,000 and $58,000, 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:
|
|
December
31, 2008
|
|
|
June 30,2008
|
|
|
|
(Unaudited)
|
|
|
|
|
Loan
from Bank of Communication; due December 2009 and September 2008; interest
rates of 6.37 and 8.64% per annum; monthly interest payment; guaranteed by
related party, Jiangbo Chinese-Western Pharmacy.
|
|
$ |
2,200,500 |
|
|
$ |
2,772,100 |
|
Total
|
|
$ |
2,200,500 |
|
|
$ |
2,772,100 |
|
Interest
expense related to the short term bank loans amounted to $58,665 and $115,463
for six months ended December 31, 2008 and 2007, respectively. Interest expense
amounted to $15 and $57,190 for the three months ended December 31, 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:
|
|
December
31, 2008
|
|
|
June 30, 2008
|
|
|
|
(Unaudited)
|
|
|
|
|
Commercial
Bank, various amounts, due from January 2009 to June
2009
|
|
$ |
6,580,962 |
|
|
$ |
5,843,295 |
|
Total
|
|
$ |
6,580,962 |
|
|
$ |
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 December 31,
2008 and June 30, 2008, accounts receivable from sales of the Company’s products
to these related entities were $188,022 and $673,808, respectively. Accounts
receivable due from related parties are receivable in cash and due within three
to six months. For the three months ended December 31, 2008 and 2007, the
Company recorded net revenues of $0 and $1,394,662, respectively, from sales to
these related parties. For the six months ended December 31, 2008 and 2007, the
Company recorded net revenues of $243,909 and $2,742,757, respectively, from
sales to related parties. For the six months ended December 31, 2008 and 2007,
the Company recorded sales to related parties as follows:
Name
of Related Party
|
|
Relationship
|
|
December
31, 2008
(Unaudited)
|
|
|
December
31 , 2007
(Unaudited)
|
|
|
|
|
|
|
|
|
|
|
Jiangbo
Chinese-Western Pharmacy
|
|
90%
owned by Chief Executive Officer
|
|
$ |
108,124 |
|
|
$ |
773,446 |
|
|
|
|
|
|
|
|
|
|
|
|
Laiyang
Jiangbo Medicals Co., Ltd.
|
|
60%
owned by Chief Executive Officer
|
|
|
- |
|
|
|
483,591 |
|
|
|
|
|
|
|
|
|
|
|
|
Yantai
Jiangbo Pharmaceuticals Co., Ltd.
|
|
Owned
by Other Related Party
|
|
|
135,785 |
|
|
|
1,485,720 |
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
|
$ |
243,909 |
|
|
$ |
2,742,757 |
|
For the
three months ended December 31, 2008 and 2007, the Company recorded sales to
related parties as follows:
Name
of Related Party
|
|
Relationship
|
|
December
31, 2008
(Unaudited)
|
|
|
December
31 , 2007
(Unaudited)
|
|
|
|
|
|
|
|
|
|
|
Jiangbo
Chinese-Western Pharmacy
|
|
90%
owned by Chief Executive Officer
|
|
$ |
- |
|
|
$ |
377,598 |
|
|
|
|
|
|
|
|
|
|
|
|
Laiyang
Jiangbo Medicals Co., Ltd.
|
|
60%
owned by Chief Executive Officer
|
|
|
- |
|
|
|
349,311 |
|
|
|
|
|
|
|
|
|
|
|
|
Yantai
Jiangbo Pharmaceuticals Co., Ltd.
|
|
Owned
by Other Related Party
|
|
|
- |
|
|
|
667,753 |
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
|
$ |
- |
|
|
$ |
1,394,662 |
|
Other receivable - related
parties
The
Company leases two of its buildings to Jiangbo Chinese-Western
Pharmacy. For the six months ended December 31, 2008 and 2007, the
Company recorded other income of $236,724 and $52,998 from leasing the two
buildings to this related party. For the three months ended December
31, 2008 and 2007, the Company recorded other income of $92,774 and $26,506 from
leasing the two aforementioned buildings. As of December 31, 2008 and
June 30, 2008, amounts due from this related party was $237,160 and $0,
respectively.
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:
|
|
December
31,
|
|
|
June 30,
|
|
|
|
2008
|
|
|
2008
|
|
|
|
(Unaudited)
|
|
|
|
|
Payable
to Wubo Cao, Chief Executive Officer and Chairman of the Board
|
|
$ |
279,158 |
|
|
$ |
281,137 |
|
|
|
|
|
|
|
|
|
|
Payable
to Haibo Xu, Chief Operating Officer and Director
|
|
|
99,635 |
|
|
|
43,835 |
|
|
|
|
|
|
|
|
|
|
Payable
to Elsa Sung, Chief Financial Officer
|
|
|
13,000 |
|
|
|
- |
|
|
|
|
|
|
|
|
|
|
Total
other payable - related parties
|
|
$ |
391,793 |
|
|
$ |
324,972 |
|
Note
11 - Concentration of major customers, suppliers, and products
For the
three months ended December 31, 2008 and 2007, three products accounted for 92%
and 90% of the Company’s total sales. For the six months ended December 31, 2008
and 2007, three products accounted for 95% and 91%, respectively, of the
Company’s total sales.
