Unassociated Document
UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
Washington,
D.C. 20549
FORM 10-Q
(Mark
One)
x
|
QUARTERLY REPORT PURSUANT TO
SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
|
For
the quarterly period ended
|
March 31,
2009
|
or
¨
|
TRANSITION REPORT PURSUANT TO
SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
|
For
the transition period from
|
|
to
|
|
Commission
File Number:
|
000-26059
|
CHINA SKY ONE MEDICAL,
INC.
|
(Exact
name of registrant as specified in its
charter)
|
Nevada
|
|
87-0430322
|
(State
or other jurisdiction of incorporation or organization)
|
|
(I.R.S.
Employer Identification No.)
|
|
|
|
|
|
|
Room
1706, Di Wang Building, No. 30 Gan Shui Road,
Nangang
District, Harbin, People’s Republic of China
|
|
150001
|
(Address
of principal executive offices)
|
|
(Zip
Code)
|
|
86-451-53994069
(China)
|
(Registrant’s
telephone number, including area code)
|
|
|
(Former
name, former address and former fiscal year, if changed since last
report)
|
Indicate
by check mark whether the registrant (1) has filed all reports required to
be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90
days. x
Yes o No
Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate Web site, if any, every Interactice Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this
chapter) during the preceding 12 months (or for such shorter period that the
registrant was required to submit and post such files).
o
Yes o No
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting
company.
Large
accelerated filer o
|
Accelerated
filer o
|
|
|
Non-accelerated
filer o
|
Smaller
reporting company x
|
Indicate
by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act).
o
Yes x No
The
registrant had 16,576,128 shares of Common Stock issued and outstanding as of
May 13, 2009.
QUARTERLY
REPORT ON FORM 10-Q
OF
CHINA SKY ONE MEDICAL, INC. AND SUBSIDIARIES
FOR
THE PERIOD ENDED MARCH 31, 2009
TABLE
OF CONTENTS
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|
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PAGE
|
|
|
|
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PART I
|
-
|
|
FINANCIAL
INFORMATION
|
|
Item
1.
|
|
|
Financial
Statements
|
|
|
|
|
Condensed
Consolidated Balance Sheets as of March 31, 2009 (unaudited) and December
31, 2008
|
1
|
|
|
|
Condensed
Consolidated Statements of Operations and Comprehensive Income for the
Three Months Ended March 31, 2009 and 2008 (unaudited)
|
2
|
|
|
|
Condensed
Consolidated Statements of Cash Flows for the Three Months Ended
March 31, 2009 and 2008 (unaudited)
|
3
|
|
|
|
Notes
to Condensed Consolidated Financial Statements (unaudited)
|
4
|
Item
2.
|
|
|
Management’s
Discussion and Analysis of Financial Condition and Results of
Operations
|
21
|
Item
3.
|
|
|
Quantitative
and Qualitative Disclosures About Market Risk
|
27
|
Item
4.
|
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Controls
and Procedures
|
27
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|
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PART II
|
-
|
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OTHER
INFORMATION
|
|
Item
1.
|
|
|
Legal
Proceedings
|
28
|
Item
1A.
|
|
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Risk
Factors
|
28
|
Item
2.
|
|
|
Unregistered
Sales of Equity Securities and Use of Proceeds
|
28
|
Item
3.
|
|
|
Defaults
Upon Senior Securities
|
28
|
Item
4.
|
|
|
Submission
of Matters to a Vote of Security Holders
|
28
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Item
5.
|
|
|
Other
Information
|
28
|
Item
6.
|
|
|
Exhibits
|
29
|
|
|
Signatures
|
30
|
PART
I. FINANCIAL INFORMATION
Item
1. Financial Statements
China
Sky One Medical, Inc. and Subsidiaries
Condensed
Consolidated Balance Sheets
|
|
March 31,
2009
|
|
|
December 31,
2008 (A)
|
|
|
|
(Unaudited)
|
|
|
|
|
ASSETS
|
|
|
|
|
|
|
Current
Assets
|
|
|
|
|
|
|
Cash
and cash equivalents
|
|
$ |
48,788,597 |
|
|
$ |
40,288,116 |
|
Accounts
receivable, net
|
|
|
14,077,827 |
|
|
|
14,978,648 |
|
Inventories
|
|
|
1,320,295 |
|
|
|
462,351 |
|
Prepaid
and other current assets
|
|
|
77,726 |
|
|
|
106,386 |
|
Land
and construction deposit
|
|
|
8,523,979 |
|
|
|
8,513,284 |
|
Total
current assets
|
|
|
72,788,424 |
|
|
|
64,348,785 |
|
|
|
|
|
|
|
|
|
|
Property
and equipment, net
|
|
|
20,907,074 |
|
|
|
21,058,779 |
|
Intangible
assets, net
|
|
|
15,531,498 |
|
|
|
15,851,765 |
|
|
|
$ |
109,226,996 |
|
|
$ |
101,259,329 |
|
|
|
|
|
|
|
|
|
|
LIABILITIES
AND STOCKHOLDERS' EQUITY
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Current
Liabilities
|
|
|
|
|
|
|
|
|
Accounts
payable and accrued expenses
|
|
$ |
3,702,703 |
|
|
$ |
2,937,068 |
|
Taxes
payable
|
|
|
3,202,051 |
|
|
|
3,362,888 |
|
Deferred
revenues
|
|
|
- |
|
|
|
26,079 |
|
Total
current liabilities
|
|
|
6,904,754 |
|
|
|
6,326,035 |
|
|
|
|
|
|
|
|
|
|
Commitments
and Contingencies
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stockholders'
Equity
|
|
|
|
|
|
|
|
|
Preferred
stock ($0.001 par value, 5,000,000 shares authorized, none issued and
outstanding)
|
|
|
- |
|
|
|
- |
|
Common
stock ($0.001 par value, 50,000,000 shares authorized, 16,446,467 and
16,306,184 issued and outstanding, respectively)
|
|
|
16,446 |
|
|
|
16,306 |
|
Additional
paid-in capital
|
|
|
40,134,162 |
|
|
|
40,105,134 |
|
Accumulated
other comprehensive income
|
|
|
5,683,748 |
|
|
|
5,566,806 |
|
Retained
earnings
|
|
|
56,487,886 |
|
|
|
49,245,048 |
|
Total
stockholders' equity
|
|
|
102,322,242 |
|
|
|
94,933,294 |
|
|
|
$ |
109,226,996 |
|
|
$ |
101,259,329 |
|
See
accompanying summary of accounting policies and notes to the condensed
consolidated financial statements.
