UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
WASHINGTON,
D.C. 20549
FORM 10-Q
(Mark
One)
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x
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QUARTERLY
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
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For the quarterly period ended:
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March 31, 2008
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OR
o
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TRANSITION
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
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For
the transition period from _______________ to
______________
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Commission file number:
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000-26059
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CHINA
SKY ONE MEDICAL, INC.
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(Exact
Name of Registrant as Specified in its
Charter)
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Nevada
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87-0430322
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(State
or Other Jurisdiction of Incorporation or
Organization)
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(I.R.S.
Employer Identification No.)
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Room
1706, No. 30 Di Wang Building, Gan Shui Road,
Nandang
District, Harbin, People’s Republic of China
150001
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(Address
of Principal Executive Offices) (Zip
Code)
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86-451-53994073
(China)
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(Registrant’s
Telephone Number, Including Area Code)
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(Former
Name, Former Address and Former Fiscal Year, if Changed Since Last
Report)
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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 shell company (as defined in
Rule 12b-2 of the
Exchange
Act).
Yes o
No x
As
of
May 12, 2008, the issuer had 14,972,531
shares of Common Stock issued and outstanding.
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a small reporting
company:
Large
accelerated filer o
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Accelerated
filer x
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Non-accelerated
filer o
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Smaller
reporting company o
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QUARTERLY
REPORT ON FORM 10-Q
OF
CHINA SKY ONE MEDICAL, INC. AND SUBSIDIARIES
FOR
THE PERIOD ENDED MARCH 31, 2008
TABLE
OF CONTENTS
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PAGE
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PART I
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-
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1
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Item
1.
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1
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1
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2
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3
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4
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Item
2.
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18
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Item
3.
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25
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Item
4.
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26
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PART II
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27
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Item
1.
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27
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Item
1A.
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27
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Item
2.
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27
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Item
3.
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27
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Item
4.
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27
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Item
5.
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27
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Item
6.
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27
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28
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Exhibit
Index
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China
Sky One Medical, Inc. and Subsidiaries
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March
31, 2008
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December
31, 2007*
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(Unaudited)
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ASSETS
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Current
Assets
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Cash
and cash equivalents
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$
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38,237,994
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$
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9,190,870
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Accounts
receivable
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9,446,680
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10,867,106
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Other
receivables
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40,577
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40,200
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Inventories
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794,730
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371,672
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Prepaid
expenses
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12,895
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17,707
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Total
current assets
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48,532,876
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20,487,555
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Property
and equipment, net
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7,110,186
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6,861,432
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Land
deposit
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9,036,409
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8,003,205
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Intangible
assets, net
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2,285,104
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1,933,014
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$
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66,964,575
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$
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37,285,206
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LIABILITIES
AND STOCKHOLDERS' EQUITY
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Current
Liabilities
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Accounts
payable and accrued expenses
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$
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2,503,762
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2,845,308
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Wages
payable
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491,035
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381,482
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Welfare
payable
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222,518
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221,911
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Taxes
payable
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1,733,135
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1,567,188
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Deferred
revenues
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18,540
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24,504
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Total
current liabilities
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4,968,990
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5,040,393
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Stockholders'
Equity
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Preferred
stock ($0.001 par value, 5,000,000 shares authorized, none issued
and
outstanding)
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-
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-
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Common
stock ($0.001 par value, 20,000,000 shares authorized, 14,952,531
and
12,228,363 issued and outstanding, respectively)
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14,953
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12,228
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Additional
paid-in capital
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33,807,551
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9,572,608
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Accumulated
other comprehensive income
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3,920,036
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2,271,843
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Retained
earnings
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24,253,045
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20,388,134
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Total
stockholders' equity
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61,995,585
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32,244,813
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$
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66,964,575
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$
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37,285,206
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See
accompanying summary of accounting policies and notes to the condensed
consolidated financial statements.
* Derived
from December 31, 2007 audited financial
statements.
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Three
Months Ended March 31,
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2008
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2007
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(Unaudited)
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(Unaudited)
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Revenues
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$
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12,413,430
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$
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5,179,116
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Cost
of Goods Sold
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2,860,428
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1,126,695
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Gross
Profit
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9,553,002
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4,052,421
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Operating
Expenses
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Selling,
general and administrative
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3,956,795
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2,043,776
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Depreciation
and amortization
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76,348
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83,355
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Research
and development
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669,833
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15,210
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Total
operating expenses
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4,702,976
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2,142,341
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Other
Income (Expense)
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Other
income
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63,048
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-
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Interest
expense
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(1,147
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)
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(16,494
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)
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Total
other income (expense)
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61,901
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(16,494
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)
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Net
Income Before Provision for Income Tax
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4,911,927
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1,893,586
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Provision
for Income Taxes
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Current
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1,047,016
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344,265
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Net
Income
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$
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3,864,911
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$
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1,549,321
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Basic
Earnings Per Share
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$
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0.28
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$
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0.13
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Basic
Weighted Average Shares Outstanding
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13,732,269
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12,036,524
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Diluted
Earnings Per Share
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$
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0.26
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$
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0.12
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Diluted
Weighted Average Shares Outstanding
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14,888,310
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12,498,303
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The
Components of Other Comprehensive Income
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Net
Income
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$
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3,864,911
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$
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1,549,321
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Foreign
currency translation adjustment
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1,620,516
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258,766
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Comprehensive
Income
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$
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5,485,427
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$
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1,808,087
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See
accompanying summary of accounting policies and notes to the condensed
consolidated financial statements.
China
Sky One Medical, Inc. and Subsidiaries
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Three
Months Ended March 31,
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2008
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2007
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(Unaudited)
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(Unaudited)
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Cash
flows from operating activities
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Net
Income
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$
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3,864,911
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$
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1,549,321
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Adjustments
to reconcile net cash provided by operating
activities
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Depreciation
and amortization
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140,009
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87,579
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Share-based
compensation expense
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10,117
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10,117
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Net
change in assets and liabilities
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Accounts
receivables and other receivables
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1,859,639
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(1,369,449
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)
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Inventories
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(408,079
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)
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(509,889
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)
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Prepaid
expenses
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5,526
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14,564
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Accounts
payable and accrued liabilities
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(456,219
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)
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765,133
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Advances
by customers
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-
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(67,541
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)
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Wages
payable
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94,178
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38,920
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Welfare
payable
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(8,337
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)
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13,147
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Taxes
payable
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102,786
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29,775
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Deferred
revenue
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(6,952
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)
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-
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Net
cash provided by operating activities
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5,197,579
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561,677
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Cash
flows from investing activities
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Purchases
of fixed assets
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(42,782
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)
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(693,667
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)
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Land
deposit
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(710,656
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)
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-
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Purchase
of subsidiary-Heilongjiang Haina Pharmaceutical, Inc.
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(427,838 |
)
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- |
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Cash
of subsidiary upon acquisition
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82,715 |
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- |
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Purchase
of intangible assets
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(7,139
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)
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(66,239
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)
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Net
cash used in investing activities
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(1,105,700
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)
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(759,906
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)
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Cash
flows from financing activities
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Sale
of common stock for cash
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25,000,000
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-
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Board
and syndication costs
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(1,512,037
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)
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-
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Proceeds
from warrants conversion
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739,588
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-
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Proceeds
from short-term loan
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-
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5,124
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Net
cash provided by (used in) financing activities
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24,227,551
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5,124
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Effect
of exchange rate
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727,694
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316,552
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Net
increase in cash
|
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29,047,124
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123,447
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Cash
and cash equivalents at beginning of year
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9,190,870
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6,586,800
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Cash
and cash equivalents at end of period
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$
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38,237,994
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$
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6,710,247
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Supplemental
disclosure of cash flow information
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Interest
paid
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$
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1,157
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$
|
5,940
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Taxes
paid
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$
|
944,230
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$
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-
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Share-based
compensation expense
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$
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10,117
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$
|
10,117
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See
accompanying summary of accounting policies and notes to the condensed
consolidated financial statements.
China
Sky One Medical, Inc. and Subsidiaries
As
of March 31, 2008
1.
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Description
of Business
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The
accompanying unaudited consolidated financial statements of China Sky One
Medical, Inc., a Nevada corporation, and subsidiaries have been prepared in
accordance with generally accepted accounting principles ("GAAP") for interim
financial information and with the instructions to Form 10-Q and Article 10
of
Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by U.S. GAAP for complete financial statements. The financial
statements for the periods ended March 31, 2008 and 2007 are unaudited and
include all adjustments necessary to a fair statement of the results of
operations for the periods then ended. All such adjustments are of a normal
recurring nature. The results of the company's operations for any interim period
are not necessarily indicative of the results of the company's operations for
a
full fiscal year. For further information, refer to the financial statements
and
footnotes thereto included in the company's annual report on Form 10-K for
the
year ended December 31, 2007 as filed with the Securities and Exchange
Commission ("SEC") on March 31, 2008.
China
Sky
One Medical, Inc. ("China Sky One" or the “Company”), a Nevada corporation, was
formed on February 7, 1986, and formerly known as Comet Technologies, Inc.
(“Comet”). On July 26, 2006, the change in the name of the reporting
company from "Comet Technologies, Inc." to "China Sky One Medical, Inc.," became
effective.
American
California Pharmaceutical Group, Inc. (“ACPG”),
our non
operating United States holding company subsidiary, was incorporated on December
16, 2003, in the State of California, under the name “QQ Group, Inc.” It changed
its name to “American California Pharmaceutical Group, Inc.” in anticipation of
the Stock Exchange Agreement with China Sky One (then known as “Comet
Technologies, Inc.”) and TDR, described herein. On December 8, 2005, ACPG
completed a stock exchange transaction with TDR a PRC based operating company
and TDR’s subsidiaries (the “TDR Acquisition”), each of which were fully
operating companies in the PRC. Under the terms of the agreement, ACPG exchanged
100% of its issued and outstanding common stock for 100% of the capital stock
of
TDR and its subsidiaries, described below.
Thereafter,
on May 11, 2006, ACPG entered into a Stock Exchange Agreement (the “Exchange
Agreement”) with the shareholders of China Sky One. The terms of the Exchange
Agreement were consummated and the acquisition was completed on May 30, 2006.
As
a result of the transaction, the Company issued a total of 10,193,377 shares
of
its common voting stock to the stockholders of ACPG, in exchange for 100% of
the
capital stock of ACPG resulting in ACPG becoming our wholly-owned subsidiary.
The
transaction is treated as a reverse merger for accounting purposes.