Five
largest customers accounted for approximately 17% and 25%, of the Company's
sales for the six months ended December 31, 2008 and 2007, respectively, and for
14% and 24% of the sales for the three months ended December 31, 2008 and 2007.
These five customers represent 9% and 26% of the Company's total accounts
receivable as of December 31, 2008 and June 30, 2008, respectively.
Five
suppliers accounted for approximately 70% and 81%, of the Company's purchases
for the six months ended December 31, 2008 and 2007, respectively, and 69% and
70% of the purchases for the three months ended December 31, 2008 and 2007,
respectively. These five suppliers represent 50% and 66% of the Company's total
accounts payable as of December 31, 2008 and June 30, 2008,
respectively.
Note 12 - Taxes
payable
The
Company is subject to the U.S. 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
six months ended December 31, 2008 and 2007.
The
Company’s wholly-owned subsidiaries Karmoya and Union Well were incorporated in
the British Virgin Islands and the Cayman Islands, respectively, and under the
current laws of the BVI and Cayman Islands, the two entities are not subject to
income taxes.
Prior to
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 Foreign Interest Enterprises
(“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 on 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 six months ended December 31, 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:
|
December
31,
|
|
June 30,
|
|
|
2008
|
|
2008
|
|
|
(Unaudited)
|
|
|
|
Value
added taxes
|
|
$ |
8,317,463 |
|
|
$ |
83,775 |
|
Income
taxes
|
|
|
4,733,711 |
|
|
|
62,733 |
|
Other
taxes
|
|
|
963,276 |
|
|
|
19,925 |
|
Total
|
|
$ |
14,014,450 |
|
|
$ |
166,433 |
|
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 the 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 three 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 six months ended December 31, 2008 and 2007,
amortization of debt issuance costs related to the November 2007 Purchase
Agreement was $59,068 and $18,049, respectively.
The remaining balance of unamortized debt issuance costs of the November 2007
Purchase Agreement at December 31, 2008 and 2007 was $228,068 and $336,359, respectively. The
amortization of debt discounts was $319,917 and $254,630, respectively, for the
six months ended December 31, 2008 and 2007, which has been included in interest
expense on the accompanying consolidated statements of income. The balance of
the unamortized debt discount was $4,134,724 and $4,328,704 at December 31, 2008
and June 30, 2008, respectively.
The
Company evaluated whether or not the secured convertible debentures contain
embedded conversion options, which meet the definition of derivatives under SFAS
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. In connection with
the May 2008 financing, the November 2007 Debenture conversion price was
subsequently adjusted to $8.00 per share (Post 40-to-1 reverse split). 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 (“SEC”) 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 SEC’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 this financing for working
capital purposes. Also pursuant to the terms of the May 2008 Securities Purchase
Agreement, the Company, among other things, was required to 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
$19,111,323. The fair value of the warrants was estimated at $10,888,677. 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 five 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 six months ended December 31,
2008, amortization of debt issuance costs related to the May 2008 Purchase
Agreement was $281,083. The remaining balance of unamortized debt issuance costs
of the May 2008 Purchase Agreement at December 31, 2008 was $1,358,569. The
amortization of debt discounts was $1,326,318 for the six months ended December
31, 2008, which has been included in interest expense on the accompanying
consolidated statements of income. The balance of the unamortized debt discount
was $26,718,998 and $28,045,316 at December 31, 2008 and June 30, 2008,
respectively.
The
Company evaluated whether or not the secured convertible debentures contain
embedded conversion options, which meets the definition of derivatives under
SFAS 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 were not so
satisfied, the applicable portion of the escrowed funds will be released pro
rata to the Investors. The Company has satisfied both of these requirements and
all of the holdback money has been released to the
Company.
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 was obligated to 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 did not timely file such
registration statement or cause it to be declared effective by the required
dates, then the Company would 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
Company satisfied its obligations under the Registration Rights Agreement by
filing the required registration statement and causing it to be declared
effective within the time periods set forth in the Registration Rights
Agreement.
The
above two convertible debenture liabilities are as follows at December 31,
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
|
|
|
(4,134,724
|
)
|
Less:
Unamortized discount on May 2008 convertible debenture note
payable
|
|
|
(26,718,998
|
)
|
Less:
Conversion
|
|
|
(160,000
|
)
|
Convertible
debentures, net
|
|
$
|
3,986,278
|
|
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 six months ended
December 31, 2008, the Company recorded settlement income of $20,000 related to
this 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).
In December 2008, the Company issued
20,000 shares of its common stock in connection with the conversion of
$250,000 of convertible
debt. In connection
with the conversion, the
Company recorded $145,524 interest expense to fully amortize the unamortized
discount related to the converted dentures.
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
$2,000,000 limitation. As of December 31, 2008, the Company has not purchased
any shares in the open market.
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 December 31, 2008, the
Company has not received the $10,000.
Union
Well was established 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
December 31, 2008, the Company has not received the $1,000.
PRC laws
require the owner of a 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 GJBT to increase its registered
capital from $12,000,000 to $30,000,000. 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 GJBT to increase its registered
capital from $30,000,000 to $59,800,000. 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 December 31,
2008, the Company has not received the remaining contribution receivable in the
amount of $27,845,000.