(A)
Reference is made to the Company’s Annual Report on Form 10-K for the year ended
December 31, 2008 filed with the Securities and Exchange Commission on April 15,
2009
China
Sky One Medical, Inc. and Subsidiaries
Condensed
Consolidated Statements of Operations and Comprehensive Income
(Unaudited)
|
|
Three Months Ended March 31,
|
|
|
|
2009
|
|
|
2008
|
|
Revenues
|
|
$ |
24,833,692 |
|
|
$ |
12,413,430 |
|
Cost
of Goods Sold
|
|
|
6,040,918 |
|
|
|
2,860,428 |
|
Gross
Profit
|
|
|
18,792,774 |
|
|
|
9,553,002 |
|
|
|
|
|
|
|
|
|
|
Operating
Expenses
|
|
|
|
|
|
|
|
|
Selling,
general and administrative
|
|
|
6,877,468 |
|
|
|
3,956,795 |
|
Depreciation
and amortization
|
|
|
451,372 |
|
|
|
76,348 |
|
Research
and development
|
|
|
2,412,780 |
|
|
|
669,833 |
|
Total
operating expenses
|
|
|
9,741,620 |
|
|
|
4,702,976 |
|
|
|
|
|
|
|
|
|
|
Other
Income (Expense)
|
|
|
|
|
|
|
|
|
Other
income
|
|
|
- |
|
|
|
63,048 |
|
Interest
expense
|
|
|
11,823 |
|
|
|
(1,147 |
) |
Total
other income (expense)
|
|
|
11,823 |
|
|
|
61,901 |
|
|
|
|
|
|
|
|
|
|
Net
Income Before Provision for Income Tax
|
|
|
9,062,977 |
|
|
|
4,911,927 |
|
|
|
|
|
|
|
|
|
|
Provision
for Income Taxes
|
|
|
|
|
|
|
|
|
Current
|
|
|
1,820,139 |
|
|
|
1,047,016 |
|
|
|
|
|
|
|
|
|
|
Net
Income
|
|
$ |
7,242,838 |
|
|
$ |
3,864,911 |
|
|
|
|
|
|
|
|
|
|
Basic
Earnings Per Share
|
|
$ |
0.44 |
|
|
$ |
0.28 |
|
|
|
|
|
|
|
|
|
|
Basic
Weighted Average Shares Outstanding
|
|
|
16,413,920 |
|
|
|
13,732,269 |
|
|
|
|
|
|
|
|
|
|
Diluted
Earnings Per Share
|
|
$ |
0.43 |
|
|
$ |
0.26 |
|
|
|
|
|
|
|
|
|
|
Diluted
Weighted Average Shares Outstanding
|
|
|
16,665,221 |
|
|
|
14,888,310 |
|
|
|
|
|
|
|
|
|
|
Comprehensive
Income
|
|
|
|
|
|
|
|
|
Net
Income
|
|
$ |
7,242,838 |
|
|
$ |
3,864,911 |
|
Foreign
currency translation adjustment
|
|
|
116,942 |
|
|
|
1,620,516 |
|
|
|
|
|
|
|
|
|
|
Comprehensive
Income
|
|
$ |
7,359,780 |
|
|
$ |
5,485,427 |
|
See
accompanying summary of accounting policies and notes to the condensed
consolidated financial statements.
China
Sky One Medical, Inc. and Subsidiaries
Condensed
Consolidated Statements of Cash Flows
(Unaudited)
|
|
Three Months Ended March 31,
|
|
|
|
2009
|
|
|
2008
|
|
Cash
flows from operating activities
|
|
|
|
|
|
|
Net
Income
|
|
$ |
7,242,838 |
|
|
$ |
3,864,911 |
|
Adjustments
to reconcile net cash provided by operating activities
|
|
|
|
|
|
|
|
|
Depreciation
and amortization
|
|
|
588,066 |
|
|
|
140,009 |
|
Share-based
compensation expense
|
|
|
- |
|
|
|
10,117 |
|
Net
change in assets and liabilities
|
|
|
|
|
|
|
|
|
Accounts
receivables
|
|
|
912,487 |
|
|
|
1,859,639 |
|
Inventories
|
|
|
(857,238 |
) |
|
|
(408,079 |
) |
Prepaid
expenses and other current assets
|
|
|
35,805 |
|
|
|
5,526 |
|
Accounts
payable and accrued expenses
|
|
|
735,730 |
|
|
|
(370,378 |
) |
Taxes
payable
|
|
|
(165,038 |
) |
|
|
102,786 |
|
Deferred
revenues
|
|
|
- |
|
|
|
(6,952 |
) |
Net
cash provided by operating activities
|
|
|
8,492,650 |
|
|
|
5,197,579 |
|
|
|
|
|
|
|
|
|
|
Cash
flows from investing activities
|
|
|
|
|
|
|
|
|
Purchases
of fixed assets
|
|
|
(66,148 |
) |
|
|
(42,782 |
) |
Land
and construction deposit
|
|
|
- |
|
|
|
(710,656 |
) |
Purchase
of subsidiary-Heilongjiang Haina Pharmaceutical, Inc.