TDR,
formerly known as “Harbin City Tian Di Ren Medical Co.,” was originally formed
in 1994 and maintained its principal executive office in Harbin City of
Heilongjiang Province, in the PRC. TDR was reorganized and incorporated as
a
limited liability company on December 29, 2000, under the “Corporation Laws and
Regulations” of the PRC. At the time of the TDR Acquisition by ACPG in December
of 2005, TDR had two wholly-owned subsidiaries, Harbin First Bio-Engineering
Company Limited and Kangxi Medical Care Product Factory, until July, 2006,
when
the two were merged, with Harbin First Bio-Engineering Company Limited (“First”)
as the surviving subsidiary of TDR. The
principal activities of TDR and First are the research, manufacture and sale
of
over-the-counter non-prescription health care products. TDR commenced its
business in the sale of branded nutritional supplements and over-the-counter
pharmaceutical products in the Heilongjiang Province. TDR has subsequently
evolved into an integrated manufacturer, marketer, and distributor of external
use natural Chinese medicine products sold primarily to and through China’s
various domestic pharmaceutical chain stores.
China
Sky
One is a holding company whose principal operations are through its
subsidiaries; it has no revenues separate from its subsidiaries, and has nominal
expenses related to its status as a public reporting company and to its
ownership interest in ACPG, TDR and TDR’s subsidiaries in the PRC.
On
April
3, 2008, TDR completed an acquisition pursuant to an Equity Transfer Agreement
dated February 22, 2008, between TDR and Heilongjiang Tianlong Pharmaceutical,
Inc., a corporation with a multitude of SFDA approved medicines and new medicine
applications, organized under the laws of the PRC (“Heilongjiang”), which is in
the business of manufacturing external-use pharmaceuticals. Our TDR subsidiary
previously acquired the Beijing sales office of Heilongjiang in mid 2006.
Pursuant to the Equity Transfer Agreement, TDR acquired 100% of the issued
and
outstanding capital stock of Heilongjiang from Heilongjiang’s sole stockholder
Wu
Jiechen, a resident of China, in consideration for an aggregate purchase price
of approximately $8,300,000, consisting of (i) approximately $8,000,000 in
cash,
and (ii) approximately $300,000 of shares of common stock (24,809 shares, $.001
par value per share) of the Registrant.
On
April
18, 2008, China Sky One through its subsidiary Harbin TDR consummated a share
acquisition pursuant to an Equity Transfer Agreement with the shareholders
of
Heilongjiang Haina Pharmaceutical Inc., a recently formed corporation organized
under the laws of the PRC (“Haina”) licensed as a wholesaler of TCD,
bio-medicines, bio-products, medicinal devices, antibiotics and chemical
medicines. Haina Pharmaceutical does not have an established sales network
and
was acquired for its primary asset, a Good Supply Practice (GSP) license
(License No. A-HLJ03-010) issued by the Heilongjian office of the SFDA. The
SFDA
recently started issuing such licenses to resellers of medicines that maintain
certain quality controls. The GSP license was issued as of December 21, 2006
and
will expire on January 29, 2012 and will enable the Company to expand its sales
of medicinal products without having to go through a lengthy license application
process.
Pursuant
to the Equity Transfer Agreement, TDR acquired 100% of the issued and
outstanding capital stock of Haina from its three stockholders in consideration
for payment of 3,000,000 RMB (approximately $428,571). TDR has been overseeing
the operations of Haina Pharmaceutical since January of 2008 as part of its
due
diligence prior to closing of this acquisition.
2. |
Basis
of Preparation of Financial
Statements
|
The
accompanying financial statements differ from the financial statements used
for
statutory purposes in PRC in that they reflect certain adjustments, recorded
on
the entities’ books, which are appropriate to present the financial position,
results of operations and cash flows in accordance with US GAAP. Such
differences are immaterial.
Principles
of Consolidation – The consolidated financial statements include the accounts of
the Company and its subsidiaries, ACPG, TDR, First, and Haina. All inter-company
transactions and balances were eliminated.
These
financial statements are stated in U.S. Dollars and have been prepared in
accordance with accounting principles generally accepted in the United States
of
America. This basis of accounting differs from that used under applicable
accounting requirements in the PRC. No material adjustment was required.
Certain amounts in prior years have been reclassified to
conform
to current year's classification.
3. |
Summary
of Significant Accounting
Policies
|
Use
of estimates –
The
preparation of these financial statements in conformity with accounting
principles generally accepted in the United States of America, requires
management to make estimates and assumptions that affect the reported amounts
of
assets and liabilities, disclosure of contingent assets and liabilities at
the
dates of the financial statements, and the reported amounts of revenues and
expenses during the reported periods.
Significant
estimates included values and lives assigned to acquired intangible assets,
reserves for customer returns and allowances, uncollectible accounts receivable,
valuation of equity issuances such as shares of the Company’s common stock and
stock options to purchase shares of the Company’s common stock, and slow moving
and/or obsolete/damaged inventory. Actual results may differ from these
estimates.
Earnings
per share - Basic
net
earnings per common share is computed by dividing net earnings applicable to
common shareholders by the weighted-average number of common shares outstanding
during the period. Diluted net earnings per common share is determined using
the
weighted-average number of common shares outstanding during the period, adjusted
for the dilutive effect of common stock equivalents, consisting of shares that
might be issued upon exercise of common stock options and warrants.
Cash
and cash equivalents – The Company
considers all highly liquid debt instruments purchased with maturity period
of
three months or less to be cash equivalents. The carrying amounts reported
in
the accompanying consolidated balance sheet for cash and cash equivalents
approximate their fair value.
Accounts
receivable – Accounts
receivable are stated at net realizable value, net of an allowance for doubtful
accounts. Provision of allowance is made for estimated bad debts based on a
periodic analysis of individual customer balances including an evaluation of
days of sales outstanding, payment history, recent payment trends, and perceived
credit worthiness. At March 31, 2008 and December 31, 2007, the Company had
no
allowance for doubtful accounts.
Inventories
–
Inventories include finished goods, raw materials, freight-in, packing
materials, labor, and overhead costs accounted for using the weighted average
method. Provisions are made for slow moving, obsolete and/or damaged inventory
based on a periodic analysis of individual inventory items including an
evaluation of historical usage and/or movement, age, expiration date, and
general conditions. There was no provision provided at March 31,
2008.
Property
and equipment –
Property and equipment are stated at the historical cost less accumulated
depreciation. Depreciation on property, plant, and equipment is provided using
the straight-line method over the estimated useful lives of the assets. An
estimated residual value of 5% of cost, or valuation, was made for each items
for both financial and income tax reporting purposes. The estimated lengths
of
useful lives are as follows:
Buildings
|
|
30
years
|
Land
use rights
|
|
50
years
|
Furniture
& Equipments
|
|
5
to 7 years
|
Motor
vehicles
|
|
5
to 15 years
|
Machineries
|
|
7
to 14 years
|
Expenditures
for renewals and betterments were capitalized while repairs and maintenance
costs were normally charged to the statement of operations in the year in which
they were incurred. In situations where it can be clearly demonstrated that
the
expenditure has resulted in an increase in the future economic benefits expected
to obtain from the use of the asset, the expenditure is capitalized as an
additional cost of the asset. Upon sale or disposal of an asset, the historical
cost and related accumulated depreciation or amortization of such asset were
removed from their respective accounts, and any gain or loss was recorded in
the
Consolidated Statements of Operations.
Property
and equipment are evaluated for impairment in value annually or whenever an
event or change in circumstances indicates that the carrying values may not
be
recoverable. If such an event or change in circumstances occurs and potential
impairment is indicated because the carrying values exceed the estimated future
undiscounted cash flows of the asset, the Company would measure the impairment
loss as the amount by which the carrying value of the asset exceeds its fair
vale.
Construction-in-progress
–
Properties currently under development are accounted for as
construction-in-progress. Construction-in-progress is recorded at acquisition
cost, including land rights cost, development expenditure, professional fees,
and the interest expenses for the purpose of financing the project capitalized
during the course of construction.
Upon
completion and readiness for use of the project, the cost of
construction-in-progress is to be transferred to the facility. In the case
of
construction-in-progress, management takes into consideration the estimated
cost
to complete the project when making the lower of cost or market
calculation.
Intangible
assets – Intangible
assets consists of patents, distribution rights and customer lists. Patent
costs
are being amortized over a total life of ten years. Distribution rights and
customer lists are being amortized over 10 years.
Intangible
assets are accounted for in accordance with Statement of Financial Accounting
Standards No. 142, Goodwill
and Other Intangible Assets
(“SFAS
142”). Intangible assets with finite useful lives are amortized while
intangible assets with indefinite useful lives are not amortized. As prescribed
by SFAS 142, goodwill and intangible assets are tested periodically for
impairment. The Company adopted SFAS No. 144, "Accounting for the Impairment
or
Disposal of Long- Lived Assets," effective January 1, 2002. Accordingly, the
Company reviews its long-lived assets, including property and equipment and
finite-lived intangible assets for impairment whenever events or changes in
circumstances indicate that the carrying amount of the assets may not be fully
recoverable. To determine recoverability of its long-lived assets, the Company
evaluates the probability that future undiscounted net cash flows will be less
than the carrying amount of the assets. Impairment costs, if any, are measured
by comparing the carrying amount of the related assets to their fair value.
There were no impairments as of March 31, 2008.
Foreign
Currency -
The
Company’s principal country of operations is in The People’s Republic of China.
The financial position and results of operations of the Company are recorded
in
RMB as the functional currency. The results of operations denominated in foreign
currency are translated at the average rate of exchange during the reporting
period.
Assets
and liabilities denominated in foreign currencies at the balance sheet date
are
translated at the market rate of exchange ruling at that date. The registered
equity capital denominated in the functional currency is translated at the
historical rate of exchange at the time of capital contribution. All translation
adjustments resulting from the translation of the financial statements into
the
reporting currency (“US Dollars”) are dealt with as a separate component within
shareholders’ equity.
Revenue
recognition–
Revenue
is recognized in accordance with Staff Accounting Bulletin No. 104, Revenue
Recognition, which states that revenue should be recognized when the following
criteria are met: (1) persuasive evidence of an arrangement exists;
(2) the product has been shipped and the customer takes ownership and
assumes the risk of loss; (3) the selling price is fixed or determinable;
and (4) collection of the resulting receivable is reasonably assured. The
Company believes that these criteria are satisfied upon shipment from its
facilities. Revenue is reduced by provisions for estimated returns and
allowances as well as specific known claims, if any, which are based on
historical averages that have not varied significantly for the periods
presented.
The
Company occasionally applies to various government agencies for research grants.
Revenue from such research grants is recognized when earned. In situations
where
TDR receives payment in advance for the performance of research and development
services, such amounts are deferred and recognized as revenue as the related
services are performed.
Interest
income is recognized when earned, taking into account the average principal
amounts outstanding and the interest rates applicable.