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 three 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 five years, (3) expected volatility
of 95%, and (4) zero expected dividends.
A summary
of the warrants as of December 31, 2008, and changes during the period are
presented below:
|
|
Number of warrants
|
|
Outstanding
as of June 30, 2007
|
|
|
74,085
|
|
Granted
|
|
|
2,275,000
|
|
Forfeited
|
|
|
-
|
|
Exercised
|
|
|
-
|
|
Outstanding
as of June 30, 2008
|
|
|
2,349,085
|
|
Granted
|
|
|
-
|
|
Forfeited
|
|
|
-
|
|
Exercised
|
|
|
-
|
|
Outstanding
as of December 31, 2008
|
|
|
2,349,085
|
|
The
following is a summary of the status of warrants outstanding at December 31,
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
|
|
|
1.91
|
|
$
|
8.00
|
|
|
474,085
|
|
|
1.91
|
|
$
|
10.00
|
|
|
1,875,000
|
|
|
4.42
|
|
$
|
10.00
|
|
|
1,875,000
|
|
|
4.42
|
|
|
Total
|
|
|
2,349,085
|
|
|
|
|
|
|
|
|
2,349,085
|
|
|
|
|
The
Company had 2,349,085 warrants outstanding and exercisable at an average
exercise price of $9.60 per share as of December 31, 2008.
Note
16 - Stock options
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
December 31, 2008, of the 7,500 options held by the Company’s executives,
directors, and employees, 3,750 were vested.
The
following is a summary of the option activity:
|
|
Number of options
|
|
Outstanding
as of June 30, 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 December 31, 2008
|
|
|
140,900
|
|
Following
is a summary of the status of options outstanding at December 31,
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
|
|
2.00
|
|
$
|
4.20
|
|
133,400
|
|
$
|
4.20
|
|
|
12.00
|
|
2,000
|
|
4.50
|
|
|
12.00
|
|
2,000
|
|
|
12.00
|
|
|
16.00
|
|
1,750
|
|
4.50
|
|
|
16.00
|
|
1,750
|
|
|
16.00
|
|
|
20.00
|
|
1,875
|
|
4.50
|
|
|
-
|
|
-
|
|
|
-
|
|
|
24.00
|
|
1,875
|
|
4.50
|
|
|
-
|
|
-
|
|
|
-
|
|
$
|
4.93
|
|
140,900
|
|
|
|
$
|
-
|
|
137,150
|
|
$
|
4.46
|
|
For the
six months ended December 31, 2008, the Company recorded stock-based
compensation expense of approximately $38,000. As of December 31,
2008, there was approximately $31,000 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 one
year.
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 six
months ended December 31, 2008 and 2007, the Company made pension contributions
in the amount of $72,463 and $15,758, respectively. For the three months ended
December 31, 2008 and 2007, the Company made pension contributions in the amount
of $62,802 and $7,954, 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 PRC ("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 fiscal year 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 six months ended December
31, 2008 and 2007, the Company appropriated to the statutory surplus reserve in
the amount of $1,431,661 and $1,250,168, 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
|
|
|
579,464
|
|
Unrealized
loss on marketable securities
|
|
|
(1,947,617
|
)
|
Balance,
December 31, 2008
|
|
$
|
6,332,752
|
|
Note
20 - Commitments and Contingencies
Operations based in the
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 training to the Company. As part
of the CRADA, the Company will pay approximately $3,500,000 (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 research institute will also provide technical services and
training to the Company. As part of the CRADA, the Company will pay
approximately $880,000 (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 December 31, 2008,
the Company’s future estimated payments to this CRADA amounted to approximately
$9,600,000.
For the
six months ended December 31, 2008 and 2007, approximately $2,196,000 and
$1,202,000, respectively, was incurred as research and development
expenses.
Legal
proceedings
The
Company is involved in various legal matters arising in the ordinary course of
business. The following summarizes the Company’s pending and settled legal
proceedings:
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. As of December 31, 2008, this
matter has been settled. (See Note 14.)
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 was equal to the dollar value of 29,978,900 shares of the Company’s
common stock (Pre 40-to-1 reverse split) in November 2007, in which the claimant
alleged were 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 $13.8
million.
The
Company subsequently filed counter claims in reference to the aforementioned
allegations of breach of contract. In February 2009, the Company was notified by
the arbitration panel of American Arbitration Association (the “Panel”) that the
Panel awarded CRG and CRGP jointly, a net total of $ 980,070 (the “Award”) to be
paid by the Company on or before February 27, 2009. Once the Award is satisfied,
CRG and CRGP would have no further claims against the Company’s common stock or
other property that were the subject of the arbitration. The amount has been
charged to operations for the six months ended December 31, 2008, and is
included in liabilities assumed from reorganization as of December 31,
2008.
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 (“AAA”) 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 sought 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 $6,700,000
estimated by CW II.
In
January 2009, the Company received a written notice from the
Panel that CW II had withdrawn the Demand for Arbitration without
prejudice.
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 sought from the Company in the amount of approximately
$7,500,000 for breach of contract and fiduciary duty damages in connection with
the Company’s October 2007 reverse merger.