|
|
|
- |
|
|
|
(427,838 |
) |
Cash
of subsidiary upon acquisition
|
|
|
- |
|
|
|
82,715 |
|
Purchase
of intangible assets
|
|
|
(3,651 |
) |
|
|
(7,139 |
) |
Net
cash used in investing activities
|
|
|
(69,799 |
) |
|
|
(1,105,700 |
) |
|
|
|
|
|
|
|
|
|
Cash
flows from financing activities
|
|
|
|
|
|
|
|
|
Sale
of common stock for cash, net of offering costs
|
|
|
- |
|
|
|
23,487,963 |
|
Proceeds
from warrants conversion
|
|
|
29,169 |
|
|
|
739,588 |
|
Net
cash provided by financing activities
|
|
|
29,169 |
|
|
|
24,227,551 |
|
|
|
|
|
|
|
|
|
|
Effect
of exchange rate changes on cash
|
|
|
48,462 |
|
|
|
727,694 |
|
|
|
|
|
|
|
|
|
|
Net
increase in cash and cash equivalents
|
|
|
8,500,481 |
|
|
|
29,047,124 |
|
|
|
|
|
|
|
|
|
|
Cash
and cash equivalents at beginning of period
|
|
|
40,288,116 |
|
|
|
9,190,870 |
|
|
|
|
|
|
|
|
|
|
Cash
and cash equivalents at end of period
|
|
$ |
48,788,597 |
|
|
$ |
38,237,994 |
|
|
|
|
|
|
|
|
|
|
Supplemental
disclosure of cash flow information
|
|
|
|
|
|
|
|
|
Interest
paid
|
|
$ |
- |
|
|
$ |
1,157 |
|
Taxes
paid
|
|
$ |
2,106,956 |
|
|
$ |
944,230 |
|
See
accompanying summary of accounting policies and notes to the condensed
consolidated financial statements.
China
Sky One Medical, Inc. and Subsidiaries
Notes
to Unaudited Condensed Consolidated Financial Statements
1. Description
of Business
China Sky
One Medical, ("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 Company changed the name of the reporting
company from "Comet Technologies, Inc." to "China Sky One Medical, Inc."
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.” QQ Group, Inc. 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 People’s Republic of China (“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 People’s Republic of China. 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 wholly-owned
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 and TDR.
On
September 30, 2008 (the “Record Date”), we obtained the written consent of the
holders of 8,158,251 shares of our common stock, which as of the Record Date,
represented 51.3% of our outstanding voting securities, to increase our number
of authorized shares of common stock from twenty million (20,000,000) to fifty
million (50,000,000) shares.
2. Acquisition
of Businesses
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 (“Tianlong”), which is in the
business of manufacturing external-use pharmaceuticals. Our TDR subsidiary
previously acquired the Beijing sales office of Tianlong in mid 2006. Pursuant
to the Equity Transfer Agreement, TDR acquired 100% of the issued and
outstanding capital stock of Tianlong from Tianlong ’s sole stockholder Wu
Jiechen, a resident of China, in consideration for an aggregate purchase price
of approximately $8,300,000, consisting of (i) $8,000,000 in cash, and (ii)
23,850 shares of the Company’s common stock (at $12 per share). The acquisition
received regulatory approval and closed on April 3, 2008.
China
Sky One Medical, Inc. and Subsidiaries
Notes
to Unaudited Condensed Consolidated Financial Statements
2. Acquisition
of Businesses (Continued)
The
following table summarizes the approximate estimated fair values of the assets
acquired in the Tianlong acquisition.
Fixed
assets
|
|
$ |
6,314,871 |
|
Intangible
assets
|
|
|
1,786,990 |
|
Other
|
|
|
170,000 |
|
Net
assets acquired
|
|
$ |
8,271,861 |
|
On April
18, 2008, China Sky One through its subsidiary 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 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 Heilongjiang 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. Although the transaction did not close until April 18, 2008, TDR began
overseeing the operations of Haina in January of 2008 as part of its due
diligence prior to closing of this acquisition.
The
following table summarizes the approximate estimated fair values of the assets
acquired in the Haina acquisition.
Intangible
assets
|
|
$ |
437,375 |
|
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 $437,375).
On June
9, 2008, TDR entered into a Merger and Acquisition Agreement (the “Acquisition
Agreement”) with Peng Lai Jin Chuang Company, a corporation organized under the
laws of the People’s Republic of China (“Peng Lai”), which was recently
organized to develop, manufacture and distribute pharmaceutical, medicinal and
diagnostic products in the PRC. Pursuant to the Acquisition Agreement, TDR
acquired all of the assets of Peng Lai in consideration for an aggregate of
approximately (i) US$2.5 million in cash, and (ii) 381,606 shares of the
Company’s common stock with a fair value of approximately $4.6 million (at $12
per share). The acquisition of Peng Lai closed on September 5,
2008.
The
following table summarizes the approximate estimated fair values of the assets
acquired in the Peng Lai acquisition.