Deferred
revenues - The
Company recognizes revenues as earned. Amounts billed in advance of the period
in which goods are delivered are recorded as a liability under “Deferred
revenue.” As of March 31, 2008 the Company has $18,540 in deferred
revenue.
Shipping
and Handling costs - Shipping
and handling costs are included in selling, general and administrative expenses
and totaled $103,616 for the three months ended March 31, 2008.
Research
and development—Research
and development expenses include the costs associated with the Company’s
internal research and development as well as research and development conducted
by third parties. These costs primarily consist of salaries, clinical trials,
outside consultants, and materials. All research and development costs discussed
above are expensed as incurred.
Third-party
expenses were reimbursed under non-refundable research and development
contracts, and are recorded as a reduction to research and development expense
in the statement of operations.7
The
Company recognizes in-process research and development in accordance with FASB
Interpretation No. 4, Applicability
of FASB Statement No. 2 to Business Combinations Accounted for by the Purchase
Method and
the AICPA
Technical Practice Aid, Assets Acquired in a Business Combination to be used
in
Research and Development Activities: A Focus on Software, Electronic
Devices, and Pharmaceutical Industries. Assets to be used in research and
development activities, specifically, compounds that have yet to receive new
drug approval and would have no alternative use, should approval not be given,
are immediately charged to expense when acquired.
For
the
three months ended March 31, 2008, the Company incurred $ 669,833
in
research and development expenditures, and $15,210 for the three months ended
March 31, 2007.
Advertising—The
Company expensed advertising and promotion expenses as they are incurred.
The total advertising expenses incurred for the three months ended March
31, 2008 and 2007 was $369,995 and $478,776, respectively.
Taxation
–
The
Company uses the asset and liability method of accounting for deferred income
taxes. The Company’s provision for income taxes includes income taxes
currently payable and those deferred because of temporary differences between
the financial statement and tax bases of assets and liabilities. The
Company records liabilities for income tax contingencies based on our best
estimate of the underlying exposures.
The
Company periodically estimates its probable tax obligations using historical
experience in tax jurisdictions and informed judgments. There are inherent
uncertainties related to the interpretation of tax regulations in the
jurisdictions in which the Company transacts business. The judgments and
estimates made at a point in time may change based on the outcome of tax audits,
as well as changes to, or further interpretations of, regulations. The
Company adjusts income tax expense in the period in which these events occur.
Provision
for the PRC’s enterprise income tax is calculated at the prevailing rate based
on the estimated assessable profits less available tax relief for losses brought
forward.
Provision
for the PRC enterprise income tax is calculated at the prevailing rate based
on
the estimated assessable profits less available tax relief for losses brought
forward.
The
Company does not accrue taxes on unremitted earnings from foreign operations
as
it is the Company’s intention to invest these earnings in the foreign operations
indefinitely.
Enterprise
income tax
Under
the
Provisional Regulations of The People’s Republic of China Concerning Income Tax
on Enterprises promulgated by the PRC, income tax is payable by enterprises
at a
rate of 25% of their taxable income. Preferential tax treatment may, however,
be
granted pursuant to any law or regulations from time to time promulgated by
the
State Council.
According
to “Enterprise Income Tax and Certain Preferential Policies Notice” published by
the Ministry of Finance and the National Tax Affairs Bureau, if the enterprise
is authorized by the State Council as a special entity, the enterprise income
tax rate is reduced to 15%. The income tax rate for TDR is 15% based on State
Council approval.
Value
added tax
The
Provisional Regulations of The People’s Republic of China Concerning Value Added
Tax promulgated by the State Council came into effect on January 1, 1994. Under
these regulations and the Implementing Rules of the Provisional Regulations
of
the PRC Concerning Value Added Tax, value added tax is imposed on goods sold
in,
or imported into, the PRC and on processing, repair and replacement services
provided within the PRC.
Value
added tax payable in the PRC is charged on an aggregated basis at a rate of
13%
or 17% (depending on the type of goods involved) on the full price collected
for
the goods sold or, in the case of taxable services provided, at a rate of 17%
on
the charges for the taxable services provided, but excluding, in respect of
both
goods and services, any amount paid in respect of value added tax included
in
the price or charges, and less any deductible value added tax already paid
by
the taxpayer on purchases of goods and services in the same financial
year.
According
to “Agriculture Product Value Added Tax Rate Adjustment and Certain Items’ Value
Added Tax Waiver” published by the Ministry of Finance and the National Tax
Affairs Bureau, the value added tax for agriculture related products is to
be
taxed at 13%. Furthermore, traditional Chinese medicine and medicinal plant
are
by definition agriculture related products.
Comprehensive
Income – Comprehensive
income consists of net income and other gains and losses affecting shareholders’
equity that, under generally accepted accounting principles are excluded from
net income. For the Company, such items consist entirely of foreign currency
translation gains and losses
Related
companies –
A
related company is a company in which the director has beneficial interests
in
and in which the Company has significant influence.
Retirement
benefit costs –
According to the PRC regulations on pension plans, the Company contributes
to a
defined contribution retirement plan organized by municipal government in the
province in which the Company was registered and all qualified employees are
eligible to participate in the plan.
Contributions
to the pension or retirement plan are calculated at 23.5% of the employees’
salaries above a fixed threshold amount. The employees contribute between
2% to 8% to the pension plan, and the Company contributes the balance
contribution of from 21.5% to 15.5%. The Company has no other material
obligation for the payment of retirement benefits beyond the annual
contributions under this plan.
Fair
value of financial instruments – The
carrying amounts of certain financial instruments, including cash, accounts
receivable, commercial notes receivable, other receivables, accounts payable,
commercial notes payable, accrued expenses, and other payables approximate
their
fair values as at March 31, 2008 because of the relatively short-term
maturity of these instruments.
Recent
accounting pronouncements:
|
-
|
In
February 2007, the FASB issued Statement No. 159 “The Fair Value Option
for Financial Assets and Financial Liabilities” (SFAS 159). This statement
permits companies to choose to measure many financial assets and
liabilities at fair value. Unrealized gains and losses on items for
which
the fair value option has been elected are reported in earnings.
SFAS 159
is effective for fiscal years beginning after November 15, 2007.
The
Company is currently assessing the impact of SFAS 159 on its consolidated
financial statements.
|
|
-
|
In
December 2007, the FASB issued SFAS No. 141 (revised 2007), “Business
Combinations” (“SFAS 141(R)”). SFAS 141(R) will change the accounting for
business combinations. Under SFAS No. 141(R), an acquiring entity
will be required to recognize all the assets acquired and liabilities
assumed in a transaction at the acquisition-date fair value with
limited
exceptions. SFAS No. 141(R) will change the accounting treatment and
disclosure for certain specific items in a business combination.
SFAS
No. 141(R) applies prospectively to business combinations for which
the acquisition date is on or after the beginning of the first annual
reporting period beginning on or after December 15, 2008. SFAS 141(R)
will impact the Company in the event of any future
acquisition.
|
|
- |
In
December 2007, the FASB issued SFAS No. 160, “Non-controlling Interests in
Consolidated Financial Statements—an amendment of Accounting Research
Bulletin No. 51” (“SFAS 160”). SFAS 160 establishes new accounting and
reporting standards for the non-controlling interest in a subsidiary
and
for the deconsolidation of a subsidiary. SFAS No. 160 is effective
for fiscal years beginning on or after December 15, 2008. The Company
does not believe that SFAS 160 will have a material impact on
its
consolidated financial
statements.
|
|
-
|
In
March 2008, the FASB issued Statement No. 161,
Disclosures about Derivative Instruments and Hedging
Activities
("SFAS 161"). This Statement will require enhanced disclosures
about
derivative instruments and hedging activities to enable investors
to
better understand their effects on an entity's financial position,
financial performance, and cash flows. It is effective for financial
statements issued for fiscal years and interim periods beginning
after
November 15, 2008, with early application encouraged. We are
assessing the impact of the adoption of this
Statement.
|
4. |
Concentrations
of Business and Credit
risk
|
The
Company maintains certain bank accounts in the PRC which are not protected
by
FDIC insurance or other insurance. As of March 31, 2008 the Company held
$2,601,706 of cash balances within the United States of which $2,301,706 was
in
excess of FDIC insurance limits. At March 31, 2008, the Company had
approximately $35,636,288, in China bank deposits, which may not be insured.
The
Company has not experienced any losses in such accounts through March 31, 2008
and December 31, 2007.
Geographic
Concentration; Fluctuations in Regional Economic Conditions. Nearly all of
the
Company’s sales are concentrated in China. Accordingly, the Company is
susceptible to fluctuations in its business caused by adverse economic
conditions in this country. Difficult economic conditions in other geographic
areas into which the Company may expand may also adversely affect its business,
operations and finances.
The
Company provides credit in the normal course of business. Substantially all
customers are located in The People's Republic of China. The Company performs
ongoing credit evaluations of its customers and maintains allowances for
doubtful accounts based on factors surrounding the credit risk of specific
customers, historical trends, and other information.
Substantially
all of the Company's fixed assets and operations are located in the Peoples
Republic of China.
The
Company is self-insured for all risks and carries no liability or property
insurance coverage of any kind.
Substantially
all of the Company's profits are generated from operations in mainland China.
Major
Customers
As
of
March 31, 2008 Xinteyao Ltd. accounted for approximately 14 % of the Company’s
sales. During the years ended December 31, 2007, Ningbo Yuehua Trading Co.
accounted for approximately 14 % of the Company’s sales. Beijing
Huali Jiuzhou Medical Ltd. accounted for 11% of all accounts receivable
as of March 31, 2008.
Major
Suppliers
Purchases
from Heilongjiang Kangda Medicine Co. accounted for approximately 45% of the
Company’s purchases for the three months ended March 31, 2008. There
were no major single suppliers for materials during the three months ended
March
31, 2007.
Payments
of dividends may be subject to some restrictions due to the Company’s operating
subsidiaries all being located in the PRC.
We
have
applied SFAS No. 128, “Earnings Per Share” in its calculation and presentation
of earnings per share - “basic” and “diluted”. Basic earnings per share are
computed by dividing income available to common shareholders (the numerator)
by
the weighted average number of common shares (the denominator) for the period.
The computation of diluted earnings per share is similar to basic earnings
per
share, except that the denominator is increased to include the number of
additional common shares that would have been outstanding if the potentially
dilutive common shares had been issued.
Stock
warrants and options to purchase 1,452,665 shares of common stock, all were
exercisable during the three months ended March 31, 2008, and Stock
warrants and options to purchase 1,868,510 shares of common stock, all were
exercisable during the three months ended March 31, 2007, were included in
the
computation of diluted earnings per share because the average market price
of
our common stock were less than the option exercise prices during these periods.