In
February 2009, the Company received a written notice from the
Panel that CW II had withdrawn the arbitration without
prejudice.
Note
21 - Subsequent event
On January 23, 2009, Laiyang
Jiangbo entered into an Assets Transfer Contract
(the “Contract”) with Shandong Traditional Chinese
Medicine College (“Medicine
College”) and Shandong
Hongrui Pharmaceutical Factory, a wholly-owned subsidiary of Medicine College
(“Shandong
Hongrui”), pursuant to
which Laiyang Jiangbo will
purchase the majority of the assets owned by Hongrui, including all tangible
assets, including without limitation, all manufacturing and office buildings,
land, equipment and inventories and all rights to manufacture and
distribute Hongrui’s 22 Traditional Chinese Medicines
(“TCM”), for an aggregate purchase price of
approximately $16,100,000
(RMB 110,000,000) consisting of approximately $9,600,000 (RMB 66,000,000) in cash and 643,651 shares of the
Company’s common stock. Because the fair market value share price of the
Company’s common stock is approximately
$2,600,000 at the time of entering into the
Contract, the Company has
valued the transaction at approximately $12,200,000.
The purchase will be consummated in
stages following the
receipt by the parties of all required regulatory approvals including the
approval of the SFDA and the approval of the Shandong State Owned Assets
Administration Department (“SSOAAD”). As of January 23, 2009, this
transaction had been approved by the SSOAAD and certain assets were transferred
to Laiyang Jiangbo. Pursuant to the terms of the Contract, the purchase
consideration will be paid to Medicine College as follows.
Approximately $2,900,000
(RMB 20,000,000 of the purchase price will be paid to
Medicine College in cash
within one month of the initial transfer of assets to Laiyang Jiangbo (by
February 23, 2009). Another approximately $6,700,000 (RMB 46,000,000) of the purchase price will be paid to
Medicine College in cash once the SFDA transfers the owner registration of
Hongrui’s 22 TCM products from Hongrui to
Laiyang Jiangbo. The Contract provides that in the event that the SFDA does not
approve the transfer of the ownership of Hongrui’s 22 TCM products from Hongrui to
Laiyang Jiangbo that Laiyang Jiangbo may cancel the Contract and
rescind any transfers and payments previously consummated or made. The remaining
RMB 44,000,000 of the purchase price will be paid to
Medicine College in the form of 643,651 newly issued shares of the
Company’s common stock within one year of the date of the
execution of the Contract.
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 six months and
three months ended December 31, 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 six months and three
months ended December 31, 2008 and 2007
The
following table sets forth the results of our operations for the periods
indicated as a percentage of total sales :
|
|
Three
Months Ended
|
|
Six
Months Ended
|
|
|
|
December 31,
|
|
December 31,
|
|
|
|
2008
|
|
%
of Revenue
|
|
2007
|
|
%
of Revenue
|
|
2008
|
|
%
of Revenue
|
|
2007
|
|
%
of Revenue
|
|
SALES
|
|
$
|
32,945
|
|
100.00
|
%
|
$
|
25,154
|
|
94.75
|
%
|
$
|
60,265
|
|
99.60%
|
|
$
|
40,417
|
|
93.65
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
SALES-
RELATED PARTY
|
|
|
-
|
|
-
|
%
|
|
1,395
|
|
5.25
|
%
|
|
244
|
|
0.4%
|
|
|
2,743
|
|
6.35
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
COST
OF SALES
|
|
|
7,138
|
|
21.67
|
%
|
|
6,524
|
|
24.58
|
%
|
|
12,851
|
|
21.24%
|
|
|
10,730
|
|
24.86
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
COST
OF SALES- RELATED PARTIES
|
|
|
|
-
|
-
|
%
|
|
292
|
|
1.10
|
%
|
|
54
|
|
0.09%
|
|
|
676
|
|
1.57
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
GROSS
PROFIT
|
|
|
25,807
|
|
78.33
|
%
|
|
19,732
|
|
74.33
|
%
|
|
47,604
|
|
78.67%
|
|
|
31,753
|
|
73.57
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
SELLING,
GENERAL AND ADMINISTRATIVE EXPENSES
|
|
|
13,283
|
|
40.32
|
%
|
|
10,312
|
|
38.84
|
%
|
|
26,636
|
|
44.02%
|
|
|
17,133
|
|
39.70
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
RESEARCH
AND DEVELOPMENT
|
|
|
1,099
|
|
3.33
|
%
|
|
937
|
|
3.53
|
%
|
|
2,196
|
|
3.63%
|
|
|
1,202
|
|
2.79
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
INCOME
FROM OPERATIONS
|
|
|
11,426
|
|
34.68
|
%
|
|
8,483
|
|
31.95
|
%
|
|
18,771
|
|
31.02%
|
|
|
13,418
|
|
31.09
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
OTHER
EXPENSES
|
|
|
3,206
|