Fixed
assets
|
|
$ |
4,176,922 |
|
Intangible
assets
|
|
|
2,917,386 |
|
Net
assets acquired
|
|
$ |
7,094,308 |
|
China
Sky One Medical, Inc. and Subsidiaries
Notes
to Unaudited Condensed Consolidated Financial Statements
2. Acquisition
of Businesses (Continued)
The
following table contains pro forma condensed consolidated statements of
operations information assuming the Tianlong, Haina and Peng Lai transactions
closed on January 1, 2008 for the three months ended March 31, 2008. Peng Lai
had dormant operations until October 2008.
Three
Months Ended March 31, 2008
|
|
Revenues
|
|
$ |
12,982,982 |
|
Operating
income
|
|
$ |
4,940,468 |
|
Net
income
|
|
$ |
3,944,500 |
|
Basic
earnings per common share
|
|
$ |
0.28 |
|
Basic
weighted average shares outstanding
|
|
|
14,137,725 |
|
Diluted
earnings per share
|
|
$ |
0.26 |
|
Diluted
weighted average shares outstanding
|
|
|
15,293,766 |
|
3. Summary
of Significant Accounting Policies
Principles of Consolidation –
The accompanying consolidated financial statements include the accounts of the
Company and its wholly-owned subsidiaries, ACPG, TDR, First, Haina, Tianlong,
and Peng Lai. All significant 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
items in the 2008 financial statements have been reclassified to conform with
the 2009 financial statements presentation.
The
financial summaries for the three months ended March 31, 2009 and March 31, 2008
are unaudited and include, in the opinion of management of the Company , all
adjustments (consisting of normal recurring accruals) necessary to present
fairly the earnings for such periods. Operating results for the three months
ended March 31, 2009 are not necessarily indicative of the results that may be
expected for the entire year ending December 31, 2009.
While the
Company believes that the disclosures presented are adequate to make the
information not misleading, it is suggested that these consolidated financial
statements be read in conjunction with the financial statements and notes
included in the Company’s audited financial statements for the year ended
December 31, 2008.
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 include values and lives assigned to acquired tangible and intangible
assets under our business acquisitions, reserves for customer returns and
allowances, uncollectible accounts receivable, share-based compensation,
impairment testing of goodwill and other intangible assets and slow moving
and/or obsolete/damaged inventory. Actual results may differ from these
estimates.
Earnings per share - Basic
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. When applicable, diluted 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.
China
Sky One Medical, Inc. and Subsidiaries
Notes
to Unaudited Condensed Consolidated Financial Statements
3. Summary
of Significant Accounting Policies
Potential
common shares issued are calculated using the treasury stock method, which
recognizes the use of proceeds that could be obtained upon the exercise of
options and warrants in computing diluted earnings per share. It assumes that
any proceeds would be used to purchase common stock at the average market price
of the common stock during the period.
Cash and cash equivalents –
The Company
considers all highly liquid debt instruments purchased with maturity period of
six months or less to be cash equivalents. The carrying amounts reported in the
accompanying consolidated balance sheets 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 each of March 31, 2009 and December 31, 2008, the
Company’s allowance for doubtful accounts was approximately
$50,000.
Inventories – Inventories
include finished goods, raw materials, freight-in, packing materials, labor, and
overhead costs and are valued at the lower of cost or market using the first-in,
first-out method. Inventory units are valued 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 inventory reserve provision recorded at March 31, 2009 and December
31, 2008.
Property and equipment –
Property and equipment are stated at historical cost less accumulated
depreciation. Depreciation on property and equipment is provided using the
straight-line method over the estimated useful lives of the assets. The Company
uses an estimated residual value of 5% of cost, or valuation for both financial
and income tax reporting purposes. The estimated lengths of useful lives are as
follows:
Building
and Improvements
|
30
years
|
Land
use rights
|
50
years
|
Furniture
& Equipment
|
5
to 7 years
|
Transportation
Equipment
|
5
to 15 years
|
Machinery
and Equipment
|
7
to 14 years
|
Expenditures
for renewals and betterments are capitalized while repairs and maintenance costs
are 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 is
removed from their respective accounts, and any gain or loss is recorded in the
Consolidated Statements of Operations.
Property
and equipment are evaluated for impairment in value 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 will measure the impairment loss as the
amount by which the carrying value of the asset exceeds its fair value. The
Company did not record any impairment charges during each of the three months
ended March 31, 2009 and 2008.
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 expenditures, professional fees,
and capitalized interest costs during the course of
construction.
China
Sky One Medical, Inc. and Subsidiaries
Notes
to Unaudited Condensed Consolidated Financial Statements
3. Summary
of Significant Accounting Policies (Continued)
Upon
completion and readiness for use of the project, the cost of
construction-in-progress is 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 and goodwill. Patent costs are amortized over an
estimated life of ten 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. The Company recognizes an impairment loss based on the excess of the
carrying amount of the assets over their respective fair values. Fair value is
determined by discounted future cash flows, appraisals or other methods. If the
assets determined to be impaired are to be held and used, the Company recognizes
an impairment loss thru a charge to operating results to the extent the present
value of anticipated cash flows attributable to the assets are less than the
asset’s carrying value. The Company would depreciate the remaining the remaining
value over the remaining estimated useful life of the asset to operating
results. The company did not record any impairment charges during each of the
three months ended March 31, 2009 and 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 at that date. The registered equity
capital denominated in the functional currency is translated at the historical
rate of exchange at the time of the capital contribution. All translation
adjustments resulting from the translation of the financial statements into the
reporting currency (“US Dollars”) are recorded as accumulated other
comprehensive income, a component of stockholders’ equity.
Revenue recognition– Revenue
is 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.
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
revenues.”