The
dilutive potential common shares on warrants and options is calculated in
accordance with the treasury stock method, which assumes that proceeds from
the
exercise of all warrants and options are used to repurchase common stock at
market value. The amount of shares remaining after the proceeds are exhausted
represent s the potential dilutive effect of the securities.
The
following table sets forth our computation of basic and diluted net income
(loss) per share:
|
|
Three
Months ended March 31,
|
|
|
|
2008
|
|
2007
|
|
Numerator:
|
|
|
|
|
|
|
|
Net
income (loss) used in calculation of basic earnings (loss) per
share
|
|
$
|
3,864,911
|
|
$
|
1,549,321
|
|
|
|
|
|
|
|
|
|
Net
income (loss) used in calculation of diluted earnings (loss)
per
share
|
|
$
|
3,864,911
|
|
$
|
1,549,321
|
|
|
|
|
|
|
|
|
|
Denominator:
|
|
|
|
|
|
|
|
Weighted-average
common shares outstanding used in calculation of basic earnings
(loss) per
share
|
|
|
13,732,269
|
|
|
12,036,524
|
|
Effect
of dilutive securities:
|
|
|
|
|
|
|
|
Stock
options and equivalents
|
|
|
1,156,041
|
|
|
461,779
|
|
Weighted-average
common shares used in calculation of diluted earnings (loss)
per
share
|
|
|
14,888,310
|
|
|
12,498,303
|
|
|
|
|
|
|
|
|
|
Net
income (loss) per share:
|
|
|
|
|
|
|
|
Basic
|
|
$
|
0.28
|
|
$
|
0.13
|
|
Diluted
|
|
$
|
0.26
|
|
$
|
0.12
|
|
6. |
Equity
and Share-based Compensation
|
Effective
January 1, 2006, we adopted the fair value recognition provisions of SFAS
No. 123R, Share-Based Payment (“SFAS No. 123R”), for options granted
to employees and directors, using the modified prospective transition method,
and therefore have not restated results from prior periods. Compensation cost
for all stock-based compensation awards granted after March 31, 2005 is based
on
the grant date fair value estimated in accordance with the provisions of SFAS
No. 123R. Under the fair value recognition provisions of SFAS
No. 123R, we recognize stock-based compensation net of an estimated
forfeiture rate and only recognize compensation cost for those shares expected
to vest on a straight-line prorated basis over the requisite service period
of
the award. In March 2005, the SEC issued Staff Accounting Bulletin (“SAB”)
No. 107, Share-Based Payment (“SAB No. 107”), regarding the SEC’s
guidance on SFAS No. 123R and the valuation of share-based payments for
public companies. We have applied the provisions of SAB No. 107 in the
adoption of SFAS No. 123R. Under SFAS 123R, the company remeasures the
intrinsic value of the options at the end of each reporting period until the
options are exercised, cancelled or expire unexercised.
In
July
2006, the Company’s stockholders approved the 2006 Stock Incentive Plan (the
“2006 Plan”). The 2006 Plan, provides for the grant of stock options, restricted
stock awards, and performance shares to qualified employees, officers,
directors, consultants and other service providers. The 2006 Plan originally
authorized the Company to grant options and/or rights to purchase up to an
aggregate of 1,500,000 shares of common stock. As of March 31, 2008,
non-qualified options to purchase a total of 113,500 shares have been granted
under the 2006 Stock Incentive Plan. All options were granted in October 2006.
All options have an exercise price of $3.65 per share, the weighted fair market
value on the date of grant was $4.25 per share. Of these 113,500 options a
total
of 60,500 were granted to employees and a total of 53,000 were granted to
consultants. These options were valued under the following Black-Scholes
assumptions: no dividends; risk-free interest rate of 4%; a contractual life
of
5 years and volatility of 39%. An additional 50,000 shares registered under
the
2006 Plan were issued outright to employees of the company. All 113,500 options
vest over various periods for the various options granted to employees and
consultants. There were no options granted in the three months ended March
31,
2008. As of March 31, 2008, these options have a remaining life of approximately
4 years, and remain outstanding and continue to be remeasured at the intrinsic
value over their remaining vesting period ranging from 6 months to 2 years.
Compensation expense in any given period is calculated as the difference between
total earned compensation at the end of the period, less total earned
compensation at the beginning of the period. Compensation earned is calculated
on a straight line basis over the requisite service period for any give option
award. The effect of adoption of the new standard for the three months ended
March 31, 2008 and 2007 related to stock options to employees were additional
non-cash expenses of $10,117 and $10,117, respectively.
Options
or stock awards issued to non-employees and consultants are recorded at their
fair value as determined in accordance with SFAS No. 123R and EITF
No. 96-18, “Accounting for Equity Instruments That Are Issued to Other Than
Employees for Acquiring, or in Conjunction with Selling, Goods or Services”, and
recognized over the related vesting or service period. In connection with
closing of the Stock Exchange Agreement, the Company agreed to grant warrants
to
advisors for the services they already performed for the reverse merger in
July
2006, entitling them to purchase up to 500,000 shares on or before July 31,
2009, at a price of US$2.00 per share and options to purchase up to 50,000
shares on or before December 20, 2008 at a price of US$3.00 per share. The
fair value of these warrants and options were determined to be $772,275 and
deducted as expenses using the Black-Scholes option-pricing model with the
following weighted assumptions: no dividends; risk-free interest rate of
4%; the contractual life of 2.5-3.5 years and volatility of 39%. The Company
based its estimate of expected volatility on the historical, expected or implied
volatility of similar entities whose share or option prices are publicly
available.
One
January 3, 2007, the holder of 50,000 warrants dated March 11, 1999, granted
prior to the May 30, 2006 company reorganization, stock exchange exercised
the
warrants by electing to use cashless conversion provision of the warrants and
acquired 5,160 shares of the Company common stock (after giving effect to the
8-to 1 reverse stock split effected after the warrant was issued). These
warrants are not included in the schedule below.
At
various times during the three months ended March 31, 2008 warrant holder
exercised their warrants, at various exercise prices, for total proceeds of
$739,588.
7. |
Securities
Purchase Agreement and Related
Transaction
|
On
January 31, 2008 China Sky One entered into a Securities Purchase Agreement
(the
“Securities Purchase Agreement”) with certain accredited investors, for the
purchase and sale of units consisting of: (i) one (1) share of the Company’s
common stock, $.001 par value per share (“Common stock”); and (ii) 750,000 Class
A Warrants exercisable at $12.50 per share, and expiring on July 31, 2011 (the
“Class A Warrants”), for a purchase price of $10.00 per Unit (the “January 2008
Offering”), and gross offering proceeds of $25,000,000.
Holders
of the 2,500,000 shares of common stock sold in our January 2008 Offering have
certain put rights and rights to receive additional shares from the Company
if
we sell low priced securities or from certain key shareholders in the event
that
certain thresholds are not met, in addition to registration rights.
Specifically, these investors have:
|
·
|
The
right to receive additional shares of common stock from China Sky
One in
the event that we sell shares (or convertible securities or warrants
convertible into or exercisable for common stock) prior to January
31,
2009 at per share price (or exercise or conversion price) of less
than
$10.00, in such amount so as to reduce the average price paid by
such
shareholder to the price per share being paid by the new investors,
|
|
·
|
The
right to receive up to 3,000,000 shares deposited into escrow by
our
principal shareholder, in the event that the Company fails to attain
Earnings Per Share, as adjusted of at least (i) $1.05 per share for
fiscal
year ended December 31, 2007 based on fully diluted shares outstanding
before the January 2008 offering (an aggregate of 13,907,696), and/or
(ii)
$1.75 per share for fiscal year ending December 31, 2008 based on
fully
diluted shares outstanding after the January 2008 Offering (an aggregate
of 16,907,696 shares). While the Company has satisfied the criterion
of
(i) above for 2007, no assurance can be made that we will satisfy
our
earnings goal next year.
|
The
Class
A Warrants represent the right to purchase an aggregate of 750,000 shares of
common stock, at an exercise price of $12.50 per share. Additional information
relating to these Class A Warrants is provided in the following “Note 8”
to this Quarterly
Report on Form 10-Q.
8. |
Detail
of the outstanding warrants and
options
|
|
|
Shares
Underlying
Warrants
|
|
Weighted
average
Exercise
Price
Warrants
|
|
Shares
underlying
Options
|
|
Weighted
average
Exercise
Price
Options
|
|
Outstanding
as of January 1, 2006
|
|
|
25,000
|
|
$
|
1.50
|
|
|
-
|
|
|
|
|
Granted
|
|
|
1,650,000
|
|
|
2.58
|
|
|
163,500
|
|
$
|
3.45
|
|
Exercised
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
|
Expired
or cancelled
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
|
Outstanding
as of December 31, 2006
|
|
|
1,675,000
|
|
|
2.57
|
|
|
163,500
|
|
$
|
3.45
|
|
Granted
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
|
Exercised
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
|
Expired
or cancelled
|
|
|
(161,667
|
)
|
|
3.19
|
|
|
-
|
|
|
-
|
|
Outstanding
as of December 31, 2007
|
|
|
1,513,333
|
|
$
|
2.48
|
|
|
163,500
|
|
$
|
3.45
|
|
Granted
|
|
|
750,000
|
|
|
12.50
|
|
|
-
|
|
|
-
|
|
Exercised
|
|
|
(224,168
|
)
|
|
3.30
|
|
|
-
|
|
|
-
|
|
Expired
or cancelled
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
|
Outstanding
as of March 31, 2008
|
|
|
2,039,165
|
|
$
|
6.08
|
|
|
163,500
|
|
$
|
3.45
|
|
The
following table summarizes information about stock warrants outstanding and
exercisable as of March 31, 2008.