|
9.73
|
%
|
|
327
|
|
1.23
|
%
|
|
5,449
|
|
9.00%
|
|
|
432
|
|
1.00
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
INCOME
BEFORE PROVISION FOR INCOME TAXES
|
|
|
8,220
|
|
24.95
|
%
|
|
8,157
|
|
30.73
|
%
|
|
13,323
|
|
22.02%
|
|
|
12,986
|
|
30.09
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
PROVISION
FOR INCOME TAXES
|
|
|
2,820
|
|
8.56
|
%
|
|
3,004
|
|
11.32
|
%
|
|
4,790
|
|
7.92%
|
|
|
4,597
|
|
10.65
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
NET
INCOME
|
|
|
5,399
|
|
16.39
|
%
|
|
5,153
|
|
19.41
|
%
|
|
8,533
|
|
14.10%
|
|
|
8,388
|
|
19.44
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
OTHER
COMPREHENSIVE INCOME
|
|
|
(136)
|
|
(0.41)
|
%
|
|
2,669
|
|
10.05
|
%
|
|
(1,368
|
)
|
(2.26)%
|
|
|
3,086
|
|
7.15
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
COMPREHENSIVE
INCOME
|
|
|
5,2
|
63
|
15.98
|
%
|
|
7,822
|
|
29.46
|
%
|
|
7,164
|
|
11.84%
|
|
|
11,474
|
|
26.58
|
%
|
REVENUES. During the six
months ended December 31, 2008, we had revenues of $60.5 million as compared to
revenues of $43.2 million for the six months ended December 31, 2007, an
increase of $17.3 million or approximately 40.02%. Our revenues include sales to
related parties of $0.2 million as compared to $2.7 million for the six months
ended December 31, 2007, a decrease of $2.5 million or approximately 91.1%. For
the three months ended December 31, 2008, we had revenues of $32.9 million as
compared to revenues of $26.5 million for the three months ended December 31,
2007, an increase of $6.4 million or 24.1%. For the three months ended December
31, 2008, we did not have any revenues from related party as compared to $1.4
million for the three months ended December 31, 2007, a decrease of $1.4 million
or 100%. The overall increase in total revenue in the second quarter and first
six months of fiscal 2009 was primarily attributable to the increase in sales
volume of our strong selling products, Itopride Hydrochloride Granules and
Baobaole chewable tables. Additionally, we released a new product, Radix
Isatidis Dispersible Tablets in the second quarter of fiscal 2009. The increase
was partially offset by the decrease in sales of Clarithromycin
Sustained-released Tablets. We believe that our sales will continue to grow in
remaining of fiscal year 2009 as our two strong selling products continue
generating strong sales and our new product, Radix Isatidis Dispersible Tablets,
has received strong market demand. With the recent acquisition of Hongrui
Pharmaceutical Factory (“Hongrui”), we also significantly increased our product
portfolio and expect to generate additional sales from the products acquired in
the Hongrui acquisition.
COST OF SALES. Cost of sales
for the six months ended December 31, 2008 increased $1.5 million or 13.11%,
from $ 11.4 million for the six months ended December 31, 2007 to $12.9 million
for the six months ended December 31, 2008. Cost of sales for the three months
ended December 31, 2008 increased $0.3 million or 4.7% from $6.8 million for the
three months ended December 31, 2007 to $7.1 million for the three months ended
December 31, 2008. The decrease in cost of sales as a percentage of net revenues
for the six months ended December 31, 2008, approximately 21.3% as compared to
the six months ended December 31, 2007, approximately 26.4%, and the decrease in
cost of sales as a percentage of net revenue for the three months ended December
31, 2008, approximately 21.7% as compared to the three months ended December 31,
2007 approximately 25.7%, was primarily attributable to more sales being
generated from products with higher- profit- margins, including highly
profitable new products Itopride Hydrochloride Granules, Baobaole chewable
tablets and Radix Isatidis Dispersible Tablets and our ability to properly
manage raw material purchase prices.
GROSS PROFIT. Gross profit
was $47.6 million for the six months ended December 31, 2008 as compared to
$31.8 million for the six months ended December 31, 2007, representing gross
margins of approximately 78.7 % and 73.6%, respectively. Gross profit was $25.8
million for the three months ended December 31, 2008 as compared to $19.7
million for the three months ended December 31, 2007, representing gross margins
of approximately 78.3% and 74.3%, respectively. The increase in our gross
profits was mainly due to the higher volume of sales with higher margin products
and decrease in raw material prices.