China
Sky One Medical, Inc. and Subsidiaries
Notes
to Unaudited Condensed Consolidated Financial Statements
3. Summary
of Significant Accounting Policies (Continued)
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 are expensed as incurred.
Third-party
expenses reimbursed under non-refundable research and development contracts 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. Certain assets and high
technologies acquired that has a foreseeable future cash flows are capitalized
as intangible assets. Such intangible assets are amortized starting
from the year revenue is generated and amortize over a period of 10 years.
Should under any circumstances these capitalized intangible assets are valued
with no future benefit, the Company will charge to expense
immediately.
The
Company incurred $2,412,780 and $669,833 in research and development costs for
each of the three months ended March 31, 2009 and 2008,
respectively.
Advertising—Advertising and
promotion costs are expensed as incurred. Total advertising costs for the
three months ended March 31, 2009 and 2008 was $2,776,126 and $369,995,
respectively. Advertising costs are reported as part of selling, general and
administrative expenses in the consolidated statement of
operations.
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 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 PRC 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.
Income tax for Peng Lai is regulated by the local government and has been
charged at the rate of 2% of total revenues commencing January 1, 2009. Peng Lai
had no business operations during the first quarter of 2008.
China
Sky One Medical, Inc. and Subsidiaries
Notes
to Unaudited Condensed Consolidated Financial Statements
3. Summary of Significant Accounting
Policies (Continued)
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, First, and Tianlong is
15%, based on State Council approval.
Value added
tax
The
Provisional Regulations of PRC 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.
Accounting for uncertainty in income
taxes – In June 2006, the Financial Accounting Standards Board (FASB)
issued Interpretation No. 48, Accounting for Uncertainty in Income
Taxes - an Interpretation of FASB Statement No. 109 (FIN 48). FIN 48 is
intended to clarify the accounting for uncertainty in income taxes recognized in
a company’s financial statements and prescribes the recognition and measurement
of a tax position taken or expected to be taken in a tax return. FIN 48 also
provides guidance on de-recognition, classification, interest and penalties,
accounting in interim periods, disclosure and transition.
Under FIN
48, evaluation of a tax position is a two-step process. The first step is to
determine whether it is more-likely-than-not that a tax position will be
sustained upon examination, including the resolution of any related appeals or
litigation based on the technical merits of that position. The second step is to
measure a tax position that meets the more-likely-than-not threshold to
determine the amount of benefit to be recognized in the financial statements. A
tax position is measured at the largest amount of benefit that is greater than
50% likely of being realized upon ultimate settlement.
Tax
positions that previously failed to meet the more-likely-than-not recognition
threshold should be recognized in the first subsequent period in which the
threshold is met. Previously recognized tax positions that no longer meet the
more-likely-than-not criteria should be de-recognized in the first subsequent
financial reporting period in which the threshold is no longer met.
The
adoption of FIN 48 at January 1, 2007 did not have a material effect on the
Company’s results of operations and financial position.
Comprehensive income –
Comprehensive income consists of net income and other gains and losses
affecting stockholders’ 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.
China
Sky One Medical, Inc. and Subsidiaries
Notes
to Unaudited Condensed Consolidated Financial Statements
3. Summary of Significant Accounting
Policies (Continued)
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 as
defined by statutory regulations are eligible to participate in the
plan.
Contributions
to the pension or retirement plan are calculated at 22.5% 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. The
Company has no other material obligations for the payment of retirement benefits
beyond the annual contributions under this plan. The Company incurred costs of
$44,211 and $7,472 for the three months ended March 31, 2009 and 2008,
respectively.
Fair value of financial instruments –
The carrying amounts of certain financial instruments, including cash and
cash equivalents, accounts receivable, other receivables, accounts payable,
accrued expenses, and other payables approximate their fair values at March
31, 2009 and 2008 because of the relatively short-term maturity of these
instruments.
Recent
accounting pronouncements
In March
2008, the FASB issued Statement No. 161, Disclosures about Derivative
Instruments and Hedging Activities an amendment of SFAS 133 ("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. SFAS 161 became effective for the Company in 2009 and did
not have a material impact on its financial position, results of operations or
cash flows.
In
December 2007, the FASB issued SFAS No. 141 (revised 2008), “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 141R requires
earn-outs and other contingent consideration to be recorded at fair value on
acquisition date and contingencies to be recorded at fair value on acquisition
date with subsequent remeasurement. SFAS 141R requires acquisition costs to be
expensed as incurred and generally requires restructuring costs to be expensed
in periods after the acquisition date. SFAS 141R requires amounts previously
called “negative goodwill” which result from a bargain purchase in which
acquisition date fair value of identifiable net assets acquired exceeds the fair
value of consideration transferred plus any non controlling interest in the
acquirer to be recognized in earnings as a gain attributable to the acquirer.
SFAS No. 141(R) became effective for the Company in 2009. SFAS 141(R) will
impact the Company in the event of any acquisition after December 31,
2008.
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 requires noncontrolling interests to be reported
in the equity section of financial statements and requires that net earnings
include the amounts attributable to both the parent and the noncontrolling
interests with disclosure on the face of the statement of operations of the net
earnings attributable to the parent and to the noncontrolling interests, with
any losses attributable to the noncontrolling interests in excess of the
noncontrolling interests’ equity to be allocated to the noncontrolling interest.
Calculation of earnings per share amounts in the financial statements will
continue to be based on amounts attributable to the parent. SFAS No. 160
became effective for the Company in 2009 and did not have a material impact on
the Company’s financial statements.
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. SFAS 159 became effective on January 1, 2008
and did not have a material impact on the Company’s financial
statements.