Exercise
Price
|
|
Outstanding
March
31,
2008
|
|
Weighted
Average
Remaining
Life
in
Years
|
|
Number
exercisable
|
|
$
|
2.00
|
|
1,000,000
|
|
1.33
|
|
1,000,000
|
|
$
|
3.00
|
|
10,000
|
|
.53
|
|
10,000
|
|
$
|
3.50
|
|
279,165
|
|
.53
|
|
279,165
|
|
$
|
12.50
|
|
750,000
|
|
3.0
|
|
-
|
|
|
|
2,039,165
|
|
|
|
1,289,165
|
|
Out
of
the 2,039,165 outstanding warrants, 1,289,165 shares were exercisable as of
March 31, 2008. The remaining Class A Warrants represent the right to purchase
an aggregate of 750,000 shares of Common Stock of the Company granted with
the
Securities Purchase Agreement, at an exercise price of $12.50 per share, and
have the following additional characteristics:
The
Class
A Warrants issued in our January 2008 Offering described in Note 7 above,
represent the right to purchase an aggregate of 750,000 shares of common stock,
at an exercise price of $12.50 per share, and have the following additional
characteristics:
|
·
|
The
Class A Warrants are exercisable beginning on the six-month anniversary
of
the closing of the January 2008 Offering and will expire July 31,
2011.
|
|
·
|
Commencing
on one-year anniversary of the Closing Date, in the event the Warrant
Shares may not be freely sold by the holders of the Class A Warrants
due
to the Company’s failure to satisfy its registration requirements, and an
exemption for such sale is not otherwise available to the Warrant-holders
under Rule 144, the Class A Warrants will be exercisable on a cashless
basis.
|
|
·
|
The
Exercise Price and number of Warrant Shares will be subject to adjustment
for standard dilutive events, including the issuance of Common stock,
or
securities convertible into or exercisable for shares of Common stock,
at
a price per share, or conversion or exercise price per share less
than the
Class A Warrant exercise price of $12.50 per
share.
|
|
·
|
At
anytime following the date a Registration Statement covering the
Warrant
Shares is declared effective, we will have the ability to call the
Class A
Warrants at a price of $0.01 per Class A Warrant, upon thirty (30)
days
prior written notice to the holders of the Class A Warrants, provided
(i)
the closing price of the Common stock exceeded $18.75 for each of
the ten
(10) consecutive trading days immediately preceding the date that
the call
notice is given by the Company, and (ii) the Company has attained
an
Adjusted EPS of at least $1.75 per share for the fiscal year ending
December 31, 2008, as set forth in our audited financial statements
of the
Company.
|
|
·
|
If,
among other things, we fail to cause a Registration Statement covering
the
Warrant Shares to be declared effective prior to the applicable dates
set
forth in the Registration Rights Agreement, the expiration date of
the
Class A Warrants shall be extended one day for each day beyond the
Effectiveness Deadlines.
|
|
·
|
If
a Warrant-holder exercises its Put Right under the Put Agreement
(defined
in Item 1.01 above), such Warrant-holder’s right to exercise the Class A
Warrants shall be suspended, pending the satisfaction of our obligations
to pay the Warrant-holder the applicable Repurchase Price. Upon receipt
of
the Repurchase Price in full by the Warrant-holder, the Warrant-holder’s
right to exercise the Class A Warrants shall automatically and permanently
terminate and expire, and the Class A Warrants shall be immediately
cancelled on the books of the
Company.
|
The
following table summarizes information about stock options outstanding as of
March 31, 2008.
Exercise
Price
|
|
Outstanding
March
31,
2008
|
|
Weighted
Average
Remaining
Life
in
Years
|
|
Exercisable
Options
|
|
Unvested
Options
|
|
$
|
3.00
|
|
50,000
|
|
.72
|
|
50,000
|
|
-
|
|
$
|
3.65
|
|
113,500
|
|
3.75
|
|
54,150
|
|
59,350
|
|
|
|
163,500
|
|
|
|
104,150
|
|
59,350
|
|
The
Company values its inventories at the lower of cost and market method.
Inventories are accounted for using the first-in, first-out method. Inventories
in the balance sheet include packing materials, raw materials, supplemental
materials, work-in-process, and finished products.
As
of
March 31, 2008 and December 31, 2007, inventories consist of the
following:
|
|
March
31, 2008
|
|
December
31,
2007
|
|
Raw
Material
|
|
$
|
249,730
|
|
$
|
252,318
|
|
Supplemental
Material
|
|
|
81,307
|
|
|
32,296
|
|
|
|
|
|
|
|
|
|
Work-in-Process
|
|
|
154,039
|
|
|
57,337
|
|
|
|
|
|
|
|
|
|
Finished
Products
|
|
|
309,654
|
|
|
29,721
|
|
Total
Inventory
|
|
$
|
794,730
|
|
$
|
371,672
|
|
10. |
Property
and Equipment
|
All
of
TDR and its subsidiaries’ buildings and fixed assets are located in the PRC and
the land is used pursuant to a land use right granted by the PRC for 50 years
commencing in 2004. As of March 31, 2008 and December 31, 2007, Property
and Equipment consist of the following:
|
|
March
31, 2008
|
|
December
31,
2007
|
|
Buildings
|
|
$
|
2,976,316
|
|
|
2,861,011
|
|
Machinery
and equipment
|
|
|
1,633,220
|
|
|
1,568,958
|
|
Land
use rights
|
|
|
583,162
|
|
|
563,469
|
|
Automobiles
|
|
|
374,010
|
|
|
318,779
|
|
Furniture
and Equipments
|
|
|
104,288
|
|
|
96,501
|
|
Construction
in progress
|
|
|
2,199,155
|
|
|
2,113,957
|
|
Total
Property and Equipment
|
|
|
7,870,151
|
|
|
7,522,675
|
|
Less:
Accumulated Depreciation
|
|
|
(759,965
|
)
|
|
(661,243
|
)
|
Property
and Equipment, Net
|
|
$
|
7,110,186
|
|
$
|
6,861,432
|
|
For
the
three months ended March 31, 2008 and 2007, depreciation expenses totaled
$70,560 and $31,131 respectively.
As
of the
three months ended March 31, 2008 and December 31, 2007, the Company’s
unamortized intangible assets consist of:
|
|
March
31, 2008
|
|
December
31,
2007
|
|
Patents
|
|
$
|
1,948,374
|
|
$
|
1,599,814
|
|
Distribution
rights and customer lists
|
|
|
336,730
|
|
|
333,200
|
|
Total
Intangible Assets, net
|
|
$
|
2,285,104
|
|
$
|
1,933,014
|
|
Amortization
expense for the three months ended March 31, 2008 and March 31, 2007 was $69,449
and $ 56,448 respectively.
Patents
are amortized over the life of the patent of ten years and the distribution
rights and customer lists are amortized over ten years.
As
of
March 31, 2008, taxes payable consists of the following:
|
|
March
31, 2008
|
|
December
31,
2007
|
|
Value
Added Tax, net
|
|
$
|
619,343
|
|
$
|
612,602
|
|
Enterprise
Income Tax
|
|
|
1,069,451
|
|
|
940,819
|
|
City
Tax
|
|
|
17,378
|
|
|
4,789
|
|
Other
Taxes and additions
|
|
|
26,963
|
|
|
8,978
|
|
Total
Taxes Payable
|
|
$
|
1,733,135
|
|
$
|
1,567,188
|
|
13. |
Land
Purchase Agreement
|
During
the second quarter in 2007 TDR entered into an agreement with the Development
and Construction Administration Committee of Harbin Song Bei New Development
district to purchase the land use rights for 50 years for development of a
new
biotech engineering project. Terms of the agreement called for a deposit of
30%
of the total land price within 15 days after signing the agreement, 40% payment
7 days prior to the start of construction and the balance of 30% 7 days after
getting the formal land use right.
The
project consists of two phases:
|
(1)
|
Construction
of main workshop, R&D center and office using land area of 30,000
square meters. Construction started in May 2007 and is projected
to be
completed by June 2008.
|
|
(2)
|
Construction
of Second workshop and show room using land area of 20,000 square
meters.
Construction is expected to start in September 2008 to be completed
by
December 2009.
|
TDR
has
committed to the Development and Construction Administration Committee of the
Harbin Song Bei New Development District that the minimum investment per square
meter will be $394.
As
of
March
31,
2008 and December 31, 2007,
the
Company has deposits totaling $9,036,409
and $8,003,205 respectively, related
to the acquisition of these land use rights.
14. |
Commitments
and Contingencies
|
The
formulation, manufacturing, processing, packaging, labeling, advertising,
distribution and sale of external use Chinese medicine such as those sold by
the
Company are subject to regulations by one or more federal agencies. The
principal federal agencies include the State Food and Drug Administration of
the
Government of the Peoples Republic of China, the Food and Drug Administration
(the “FDA”), Heilongjiang Provincial Food and Drug Administration of the
People's Republic of China (PFDA), National Biology Products Inspection
Institute (NBPI) and the National Food and Drug Administration (NFDA) of the
People's Republic of China and, to a lesser extent, the Consumer Product Safety
Commission. These activities are also regulated by various governmental agencies
for the countries, states and localities in which the Company’s products are
sold.
Although
management believes that the Company is in material compliance with the
statutes, laws, rules and regulations of every jurisdiction in which it
operates, no assurance can be given that the Company’s compliance with the
applicable statutes, laws, rules and regulations will not be challenged by
governing authorities or private parties, or that such challenges will not
lead
to material adverse effects on the Company’s financial position, results of
operations, or cash flows.
The
Company, like any other distributor or manufacturer of products that are
designed to be ingested, exposes the Company to the inherent risk of product
liability claims in the events of possible injuries caused by the use of its
products. The Company does not have liability insurance with respect to product
liability claims; the insurance environment of China is neither sufficient
nor
mature. Inadequate insurance or lack of contractual indemnification from parties
supplying raw materials or marketing its products, and product liabilities
related to defective products could have material adverse effects on the
Company.
The
Company is not involved in any legal matters arising in the normal course of
business. While incapable of estimation, in the opinion of the management,
the
individual regulatory and legal matters in which it might involve in the future
are not expected to have a material adverse effect on the Company’s financial
position, results of operations, or cash flows.
FORWARD
LOOKING STATEMENTS
The
following discussion should be read in conjunction with the information
contained in the consolidated financial statements of the Company and the notes
thereto appearing elsewhere herein and in the risk factors and “Forward Looking
Statements” summary set forth in the forepart of this Annual Report as well as
the “Risk Factors” section above and are afforded the safe harbor provisions of
Section 27A of the Securities Act and Section 21E of the Securities
Exchange Act of 1934, as amended. Readers should carefully review the risk
factors disclosed in this Annual Report and other documents filed by us with
the
SEC.
DISCUSSION
We
primarily generate revenues, through our China based indirect subsidiaries
described below, in the development, manufacture, marketing and sale of
over-the-counter, branded nutritional supplements and over-the-counter plant
and
herb based pharmaceutical and medicinal products. Our principal
products are external use Traditional Chinese Herbal Remedies/ Medicines
commonly referred to in the industry as “TCM.” We have evolved into an
integrated manufacturer, marketer and distributor of external use Chinese
medicine products sold primarily in China and through Chinese domestic
pharmaceutical chains and have been expanding our worldwide sales effort as
well. We sell both our own manufactured products, as well as medicinal and
pharmaceutical products manufactured by others in China.
The
Company achieved continuing growth on the sale of both our own product line
and
a contract service line of manufacturer’s products which we sell through our
distribution channel. For the three months ended March 31, 2008, total
revenue was $12,413,430, a 140% increased over the same period in 2007, and
the
first three months of 2008 net income was $3,864,911, or $0.26 per share on
a diluted basis compared to net income of $1,549,321, or $0.13 per share on
a
diluted basis in the same period in 2007.