SELLING, GENERAL AND ADMINISTRATIVE
EXPENSES. Selling, general and administrative expenses totaled $26.6
million for the six months ended December 31, 2008, as compared to $ 17.1
million for the six months ended December 31, 2007, an increase of $9.5 million
or approximately 55.5%. Selling, general and administrative expenses
totaled $13.3 million for the three months ended December 31, 2008, as compared
to $ 10.3 million for the three months ended December 31, 2007, an increase of
$3.0 million or approximately 28.8% as summarized below ($ in
thousands):
|
|
Three
Months Ended
|
|
|
Six
Months Ended
|
|
|
|
December 31,
2008
|
|
|
December 31,
2007
|
|
|
December 31,
2008
|
|
|
December 31,
2007
|
|
Advertisement,
marketing and promotion
|
|
$ |
2,607 |
|
|
$ |
2,867 |
|
|
$ |
5,835 |
|
|
$ |
5,741 |
|
Travel
and entertainment - sales related
|
|
|
671 |
|
|
|
517 |
|
|
|
1,313 |
|
|
|
712 |
|
Salaries,
wages, commissions and related benefits
|
|
|
9,199 |
|
|
|
6,297 |
|
|
|
17,837 |
|
|
|
9,521 |
|
Travel
and entertainment - non sales related
|
|
|
48 |
|
|
|
106 |
|
|
|
130 |
|
|
|
156 |
|
Depreciation
and amortization
|
|
|
151 |
|
|
|
96 |
|
|
|
302 |
|
|
|
185 |
|
Shipping
and handling
|
|
|
130 |
|
|
|
99 |
|
|
|
252 |
|
|
|
147 |
|
Other
|
|
|
478 |
|
|
|
330 |
|
|
|
965 |
|
|
|
671 |
|
Total
|
|
$ |
13,284 |
|
|
$ |
10,312 |
|
|
$ |
26,634 |
|
|
$ |
17,133 |
|
The
changes in these expenses during the second quarter and first six months of
fiscal 2009, as compared to the corresponding period in 2008 included the
following:
·
|
A
decrease of $0.3 million or approximately 9.1% in advertisement, marketing
and promotion spending for the second quarter of fiscal 2009 and an
increase of $0.1 million or less than 1.6% for the first six months of
fiscal 2009 as compared to the corresponding period in fiscal 2008. The
advertising, marketing and promotion costs remained materially
consistently with prior year corresponding period as we better managed
advertising and promotional costs in fiscal
2009.
|
·
|
Travel
and entertainment - sales related expenses increased by $0.2 million or
29.8% for the second quarter of fiscal 2009 as compared to the
corresponding period in fiscal 2008 and increased by $0.6 million or 84.4%
for the first six months of fiscal 2009 as compared to the corresponding
period in fiscal 2008. The increase was primarily due to the increase in
our sales and trade show activities related to promoting our products and
establishing the distribution network for
them.
|
·
|
Salaries,
wages, commissions and related benefits increased by $2.9 million or 46.1%
during the second quarter of fiscal 2009 and increased by $8.3 million or
87.3% during the first six months of fiscal 2009 as compared to the
corresponding period of fiscal 2008. The increases were primarily due to
increase in commission payments as a percentage of sales to sales
representatives and increase in sales
volume.
|
·
|
Travel
and entertainment - non sales related expenses decreased slightly for the
second quarter of fiscal 2009 and the first six months of fiscal 2009 as
compared to prior year corresponding period was primarily due to better
expense spending controls in fiscal
2009.
|
·
|
For
the six months ended December 31, 2008 and 2007 and for the three months
ended December 2008 and 2007, shipping and handling expenses remained
materially consistent.
|
·
|
Depreciation
and amortization increased by $0.05 million or 57.3% during the second
quarter of fiscal 2009 and increased by $0.1 million or 63.2% during the
first six months of fiscal 2009 as compared to the corresponding period of
fiscal 2008, due to more fixed and intangible assets being depreciated and
amortized.
|
·
|
Other
selling, general and administrative expenses, which include professional
fees, utilities, office supplies and expenses increased by $0.1 million or
44.8% for the second quarter of fiscal 2009 and increased by $ 0.3 million
or 43.96% for the first six months of fiscal 2009 as compared to the
corresponding period in fiscal 2008 primarily due to more professional
fees and other expenses related to being a publicly traded company in
fiscal 2009.
|
RESEARCH AND DEVELOPMENT
COSTS. Research and development costs, which consist of cost of materials
used and salaries paid for the development of the Company’s products and fees
paid to third parties, totaled $ 2.2 million for the six months ended December
31, 2008, as compared to $1.2 million for the six months ended December 31,
2007, an increase of $1.0 million or approximately 82.7%. Research
and development costs totaled $1.1 million for the three months ended December
31, 2008, as compared to $0.9 million for the three months ended December 31,
2007, an increase of $0.2 million or approximately 17.2%. The increase in
research and development expenses was mainly due to two new R&D cooperative
agreements being signed in the latter part of 2008; we began making monthly
payments to the designated university research and development products, plus
expenses incurred.
OTHER EXPENSES. Our other
expenses consisted of financial expenses and non-operating expenses. We had
other expenses of $5.4 million for the six months ended December 31, 2008 as
compared to other expenses $0.4 million for the six months ended December 31,
2007, an increase of $5.0 million or approximately 1162.2%.
For the three months ended December 31, 2008, we had other expenses of $3.2
million as compared to $0.3 million for the three months ended December 31,
2007, an increase of $2.9 million or 884.5%. The increase in net other expenses
was primarily due to increases in realized and unrealized losses on our security
investments of $1.3 million, the increase in interest expense and amortization
of debt discounts related to our financing in November 2007 and May 2008 of $2.7
million, and loss from discontinued operation of 1.6 million for the six months
ended December 31, 2008.