China
Sky One Medical, Inc. and Subsidiaries
Notes
to Unaudited Condensed Consolidated Financial Statements
3. Summary of Significant Accounting
Policies (Continued)
In
September 2006, the FASB issued Statement of Financial Accounting Standards No.
157, Fair Value
Measurements (“SFAS 157”). The statement provides enhanced guidance
for using fair value to measure assets and liabilities and also responds to
investors’ requests for expanded information about the extent to which company’s
measure assets and liabilities at fair value, the information used to measure
fair value, and the effect of fair value measurements on earnings. While
the standard applies whenever other standards require (or permit) assets or
liabilities to be measured at fair value, it does not expand the use of fair
value in any new circumstances. Statement No. 157 is effective for the
Company beginning in 2008 except for the nonfinancial assets and liabilities
that are subject to a one-year deferral allowed by FASB Staff Position (FSP)
SFAS 157-2 (“ FSP SFAS 157-2”). FSP SFAS 157-2 delays the effective date of SFAS
157 until fiscal years beginning after November 15, 2008 for nonfinancial assets
and liabilities that are not recognized or disclosed at fair value in the
financial statements on a recurring basis (at least annually). The adoption of
SFAS 157 nor the adoption relating to the deferral provision of FSP SFAS 157-2
had a material effect on our consolidated financial statements.
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, 2009 the Company held
approximately $2,562,000 of cash balances within the United States of which
approximately $404,000 was in excess of FDIC insurance limits. At March 31,
2009, the Company had approximately $46,212,000, in China bank deposits, which
is not insured. Historically, the Company has not experienced any losses in such
accounts.
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 China. 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 PRC. 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
PRC.
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 businesses are generated from operations in mainland
China.
Major
Customers
For the
three months ended March 31, 2009, Shanxi Xintai and Harbin Shiji Baolong
accounted for 22% and 20% respectively of sales revenues. For the three months
ended March 31, 2008, Xinteyao Ltd. accounted for approximately 11% of sales
revenues. Shanxi Xintai and Harbin Shiji Baolong accounted for 25% and 29% of
all account receivable, for the three months ended March 31, 2009.
Major
Suppliers
Heilongjiang
Kangda Medicine Co. accounted for approximately 43% of the Company’s inventory
purchases for the three months ended March 31, 2009 and 45% for the three months
ended March 31, 2008.
China
Sky One Medical, Inc. and Subsidiaries
Notes
to Unaudited Condensed Consolidated Financial Statements
5. Earnings
Per Share
We have
applied SFAS No. 128, “Earnings Per Share” in our calculation and presentation
of earnings per share - “basic” and “diluted”. Basic earnings per share are
computed by dividing net earnings available to common shareholders
(the numerator) by the weighted average number of common shares (the
denominator) for the period presented. 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 1,001,000 shares and 1,452,665 of common stock
were outstanding and exercisable as of March 31, 2009 and 2008,
respectively. These common stock equivalents were included in the
computation of diluted earnings per share because the option exercise prices
were less than the average market price of our common stock 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
represents the potential dilutive effect of the securities.
The
following table sets forth our computation of basic and diluted net income per
share:
|
|
For the three months ended March
31,
|
|
|
|
2009
|
|
|
2008
|
|
Numerator:
|
|
|
|
|
|
|
Net
income used in calculation of basic and diluted earnings per
share
|
|
$ |
7,242,838 |
|
|
$ |
3,864,911 |
|
|
|
|
|
|
|
|
|
|
Denominator:
|
|
|
|
|
|
|
|
|
Weighted-average
common shares outstanding used in calculation of basic earnings per
share
|
|
|
16,413,920 |
|
|
|
13,732,269 |
|
|
|
|
|
|
|
|
|
|
Effect
of dilutive securities:
|
|
|
|
|
|
|
|
|
Stock
options and equivalents
|
|
|
251,301 |
|
|
|
1,156,041 |
|
Weighted-average
common shares used in calculation of diluted earnings (loss) per
share
|
|
|
16,665,221 |
|
|
|
14,888,310 |
|
|
|
|
|
|
|
|
|
|
Net
income per share:
|
|
|
|
|
|
|
|
|
Basic
|
|
$ |
0.44 |
|
|
$ |
0.28 |
|
Diluted
|
|
$ |
0.43 |
|
|
$ |
0.26 |
|
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 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.
China
Sky One Medical, Inc. and Subsidiaries
Notes
to Unaudited Condensed Consolidated Financial Statements
6. Equity
and Share-Based Compensation (Continued)
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, 2009,
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 using the Black-Scholes option-pricing
model with the following assumptions: no dividends; risk-free interest rate of
4%; a contractual life of 5 years and volatility of 39%. All 113,500
options vest over various periods for the options granted to employees and
consultants.
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 $2.00 per share and options to purchase up to 50,000 shares
on or before December 20, 2008 at a price of $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%; a
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.
During
the three months ended March 31, 2009, warrant holders exercised 158,334
warrants in total. 150,000 of the warrants were exercised on a cashless basis
for a total of 131,949 shares of the Company’s common stock. 8,334 of the
warrants were exercised for cash, at an exercise price of $3.50 per share, for
total proceeds of $29,169.
7. Securities
Purchase Agreement and Related Transaction
On
January 31, 2008 (the “Closing Date”), the Company entered into a Securities
Purchase Agreement (the “Purchase Agreement”) with certain accredited investors
(the “Investors”), for the purchase and sale of units consisting of an aggregate
of: (i) 2,500,000 shares of the Company’s common stock, and (ii) Class A
Warrants to purchase 750,000 additional shares of the Company’s common stock
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 “Unit Purchase Price”),
or gross offering proceeds of $25.0 million (the “2008
Offering”). The Company received net proceeds of approximately $23.5
million in connection with the 2008 Offering.