All
of
our business is conducted through our wholly-owned subsidiary, ACPG which,
in
turn, wholly owns Harbin Tian Di Ren Medical Science and Technology Company
(referred to herein as “TDR”) a company organized in the PRC and TDR’s
subsidiaries, described above and below.
TDR,
formerly known as “Harbin City Tian Di Ren Medical Co.,” was originally formed
in 1994 and maintained its principal executive office in Harbin City of
Heilongjiang Province, in the PRC. TDR was reorganized and incorporated as
a
limited liability company on December 29, 2000, under the “Corporation Laws and
Regulations” of the PRC. At the time of the TDR Acquisition by ACPG in December
of 2005, TDR had two wholly-owned subsidiaries, Harbin First Bio-Engineering
Company Limited and Kangxi Medical Care Product Factory, until July, 2006,
when
the two were merged, with Harbin First Bio-Engineering Company Limited (“First”
or “Harbin Bio Engineering”) as the surviving subsidiary of TDR.
We
have
also recently organized Harbin Tian Qing Biotech Application Company as a
wholly-owned PRC subsidiary of TDR, to conduct research and development in
the
areas of tissue and stem cell banks, which is described in more detail below.
Recent
Developments
On
April
3, 2008, TDR completed an acquisition pursuant to an Equity Transfer Agreement
dated February 22, 2008, between TDR and Heilongjiang Tianlong Pharmaceutical,
Inc., (“Heilongjiang”), a corporation with a multitude of SFDA approved
medicines and new medicine applications, organized under the laws of the PRC
which is in the business of manufacturing external-use pharmaceuticals. Our
TDR
subsidiary previously acquired the Beijing sales office of Heilongjiang in
mid
2006. Pursuant to the Equity Transfer Agreement, TDR acquired 100% of the issued
and outstanding capital stock of Heilongjiang from Heilongjiang’s sole
stockholder Wu
Jiechen, a resident of China, in consideration for an aggregate purchase price
of approximately $8,300,000, consisting of (i) approximately $8,000,000 in
cash,
and (ii) approximately $300,000 of shares of common stock (24,809 shares, $.001
par value per share) of the Registrant. The seller had no material relationship
with the Registrant or any of its affiliates, or any director or officer of
the
registrant, or any associate of any such director or officer.
On
April
18, 2008, TDR consummated a share acquisition pursuant to an Equity Transfer
Agreement with the shareholders of Heilongjiang Haina Pharmaceutical Inc.,
a
recently formed corporation organized under the laws of the PRC (“Haina”)
licensed as a wholesaler of TCD, bio-medicines, bio-products, medicinal devices,
antibiotics and chemical medicines. Haina Pharmaceutical does not have an
established sales network and was acquired for its primary asset, a Good Supply
Practice (GSP) license (License No. A-HLJ03-010) issued by the Heilongjian
office of the SFDA. The SFDA recently started issuing such licenses to resellers
of medicines that maintain certain quality controls. The GSP license was issued
as of December 21, 2006 and will expire on January 29, 2012 and will enable
the
Company to expand its sales of medicinal products without having to go through
a
lengthy license application process.
Pursuant
to the Equity Transfer Agreement, TDR acquired 100% of the issued and
outstanding capital stock of Haina Pharmaceutical from its three stockholders
in
consideration for payment of 3,000,000 RMB (approximately $428,571). TDR has
been overseeing the operations of Haina Pharmaceutical since January of 2008
as
part of its due diligence prior to closing of this acquisition.
Summary
of Our Research and Development Activities
We
currently conduct all of our research and development (“R&D”) activities,
either internally or through collaborative arrangements with universities and
research institutions in the PRC. We have our own research, development and
laboratory facilities located at TRD’s principal headquarters in the city of
Harbin, Heilongjiang Province.
Additionally,
we have established several long-term partnerships with well-known universities
and enterprises in the PRC. We have built a gene medicine laboratory through
a
collaborative effort with Harbin Medical University; established a cell
laboratory with North East Agricultural University; and founded a monoclonal
antibody laboratory with Jilin University. The foregoing are more fully
described in our annual report.
In
collaboration with Harbin Medical University, we have completed a laboratory
experimental study pertaining to Endothelin-1, which is required prior to
clinical trials, and we are currently applying for approval to enter clinical
experiments. This medicine has been recognized by the PRC as the “Top
Category in New Medicine.” In order to qualify as the “Top Category in New
Medicine,” a company must have intellectual property rights, high technology
involvement, strong innovation, and the medicine must be the first of its kind
to be introduced to the PRC. We hold the intellectual property rights
pertaining to this technology, and we have obtained an invention patent to
this
intellectual property in the PRC. Under our partnership arrangements with
other universities and research institutions, we will generally hold the
intellectual property rights to any developed technology.
At
present, our ongoing research is divided into five general areas: (1) the
development of an enzyme linked immune technique to prepare extraneous
diagnostic kits (see table below); (2) the development of an enzyme linked
gold
colloid technique to prepare extraneous rapid diagnostic test strip; (3) the
development of a gene recombination technique to prepare gene drug; (4) the
development of a biology protein chip for various tumor diagnostic applications;
and (5) the development of a cord blood stem cell bank, as more fully described
in other reports of the Company.
We
currently have eight biological products under development: HIV detection
kit; a uterus cancer diagnostic kit; a breast cancer diagnostic kit; a liver
cancer diagnostic kit; a rectum cancer diagnostic kit; a gastric cancer
diagnostic kit; a gene recombination drug; and a multi-tumor marker protein
chip
detection kit. We are also working to establish additional sales networks
and cell banks covering domestic and international markets.
Testing
Kits and Other Products in Production
We
also
have three products: AMI Diagnostic Kit, Human Urinary Albumin Elisa Kit and
Early Pregnancy Diagnostic Kit that have passed the final stages of national
inspection in 2006 or 2007. These diagnostic kits are being sold through drug
stores, hospitals, examination stations and independent sales agents throughout
the PRC. We also plan to market these products in Vietnam, Indonesia,
Philippines and eventually in Africa. We expect our sales in this product
category to increase in mid 2008.
Our
AMI
Diagnostic Kit, which entered markets in 2007, is used for early
diagnosis of Myocardial Infarction (MI), also known as heart disease. All the
test kits require users to place a blood or urine sample on the marker and
a
positive (+) or negative (-) reaction signal will result, showing if a user
should consult his or her doctor for further testing. According to the
China Medical Newspaper, Several million people die from MI every year. MI
often occurs to people who are, but not limited to, smokers, over-weight and
diabetic. There are approximately 8 million new MI patients in China every
year. Recent medical studies have shown that heart failure or heart
attacks are increasing among younger people in China. This is a result from
a
more modern life style, the fast pace of city life and increased pressure from
work or school. The use of AMI Diagnostic Kits will help in early
detection that can help in reducing these statistics.
We
are
continuing our marketing efforts with respect to these testing kits which we
anticipate will result in continued increased sales of these products in
2008.
Significant
Accounting Estimates and Policies
The
discussion and analysis of our financial condition and results of operations
is
based upon our financial statements which have been prepared in accordance
with
accounting principles generally accepted in the United States. The preparation
of these financial statements requires us to make estimates and judgments that
affect the reported amounts of assets and liabilities. On an on-going basis,
we
evaluate our estimates including the allowance for doubtful accounts, the
salability and recoverability of our products, income taxes and contingencies.
We base our estimates on historical experience and on other assumptions that
we
believes to be reasonable under the circumstances, the results of which form
our
basis for making judgments about the carrying values of assets and liabilities
that are not readily apparent from other sources. Actual results may differ
from
these estimates under different assumptions or conditions.
Property
and equipment are evaluated for impairment whenever indicators of impairment
exist. Accounting standards require that if an impairment indicator is present,
we must assess whether the carrying amount of the asset is unrecoverable by
estimating the sum of the future cash flows expected to result from the asset,
undiscounted and without interest charges. If the recoverable amount is less
than the carrying amount, an impairment charge must be recognized based on
the
fair value of the asset.
As
part
of the process of preparing our consolidated financial statements, we are
required to estimate our income taxes. This process involves estimating our
current tax exposure together with assessing temporary differences resulting
from differing treatment of items for tax and accounting purposes. These
differences result in deferred tax assets and liabilities. We must then assess
the likelihood that our deferred tax assets will be recovered from future
taxable income, and, to the extent we believe that recovery is not likely,
we
must establish a valuation allowance. To the extent that we establish a
valuation allowance or increase this allowance in a period, we must include
a
tax provision or reduce our tax benefit in the statements of operations. We
use
our judgment to determine our provision or benefit for income taxes, deferred
tax assets and liabilities and any valuation allowance recorded against our
net
deferred tax assets. We believe, based on a number of factors including
historical operating losses, which we will not realize the future benefits
of a
significant portion of our net deferred tax assets and we have accordingly
provided a full valuation allowance against our deferred tax assets. However,
various factors may cause those assumptions to change in the near
term.
We
cannot
predict what future laws and regulations might be passed that could have a
material effect on our results of operations. We assess the impact of
significant changes in laws and regulations on a regular basis and update the
assumptions and estimates used to prepare our financial statements when we
deem
it necessary.
We
have
determined the significant principles by considering accounting policies that
involve the most complex or subjective decisions or assessments. Our most
significant accounting policies are those related to intangible assets and
research and development.
Intangible
assets -
Intangible assets consist of patents, distribution rights and customer lists.
Patent costs are being amortized over the remaining term of the patent.
Distribution rights and customer lists are being amortized over 10
years.
Intangible
assets are accounted for in accordance with Statement of Financial Accounting
Standards No. 142,
Goodwill and Other Intangible Assets
(“SFAS
142”). Intangible assets with finite useful lives are amortized while
intangible assets with indefinite useful lives are not amortized. As prescribed
by SFAS 142, goodwill and intangible assets are tested periodically for
impairment. The Company adopted SFAS No. 144, "Accounting for the Impairment
or
Disposal of Long- Lived Assets," effective January 1, 2002. Accordingly, the
Company reviews its long-lived assets, including property and equipment and
finite-lived intangible assets for impairment whenever events or changes in
circumstances indicate that the carrying amount of the assets may not be fully
recoverable. To determine recoverability of its long-lived assets, the Company
evaluates the probability that future undiscounted net cash flows will be less
than the carrying amount of the assets. Impairment costs, if any, are measured
by comparing the carrying amount of the related assets to their fair
value.
Research
and development—Research
and development expenses include the costs associated with the Company’s
internal research and development as well as research and development conducted
by third parties. These costs primarily consist of salaries, clinical trials,
outside consultants, and materials. All research and development costs discussed
above are expensed as incurred.
Third-party
expenses were reimbursed under non-refundable research and development
contracts, and are recorded as a reduction to research and development expense
in the statement of operations.