NET INCOME. Our net income
for the six months ended December 31, 2008 was $8.5 million as compared to $8.4
million for the six months ended December 31, 2007, an increase of $0.1 million
or 1.7%. The net income for the three months ended December 31, 2008 was $5.4
million as compared to $5.2 million for the three months ended December 31,
2007, an increase of $0.2 million or 4.8%. Although we had a $5.4 million or
39.9% increase in income from operations, the amount was largely offset by the
significant increase of $5.0 million in other expenses. Management believes
that net income will improve in the remainder of fiscal year 2009 as
we have recently completed the Hongrui acquisition and expect to generate
additional sales from the products acquired in the acquisition. We also intend
to continue to strengthen our sales efforts to gain market share and control our
spending.
LIQUIDITY
AND CAPITAL RESOURCES
Net
cash provided by operating activities for the six months ended December 31, 2008
was $26.4 million as compared to net cash provided by operating activities of
$2.9 million for the six months ended December 31, 2007. For the six months
ended December 31, 2008, the significant increase in cash provided by operating
activities included the following: 1) increase in income from continuing
operations of $1.6 million 2) an add-back of unrealized loss on marketable
securities of $ 1.5 million 3) an add-back of amortization on debt
discount and deferred debt costs of $2.0 million 4) decrease in advances to
suppliers and other assets 5) increase in accounts payable of $0.6 million 6)
increase in other payables of $2.1 million and 7) increase in $13.8 million,
partially offset by the increase in accounts receivable of $1.8 million,
increase in inventories of $1.0 million, and an increase in other receivables of
$2.2 million
Net cash
used in investing activities for the six months ended December 31, 2008 was
mainly attributable to proceeds from sale of marketable securities and offset by
payments for purchase of equipment. For the six months ended December 31, 2007,
the cash used by investing activities amounted to $1.9 million which were
primarily attributable to the payment for land use rights and partially offset
by proceeds from sale of marketable securities and cash receipts from reverse
acquisition.
Net cash
provided by financing activities was $1.4 million for the six months ended
December 31, 2008 and was primarily attributable to decrease in restricted cash
of $1.3 million, proceeds from bank loans of $2.2 million and increase in
payments on notes payable of $0.7 million, partially offset by the principal
payments on short term bank loans of $2.8 million.
We
reported a net increase in cash for the six months ended December 31, 2008 of
$28.4 million as compared to a net decrease in cash of $4.1 million for the six
months ended December 31, 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 December 31, 2008, the majority of our liquid assets
were held in the Renminbi (“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. Management has been evaluating and
resolving the situation. Our working capital position improved by $11.2 million
to $83.7 million at December 31, 2008 from $72.5 million at June 30, 2008. This
increase in working capital is primarily attributable to an increase in cash of
$28.1 million, an increase in net accounts receivable of approximately $1.8
million, an increase in inventories of $1.1 million, an increase in
other receivable of $2.2 million, and a decrease in short term bank loans of
$0.6 million, offset by a decrease in restricted cash of $1.3 million, a
decrease in investments of $1.5 million, a decrease in accounts receivable -
related parties of $0.5 million, decrease in advances to suppliers and other
assets of $1.6 million, an increase in accounts payable of $0.6 million, an
increase in notes payable of $0.7 million, an increase in other payable of $1.9
million, and an increase in taxes payable of $13.8 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 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
shareholders’ 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
December 31, 2008, we had approximately $76.4 million 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 the U.S. dollars and the 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 $ 0.6 million
and $1.5 million for the six months ended December 31, 2008 and 2007,
respectively. For the three months ended December 31, 2008 and 2007, the net
foreign currency gains amounted to $0.3 million and $1.1 million, 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 RMB,
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. At December 31,
2008 and June 30, 2008, accounts receivable from sales of the Company’s products
to these related entities were $237,160 and $673,808, respectively. Accounts
receivable due from related parties are receivable in cash and due within 3 to 6
months. For the six months ended December 31, 2008 and 2007, the Company
recorded net revenues of $243,909 and $2,742,757, respectively, from sales to
related parties. For the three months ended December 31, 2008 and 2007, the
Company recorded net revenues of $243,909 and $1,394,662, respectively, from
sales to related parties.
For the
six months and three months ended December 31, 2008 and 2007, the Company
recorded sales to related parties as follows:
Name
of Related Party
|
|
Relationship
|
|
December
31, 2008
(Unaudited)
|
|
December
31 , 2007
(Unaudited)
|
|
|
|
|
|
|
|
|
|
Jiangbo
Chinese-Western Pharmacy
|
|
90%
owned by Chief Executive Officer
|
|
$
|
108,124
|
|
$
|
773,446
|
|
|
|
|
|
|
|
|
|
|
|
Laiyang
Jiangbo Medicals Co., Ltd.
|
|
60%
owned by Chief Executive Officer
|
|
|
-
|
|
|
483,591
|
|
|
|
|
|
|
|
|
|
|
|
Yantai
Jiangbo Pharmaceuticals Co., Ltd.
|
|
Owned
by Other Related Party
|
|
|
135,785
|
|
|
1,485,720
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
|
$
|
243,909
|
|
$
|
2,742,757
|
|
For the
three months ended December 31, 2008 and 2007, the Company recorded sales to
related parties as follows:
Name
of Related Party
|
|
Relationship
|
|
December
31, 2008
(Unaudited)
|
|
December
31 , 2007
(Unaudited)
|
|
|
|
|
|
|
|
|
|
Jiangbo
Chinese-Western Pharmacy
|
|
90%
owned by Chief Executive Officer
|
|
$
|
-
|
|
$
|
377,598
|
|
|
|
|
|
|
|
|
|
|
|
Laiyang
Jiangbo Medicals Co., Ltd.