Pursuant
to the Purchase Agreement, among other things, if, and whenever, within twelve
(12) months of the Closing Date, the Company issues or sells, or is deemed to
have issued or sold, any shares of common stock, or securities convertible into
or exercisable for shares of common stock, or modifies any of the foregoing
which may be outstanding (with the exception of certain excluded securities), to
any person or entity at a price per share, or conversion or exercise price per
share less than the Unit Purchase Price, then the Company shall issue, for each
such occasion, additional shares of its common stock to the Investors in such
number so that the average per share purchase price of the shares of common
stock purchased by the Investors in the 2008 Offering shall automatically be
reduced to such other lower price per share.
China
Sky One Medical, Inc. and Subsidiaries
Notes
to Unaudited Condensed Consolidated Financial Statements
7. Securities Purchase Agreement and
Related Transaction (Continued)
In
addition, as of the Closing Date, the Company entered into a Make Good Agreement
(the “Make Good Agreement”) with Liu Yan-Qing, its Chairman, Chief Executive
Officer and President, and a principal shareholder of the Company, (the
“Principal Shareholder”) and the Investors (collectively, the “Make Good
Parties”), pursuant to which the Principal Shareholder deposited 3,000,000
shares of his common stock of the Company (the “Escrow Shares”) into escrow, to
be released to the Investors in an amount pro rata pro to their initial
investments in the 2008 Offering, in the event the Company failed to attain
earnings per share, as adjusted, of at least (i) $1.05 per share for the fiscal
year ending December 31, 2007 (based on an aggregate of 13,907,696 shares
outstanding), and/or (ii) $1.63 per share for the fiscal year ending December
31, 2008 (based on 16,907,696 shares outstanding).
The
Company deems the Escrow Shares arrangement as analogous to the issuance of a
fixed number of warrants in an equity transaction. Under the Make
Good Agreement these Escrow Shares would have been reallocated on a
pro rata basis to the Investors only if certain earnings targets were not
achieved in years 2007 and 2008. If the earnings targets were met,
the Escrow Shares would automatically be released to the Principal
Shareholder. As of January 31, 2008, the date the common shares were
placed into escrow, the Company achieved the 2007 earnings target and, based
upon internal forecasts, was confident the 2008 target would also be
met. Based upon certain assumptions, including the low probability
that the Escrow Shares would be released to the Investors and not be returned to
the Principal Shareholder, the Company considered the fair value of the right
held by the Investors through the Escrow Shares provision under the Make Good
Agreement to be immaterial. As of December 31, 2008, the Company
satisfied the earnings per common share targets for each of fiscal 2007 and 2008
as defined under the Make Good Agreement and, as such, the Escrow Shares shall
be released to the Principal Shareholder in 2009.
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 Note 8.
8. 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
|
|
|
(1,205,002 |
) |
|
|
|
|
|
|
(50,000 |
) |
|
|
- |
|
Expired
or cancelled
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
Outstanding
as of December 31, 2008
|
|
|
1,058,334 |
|
|
$ |
9.50 |
|
|
|
113,500 |
|
|
$ |
3.45 |
|
Granted
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
Exercised
|
|
|
(158,334 |
) |
|
|
|
|
|
|
- |
|
|
|
- |
|
Expired
or cancelled
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
Outstanding
as of March 31, 2009
|
|
|
900,000 |
|
|
$ |
9.50 |
|
|
|
113,500 |
|
|
$ |
3.45 |
|
China
Sky One Medical, Inc. and Subsidiaries
Notes
to Unaudited Condensed Consolidated Financial Statements
8. Outstanding
Warrants and Options (Continued)
As of
January 20, 2009, warrants to purchase 8,334 shares of our common stock, which
we issued to “accredited” investors in connection with the private offering we
completed in October 2006, were exercised at a price of $3.50 per share, for an
aggregate of $29,169.
As of
January 22, 2009, warrants to purchase an aggregate of 150,000 shares of our
common stock, which we issued to a consultant in consideration for services
rendered in connection with the share exchange transaction we consummated in May
2006, were exercised on a cashless basis. In connection with the cashless
exercise, the warrant holder was deemed to have paid an amount equal to the
difference between the exercise price ($2.00 per share) and the average closing
price of a share of our common stock during the ten (10) trading days ending on
the date of exercise ($16.62 per share). As a result of such cashless
exercise, we issued an aggregate of 131,949 shares of our common stock to the
warrant holder. Following this exercise, the warrant holder still held warrants
to purchase an additional 150,000 shares of our common stock, at an exercise
price of $2.00 per share, which may be exercised in whole, or in part, for cash,
or on a cashless basis.
The
following table summarizes information about stock warrants outstanding and
exercisable as of March 31, 2009.