The
Company recognizes in-process research and development in accordance with FASB
Interpretation No. 4,
Applicability of FASB Statement No. 2 to Business Combinations Accounted for
by
the Purchase Method
and
the
AICPA
Technical Practice Aid, Assets Acquired in a Business Combination to be used
in
Research and Development Activities: A Focus on Software, Electronic
Devices, and Pharmaceutical Industries. Assets to be used in research and
development activities, specifically, compounds that have yet to receive new
drug approval and would have no alternative use, should approval not be given,
are immediately charged to expense when acquired.
For
the
three months ended March 31, 2008, the Company incurred $669,833 in research
and
development expenditures, and $15,210 for year 2007.
RESULTS
OF OPERATIONS
Three
months ended March 31, 2008 as compared to Three months ended March 31,
2007
Our
principal business operations are conducted through our wholly owned subsidiary,
TDR, and TDR’s subsidiaries. The results of operations of TDR have been
included in the below financial statements since the acquisition
date.
|
|
March
31
|
|
|
|
2008
|
|
Variance
|
|
2007
|
|
REVENUES
|
|
|
|
|
|
|
|
|
|
|
Product
Sales (net of sales allowance)
|
|
$
|
9,467,414
|
|
|
174
|
% |
$
|
3,457,558
|
|
Contract
Sales
|
|
|
2,946,016
|
|
|
71
|
% |
|
1,721,558
|
|
Total
revenues
|
|
$
|
12,413,430
|
|
|
140
|
% |
|
5,179,116
|
|
|
|
|
|
|
|
|
|
|
|
|
COST
OF GOOD SOLD
|
|
|
|
|
|
|
|
|
|
|
Cost
of good sold
|
|
|
2,860,428
|
|
|
154
|
% |
|
1,126,695
|
|
Gross
Profit
|
|
$
|
9,553,002
|
|
|
136
|
% |
$
|
4,052,421
|
|
Total
sales increased by 140% in the three months ended March 31, 2008 compared to
2007. The $7.2 million increase in sales is attributable to strong
performances from our sales distribution channel.
Product
sales increased by 174% in the three months ended March 31, 2008, to $9,467,414
from $ 3,457,558 in 2007. This growth in sales is attributable to volume
and continuing efforts to develop our distribution channels by hiring direct
territory managers and sales agents to assure that our products and their
associated benefits are seen by those making or influencing the purchasing
decisions. A new subsidiary, Haina Medical (Haina) contributed $1.8 million
to
the product sales. TDR’s product sales in the three months ended March 31, 2008,
which accounted for 81% of the total product sales for the same period,
increased 114% over 2007.
Contract
and Other Revenue
The
following table summarizes the period over period changes in our contract and
other revenues:
|
|
March
31
|
|
|
|
2008
|
|
Change
|
|
2007
|
|
Contract
and other revenue
|
|
$
|
2,946,016
|
|
|
71
|
%
|
$
|
1,721,558
|
|
Contract
and other revenue was $2,946,016 in the three months ended March 31, 2008,
or a
significant increase of $ 1,224,458 over sales of $1,721,558 in 2007. In 2008,
contract and other revenue increased primarily due to net product distribution
service revenue from sales of other manufactured brands through our distribution
channel, which constitutes approximately 31% of total sales in
2008.
Sales
by Product Line
A
break-down of our sales by product line for the three months ended March 31
2008
and 2007 is as follows:
|
|
Three
Months Ended March 31,
|
|
|
|
|
|
2008
|
|
2007
|
|
Period-on-
|
|
|
|
|
|
|
|
%
|
|
|
|
|
|
%
|
|
period
|
|
Product
category
|
|
Quantity
(Kilogram)
|
|
Sales
USD
|
|
of
Sales
|
|
Quantity
(Kilogram)
|
|
Sales
USD
|
|
of
Sales
|
|
Quantity
Variance
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Spray
|
|
|
723,142
|
|
|
1,863,371
|
|
|
15
|
%
|
|
534,729
|
|
|
1,344,730
|
|
|
26
|
%
|
|
188,413
|
|
Plaster
|
|
|
126,623
|
|
|
362,478
|
|
|
3
|
%
|
|
101,099
|
|
|
268,550
|
|
|
5
|
%
|
|
25,524
|
|
Ointment
|
|
|
1,163,937
|
|
|
1,487,146
|
|
|
12
|
%
|
|
417,680
|
|
|
615,322
|
|
|
12
|
%
|
|
746,257
|
|
Cleaning
Liquid
|
|
|
353,423
|
|
|
493,293
|
|
|
4
|
%
|
|
245,810
|
|
|
295,041
|
|
|
6
|
%
|
|
107,613
|
|
Lose
weight Series
|
|
|
261,100
|
|
|
2,026,719
|
|
|
16
|
%
|
|
9,127
|
|
|
79,964
|
|
|
2
|
%
|
|
251,973
|
|
Antihypertension
|
|
|
136,969
|
|
|
1,408,792
|
|
|
11
|
%
|
|
93,187
|
|
|
884,647
|
|
|
17
|
%
|
|
43,782
|
|
Bio-chemical
Products
|
|
|
278,320
|
|
|
1,825,615
|
|
|
15
|
%
|
|
19,622
|
|
|
3,890
|
|
|
0
|
%
|
|
258,698
|
|
Contract
sales
|
|
|
1,525,670
|
|
|
2,946,016
|
|
|
24
|
%
|
|
952,481
|
|
|
1,686,972
|
|
|
32
|
%
|
|
573,189
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
4,569,184
|
|
|
12,413,430
|
|
|
100
|
%
|
|
2,373,735
|
|
|
5,179,116
|
|
|
100
|
%
|
|
|
|
There
were various changes in the break-down of sales among our product lines over
the
three months ended March 31, 2008 as we are now operating an additional
subsidiary and are in the process of developing new products and new markets.
As
shown in the table above, sales volume for all product increased as compared
to
the three months ended March 31, 2007. To
maintain our competitiveness in the PRC market, unit selling prices
were reduced, however, as overall selling prices in the Chinese market
decreased. Decrease of unit selling prices was also due to negotiation with
certain significant customers.
Cost
of Goods Sold and Product Gross Margin
|
|
March
31
|
|
|
|
2008
|
|
December
Variance
|
|
2007
|
|
Total
sales
|
|
$
|
12,413,430
|
|
|
140
|
%
|
$
|
5,179,116
|
|
Cost
of goods sold
|
|
$
|
2,860,428
|
|
|
154
|
%
|
$
|
1,126,695
|
|
Product
gross margin
|
|
|
77
|
%
|
|
|
|
|
78
|
%
|
Our
product’s gross margin was 77% for first quarter 2008, compared to 78% of first
quarter 2007. Although the unit selling price for the three months ended 2008
decreased compared to the comparable period in 2007, cost of sales decreased
at
a similar rate as more product sales were from self- production. As a result,
the product gross margin decreased only 1% compared to the three months ended
2007.
Selling,
General and Administrative Expenses.
The
following table summarizes the period over period changes in our selling,
general and administrative expenses over the last two years:
|
|
March
31
|
|
|
|
2008
|
|
Variance
|
|
2007
|
|
Operating
Expenses
|
|
|
|
|
|
|
|
|
|
|
R&D
Expenses
|
|
$
|
669,833
|
|
|
4304
|
%
|
$
|
15,210
|
|
General,
administrative and selling expenses
|
|
|
3,956,795
|
|
|
94
|
%
|
|
2,043,776
|
|
Depreciation
and amortization
|
|
|
76,348
|
|
|
(8
|
|
|
83,355
|
|
Total
operating expenses
|
|
|
4,702,976
|
|
|
120
|
%
|
|
2,142,341
|
|
|
|
|
|
|
|
|
|
|
|
|
Other
(Income) Expenses
|
|
|
|
|
|
|
|
|
|
|
Other
income
|
|
|
(63,048
|
)
|
|
|
|
|
-
|
|
Interest
expense
|
|
|
1,147
|
|
|
|
|
|
16,494
|
|
Total
other ( income) expenses
|
|
$
|
(61,901
|
)
|
|
|
|
$
|
16,494
|
|
Gross
sales increased approximately $7.2 million in the three months ended March
31,
2008 and corresponding, selling, general and administrative expenses for the
three months ended March 31, 2008 increased by $2.0 million over 2007. Selling
expenses increased 90% due to the increase of sales. General and administrative
expenses increased 359% compare to 2007.
Research
and development expenses were $669,833 in the three months ended March 31,
2008
compared to $15,210 for 2007. We anticipate R&D expenses will increase
as we conduct additional clinical trials and seek out additional patents and
claims for our products.
2008
Outlook
We
expect
slaes in 2008 to increase by 62% to approximately $80 million with increase
in
all categories of our product sales. Sales are expected to increase $0.77
million in Spray products, $0.27 million in Plaster products, $5.32 million
in
Ointment products, $0.62 million in Cleaning Liquid products, $5.60 million
in
Lose Weight Series, $0.77 million in Antihypertension products, $8.07 million
in
Bio-chemical products. Contract sales are expected to decrease $5 million due
to
the acquisition of Heilongjiang Tianlong Pharmaceutical, Inc. while sales from
Heilongjiang Tianlong Pharmaceuticalwill increase $14.40 million. We expect
our
cost of sales will increase $6.26 million, gross profit will increase $24.52
million, and gross margin will be at 78.5%.
LIQUIDITY
AND CAPITAL RESOURCES
The
following table summarizes our cash, cash equivalents and marketable securities,
our working capital, and our cash flow activity as of the end of, and for each
of, three months period for the last two years:
|
|
2008
|
|
2007
|
|
|
|
|
|
|
|
As
of March 31:
|
|
|
|
|
|
|
|
Cash,
cash equivalents and marketable securities
|
|
$
|
38,237,994
|
|
$
|
6,710,247
|
|
Working
capital
|
|
$
|
43,563,886
|
|
|
9,001,591
|
|
|
|
|
|
|
|
|
|
Three
Months Ended March 31:
|
|
|
|
|
|
|
|
Cash
provided by (used in):
|
|
|
|
|
|
|
|
Operating
activities
|
|
$
|
5,197,579
|
|
$
|
561,677
|
|
|
|
|
|
|
|
|
|
Investing
activities
|
|
$
|
(1,105,700
|
)
|
$
|
(759,906
|
)
|
Financing
activities
|
|
$
|
24,227,551
|
|
$
|
5,124
|
|
As
of
March 31, 2008, cash and cash equivalents were $38,237,994, an increase of
470%
over March 31, 2007. The increase of $31.5 million in 2007 was primarily due
to: an increase net income of $2.3 million and the issuance of 2,500,000
shares of common stock for $24.2 million.