|
|
60%
owned by Chief Executive Officer
|
|
|
-
|
|
|
349,311
|
|
|
|
|
|
|
|
|
|
|
|
Yantai
Jiangbo Pharmaceuticals Co., Ltd.
|
|
Owned
by Other Related Party
|
|
|
-
|
|
|
667,753
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
|
$
|
-
|
|
$
|
1,394,662
|
|
Other receivable - related
parties
For the
three months ended December 31, 2008 and 2007, the Company recorded other income
of $92,774 and $26,506
from leasing the two buildings to this related party. The Company leases two of
its buildings to Jiangbo Chinese-Western Pharmacy. For the six months ended
December 31, 2008 and 2007, the Company recorded other income of $236,724 and $52,998 from leasing
the two buildings to this related party. As of December 31, 2008 and June 30,
2008, amounts due from this related party was $237,160 and $0,
respectively.
The
Company leases two of its buildings to Jiangbo Chinese-Western Pharmacy. For the
six months ended December 31, 2008 and 2007, the Company recorded other income
of $236,724 and
$52,998 from leasing the two buildings to this related party. For the three
months ended December 31, 2008 and 2007, the Company recorded other income of
$92,774 and $26,506
from leasing the two buildings to this related party. As of December 31, 2008,
amount due from this related party was $277,355.
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:
|
|
December
31,
|
|
|
June 30,
|
|
|
|
2008
|
|
|
2008
|
|
|
|
(Unaudited)
|
|
|
|
|
Payable
to Cao Wubo, Chief Executive Officer and Chairman of the Board
|
|
$ |
279,158 |
|
|
$ |
164,137 |
|
|
|
|
|
|
|
|
|
|
Payable
to Haibo Xu, Chief Operating Officer and Director
|
|
|
99,635 |
|
|
|
- |
|
|
|
|
|
|
|
|
|
|
Payable
to Elsa Sung, Chief Financial Officer
|
|
|
13,000 |
|
|
|
- |
|
|
|
|
|
|
|
|
|
|
Total
other payable - related parties
|
|
$ |
391,793 |
|
|
$ |
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 six months ended December 31, 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 six months ended December 31, 2008, our senior
management has started interviewing and selecting outside internal control
consultants. In December 2008, we engaged a reputable independent accounting
firm as internal control consultants to provide advice and assistance on
improving our internal controls. The internal control consultants have began
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 six months ended
December 31, 2008, we have established an internal audit department and the
department has 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 December 31, 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 first half fiscal year 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 December 31, 2008.
The
following summarizes the Company’s pending and settled legal proceedings as of
December 31, 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. (See Note 14) As of December 31, 2008,
this matter has been settled.
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 was equal to the dollar value of 29,978,900 shares of the Company’s
common stock (Pre 40-to-1 reverse split) in November 2007, in which the claimant
alleged were 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 $13.8
million.
The
Company subsequently filed counter claims in reference to the aforementioned
allegations of breach of contract. In February 2009, the Company was notified by
the arbitration panel of American Arbitration Association (the “Panel”)
that the Panel awarded CRG and CRGP jointly, a net total of $ 980,070
(the “Award”) to be paid by the Company on or before February 27, 2009. Once the
Award is satisfied, CRG and CRGP would have no further claims against the
Company’s common stock or other property that were the subject of the
arbitration. The amount has been charged to operations for the six months ended
December 31, 2008, and is included in liabilities assumed from reorganization as
of December 31, 2008.
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 (“AAA”) 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 sought 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.
In
January 2009, the Company received a written notice from AAA that CW II had
withdrawn the arbitration without prejudice.
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 sought 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 merger.
In
Feburary 2009, the Company received a written notice from AAA that CW II had
withdrawn the arbitration without prejudice.
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 $14,167 and deferred compensation
of $5,833 for the six months ended December 31, 2008, accordingly. The shares
were issued to accredited investors, without any general solicitation and,
accordingly, were 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
former 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
$15,000 and deferred compensation of $7,500 for the six months ended December
31, 2008, accordingly. The shares were issued to accredited investors, without
any general solicitation and, accordingly, were exempt from Securities Act
registration pursuant to Section 4(2) thereof.
In
December 2008, the Company issued 20,000 shares of its common stock in
connection with the conversion of $160,000 of convertible debt relating to the
debt financing. As a result of the conversion, the Company recorded $145,524
interest expense to fully amortize the unamortized discount related to the
converted dentures.
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.
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Description
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31.1
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Rule
13a-14(a)/ 15d-14(a) Certification of Chief Executive
Officer
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31.2
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Rule
13a-14(a)/ 15d-14(a) Certification of Chief Financial
Officer
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32.1
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Section
1350 Certification of Chief Executive Officer and Chief Financial
Officer
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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.
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GENESIS
PHARMACEUTICALS
ENTERPRISES,
INC.
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By:
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/s/ Cao
Wubo |
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Cao
Wubo
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Chief
Executive Officer and President
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