The
Company’s current ratio at March 31, 2008 was 9.77, and quick ratio was 9.60.
Its primary sources of funds include cash balances, cash flow from
operations, and sales of equity. Management endeavors to ensure that funds
are available to take advantage of new investment opportunities and that funds
are sufficient to meet future liquidity and capital needs. Management
considers current working capital and borrowing capabilities adequate to cover
the Company's current operating and capital requirements.
There
was
no restrictive bank deposit pledged as of March 31, 2008. Therefore, the Company
did not have to maintain any minimum balance in the relevant deposit account
as
security.
Cash
flows provided by operating activities were $5.2 million for the three months
ended March 31, 2008 compared to cash provided by operating activities of
$562,000 for the comparable 2007 period. The increase in cash provided by
operating activities of $4.6 million was attributable primarily to the
greater sales compared to three months ended March 31, 2007.
Working
capital at March 31, 2008 was $43.6 million, compared to $9.0 million at March
31, 2007. Significant factors that resulted in an increase in 2008 working
capital were: a $31.5 million increase in cash, cash equivalents, and a
$5.0 million increase in accounts receivable primarily due to increased sales
of
$7.2 million in three months ended March 31, 2008.
These
increases were partially offset by: a $ 1.1 million increase in income
taxes payable primarily due to higher profitability; a $916,000 increase in
accounts payable, and other accrued liabilities including increases in accruals
in wages.
Inventories
increased only marginally as of March 31, 2008, from 2007. The Company has
a small inventory on hand primarily due to the enhanced productivity of newly
purchased equipment and machinery, and the popularity of Company products in
the
market.
As
of
March 31, 2008, the Company had no material derivative instruments. The Company
may enter into derivative financial instrument transactions in order to mitigate
its interest rate risk on a related financial instrument in the
future.
Our balance
sheet includes amount of assets and liabilities whose fair values are subject
to
market risk. Market risk is the risk of loss arising from adverse changes in
market prices or interest rates. Generally, the Company’s borrowing is short to
medium term in nature and therefore approximates fair value. The Company
currently has interest rate risk as it relates to its fixed maturity mortgage
participation interest. The Company seeks to limit the impact of interest rate
changes on earnings and cash flows and to lower its overall borrowing costs
by
closely monitoring its interest rate debt.
The
Company has certain equity risks as it relates to its marketable equity
securities, and foreign currency risks as it relates to investments denominated
in foreign currencies. The Company and its subsidiaries are mainly located
in
China, and there were no significant changes in exchange rates, during the
reported periods. However, unforeseen developments may cause a significant
change in exchange rates. The Company is subject to commodity price risks
arising from price of construction materials.
The
Company is subject to market and channel risks. Over 90% of the Company’s sales
are made in the PRC, where the Company primarily sells its products through
drug
chain stores. Because of this, the Company is dependent to a large degree upon
the success of that distribution channel as well as the success of specific
retailers in the distribution channel. Many of the drug stores are individual
stores or very small chains, and only a few are large chain drug stores.
The Company relies on these distribution channels to purchase, market, and
sell its products. The Company’s success is dependent, to a large degree,
on the growth and success of the drug stores, which may be outside its control.
There can be no assurance that the drug store distribution channels will be
able
to grow or prosper as it faces price and service pressure from other channels,
including the mass market. There can be no assurance that retailers in the
drug
store distribution channel, in the aggregate, will respond or continue to
respond to the Company’s marketing commitment in these channels.
The
Company is highly dependent upon the public perception and quality of its
products, consumers’ perception of the safety and quality of its products, as
well as similar products distributed by other companies. Thus, the mere
publication of reports asserting that such products may be harmful could have
a
material adverse effect on the Company, regardless of whether these reports
are
scientifically supported. Adverse publicity may have a material adverse
effect on the Company’s business, financial condition, and results of
operations. There can be no assurance of future favorable scientific
results and media attention, or of the absence of unfavorable or inconsistent
findings.
Currency
Exchange Fluctuations
All
of
Company’s revenues and majority of the expenses in 2007 were denominated
primarily in Renminbi (“RMB”), the currency of China, and was converted into US
dollars at the exchange rate of 7.006 RMB to 1 U.S. Dollar. In the third quarter
of 2005, the Renminbi began to rise against the US dollar. There could be no
assurance that RMB-to-U.S. dollar exchange rates will remain stable. A
devaluation of RMB relative to the U.S. dollar would adversely affect our
business, financial condition and results of operations. We do not engage in
currency hedging.
Off-Balance
Sheet Arrangements
We
do not
have any off-balance sheet arrangements that are currently material or
reasonably likely to be material to our financial position or results of
operations.
Item
3. Quantitative and Qualitative Disclosures About Market
Risk.
As
of
March 31, 2008, the Company had no material derivative instruments. The Company
may enter into derivative financial instrument transactions in order to mitigate
its interest rate risk on a related financial instrument in the future.
Our
balance sheet includes amount of assets and liabilities whose fair values
are
subject to market risk. Market risk is the risk of loss arising from adverse
changes in market prices or interest rates. Generally, the Company’s borrowing
is short to medium term in nature and therefore approximates fair value.
The
Company currently has interest rate risk as it relates to its fixed maturity
mortgage participation interest. The Company seeks to limit the impact of
interest rate changes on earnings and cash flows and to lower its overall
borrowing costs by closely monitoring its interest rate debt.
The
Company has certain equity risks as it relates to its marketable equity
securities, and foreign currency risks as it relates to investments denominated
in foreign currencies. The Company and its subsidiaries are mainly located
in
China, and there were no significant changes in exchange rates, during the
reported periods. However, unforeseen developments may cause a significant
change in exchange rates. The Company is subject to commodity price risks
arising from price of construction materials.
The
Company is subject to market and channel risks. Over 90% of the Company’s sales
are made in the PRC, where the Company primarily sells its products through
drug
chain stores. Because of this, the Company is dependent to a large degree upon
the success of that distribution channel as well as the success of specific
retailers in the distribution channel. Many of the drug stores are individual
stores or very small chains, and only a few are large chain drug stores.
The Company relies on these distribution channels to purchase, market, and
sell its products. The Company’s success is dependent, to a large degree,
on the growth and success of the drug stores, which may be outside its control.
There can be no assurance that the drug store distribution channels will be
able
to grow or prosper as it faces price and service pressure from other channels,
including the mass market. There can be no assurance that retailers in the
drug store distribution channel, in the aggregate, will respond or continue
to
respond to the Company’s marketing commitment in these channels.
The
Company is highly dependent upon the public perception and quality of its
products, consumers’ perception of the safety and quality of its products, as
well as similar products distributed by other companies. Thus, the mere
publication of reports asserting that such products may be harmful could have
a
material adverse effect on the Company, regardless of whether these reports
are
scientifically supported. Adverse publicity may have a material adverse
effect on the Company’s business, financial condition, and results of
operations. There can be no assurance of future favorable scientific
results and media attention, or of the absence of unfavorable or inconsistent
findings.
Currency
Exchange Fluctuations
All
of
Company’s revenues and majority of the expenses in the first quarter ended March
31, 2008 of fiscal 2008 were denominated primarily in Renminbi (“RMB”), the
currency of China, and was converted into US dollars at the exchange rate of
7.006 RMB to 1 U.S. Dollar. In the third quarter of 2005, the Renminbi began
to
rise against the US dollar. There could be no assurance that RMB-to-U.S. dollar
exchange rates will remain stable. A devaluation of RMB relative to the U.S.
dollar would adversely affect our business, financial condition and results
of
operations. We do not engage in currency hedging.
Off-Balance
Sheet Arrangements
We
do not
have any off-balance sheet arrangements that are currently material or
reasonably likely to be material to our financial position or results of
operations.
The
Company’s management, with the participation of the Company’s Chief Executive
Officer and Chief Financial Officer, has evaluated the effectiveness of the
Company’s disclosure controls and procedures as of March 31, 2008. Based on
that evaluation, the Company’s Chief Executive Officer and Chief Financial
Officer concluded that the Company’s disclosure controls and procedures were
effective as of March 31, 2008.
Changes
in Internal Control Over Financial Reporting
There
was
no change in our internal control over financial reporting that occurred during
our first quarter ended March 31, 2008 of fiscal 2008, that has materially
affected, or is reasonably likely to materially affect, our internal control
over financial reporting. The Company regularly reviews its internal controls
and plans on updating and expanding the same as an accelerated filer.
We
are
not a party to any pending legal proceedings.
In
the
three month period ended March 31, 2008, and subsequent period through the
date
hereof, there were no material changes to our risk factors previously disclosed
in Item 1. to Part 1 of our Annual Report on Form 10-KSB for the year
ended December 31, 2007.
In
the
three-month period ended March 31, 2008, and subsequent period through the
date
hereof, other than as previously reported (as such term is defined in Rule
12b-2) we did not engage in any unregistered sales of equity securities other
then as a result of the exercise of various options and warrants.
In
all,
an aggregate of 243,018 shares were issued upon exercise of warrants or options
held by 12 persons between January 1, 2008 and March 31, 2008, at exercise
prices varying between $3.00 and $3.50. An additional 110,000 shares were issued
upon exercise of warrants or options and employee options held by 5 persons
since March 31, 2008 and the date hereof.
Management
believes that these transactions were exempt from the registration requirements
of the Securities Act of 1933, as amended (the “Securities Act”) since, among
other exemptions, pursuant to Regulation D and Section 4(2) of the Securities
Act, since sales were made on an unsolicited basis, to a limited number of
investors who represented that they are accredited investors.
In
the
three-month period ended March 31, 2008, and subsequent period through the
date
hereof, we did not default upon any senior securities.
In
the
three-month period ended March 31, 2008, and subsequent period through the
date
hereof, the we did not submit any matters to a vote of our
stockholders:
There
was
no information we were required to disclose in a report on Form 8-K during
the
three-month period ended March 31, 2008, or subsequent period through the date
hereof, which was not so reported.
Exhibit No.
|
|
Description
of Exhibit
|
31.1
|
|
Certification
of principal executive officer pursuant to Section 13a-14(a) — filed
herewith
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31.2
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Certification
of principal financial and accounting officer pursuant to Section
13a-14(a) — filed herewith
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32.1
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Certification
of principal executive officer pursuant to Section 1350 — filed
herewith
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32.2
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Certification
of principal financial and accounting officer pursuant to Section
1350 —
filed herewith
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Pursuant
to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
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CHINA
SKY ONE MEDICAL, INC.
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Dated:
May 12, 2008
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By:
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/s/
Liu Yan-Qing |
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Liu
Yan-Qing
President
and Chief Executive Officer
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Dated:
May 12, 2008
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By:
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/s/
Liao Xiaoqing |
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Liao
Xiaoqing
Chief
Financial Officer, Secretary
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