Exercise
Price
|
|
|
Outstanding
March 31,
2009
|
|
|
Weighted
Average
Remaining
Life in Years
|
|
|
Number
exercisable
|
|
$ |
2.00 |
|
|
|
150,000 |
|
|
|
0.25 |
|
|
|
150,000 |
|
$ |
12.50 |
|
|
|
750,000 |
|
|
|
2.25 |
|
|
|
750,000 |
|
|
|
|
|
|
900,000 |
|
|
|
|
|
|
|
900,000 |
|
Out of
the 900,000 outstanding warrants, all were exercisable as of March 31, 2009. The
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 8 above,
represent the right to purchase an aggregate of 750,000 shares of common stock,
at an exercise price of $12.50 per share (the “Exercise Price”), and have the
following additional characteristics:
|
·
|
The
Class A Warrants became exercisable beginning on the six-month anniversary
of the closing of the January 2008 Offering and will expire
July 31, 2011.
|
|
·
|
Commencing
on the one-year anniversary of the date of issuance, in the event the
shares underlying the Class A Warrants (the “Warrant Shares”) are not
freely sold by the holders 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 are 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
any time following the date a Registration Statement covering the Warrant
Shares is declared effective, the Company 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 earnings per share of at least $1.63 per share (as adjusted
pursuant to the terms of the Make Good Agreement describer above) for the
fiscal year ending December 31,
2008.
|
China
Sky One Medical, Inc. and Subsidiaries
Notes
to Unaudited Condensed Consolidated Financial Statements
8. Outstanding
Warrants and Options (Continued)
|
·
|
If,
among other things, the Company fails 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.
|
The
following table summarizes information about stock options outstanding and
exercisable as of March 31, 2009.
Exercise
Price
|
|
|
Outstanding
March 31,
2009
|
|
|
Weighted
Average
Remaining
Life in
Years
|
|
|
Exercisable
Options
|
|
|
Unvested
Options
|
|
$ |
3.65 |
|
|
|
113,500 |
|
|
|
2.75 |
|
|
|
101,000 |
|
|
|
12,500 |
|
9. Inventories
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 include packing materials, raw materials,
supplemental materials, work-in-process, and finished products.
As of
March 31, 2009 and December 31, 2008, inventories consist of the
following:
|
|
March 31, 2009
|
|
|
December 31, 2008
(Audited)
|
|
Raw
Material
|
|
$ |
357,872 |
|
|
$ |
330,275 |
|
Work-in-Process
|
|
|
464,328 |
|
|
|
76,462 |
|
Finished
Products
|
|
|
498,095 |
|
|
|
55,614 |
|
Total
Inventories
|
|
$ |
1,320,295 |
|
|
$ |
462,351 |
|
10. Property
and Equipment
As
of March 31, 2009 and December 31, 2008, Property and Equipment, net consist of
the following:
|
|
March 31, 2009
|
|
|
December 31, 2008
(Audited)
|
|
Buildings
and improvements
|
|
$ |
9,548,869 |
|
|
|
9,961,820 |
|
Machinery
and equipment
|
|
|
5,446,472 |
|
|
|
4,946,247 |
|
Land
use rights
|
|
|
1,929,579 |
|
|
|
1,945,209 |
|
Transportation
equipment
|
|
|
886,993 |
|
|
|
885,880 |
|
Furniture
and equipment
|
|
|
297,456 |
|
|
|
299,467 |
|
Construction
in progress (See Note 14)
|
|
|
4,326,340 |
|
|
|
4,317,265 |
|
Total
Property and Equipment
|
|
|
22,435,709 |
|
|
|
22,355,888 |
|
Less:
Accumulated Depreciation
|
|
|
(1,528,635 |
) |
|
|
(1,297,109 |
)
|
Property
and Equipment, Net
|
|
$ |
20,907,074 |
|
|
$ |
21,058,779 |
|
China
Sky One Medical, Inc. and Subsidiaries
Notes
to Unaudited Condensed Consolidated Financial Statements
10. Property
and Equipment (Continued)
For the
three months ended March 31, 2009 and 2008, depreciation expense totaled
$247,934 and $70,560 respectively. Depreciation expense for cost of goods sold
amounted to $136,694 and $39,115 for the three months ended March 31, 2009 and
2008, respectively.
11. Intangible
Assets
As of
March 31, 2009 and December 31, 2008, the Company’s net unamortized intangible
assets consist of:
|
|
March 31,
2009
|
|
|
December 31,
2008 (Audited)
|
|
|
Patents
|
|
$ |
14,772,399 |
|
|
$ |
15,093,718 |
|
Goodwill
|
|
|
759,099 |
|
|
|
758,047 |
|
Total
Intangible Assets, net
|
|
$ |
15,531,498 |
|
|
$ |
15,851,765 |
|
Amortization
expense for the three months ended March 31, 2009 and 2008 was $340,132 and
$69,449, respectively.
12. Taxes
Payable
Taxes
payable consists of the following:
|
|
March
31,
2009
|
|
|
December
31,
2008
(Audited)
|
|
Value
Added Tax, net
|
|
$ |
1,294,150 |
|
|
$ |
1,179,383 |
|
Enterprise
Income Tax
|
|
|
1,820,139 |
|
|
|
2,106,956 |
|
City
Tax
|
|
|
34,672 |
|
|
|
32,013 |
|
Other
Taxes and additions
|
|
|
53,090 |
|
|
|
44,536 |
|
Total
Taxes Payable
|
|
$ |
3,202,051 |
|
|
$ |
3,362,888 |
|
13. Income
Taxes
Under the
Provisional Regulations of PRC 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, First, and Tianlong is
15%, based on State Council approval. Income tax for Peng Lai is regulated by
the local government and has been charged at the rate of 2% of total revenues
commencing January 1, 2009. Peng Lai had no business operations during the first
quarter of 2008.
We record
a full valuation allowance to reduce our deferred tax assets to the amount that
is more likely than not to be realized. While we have considered future taxable
income and ongoing prudent and feasible tax planning strategies in assessing the
need for the valuation allowance, in the event we were to determine that we
would be able to realize our deferred tax assets in the future in excess of its
net recorded amount, an adjustment to the deferred tax asset would increase
income in the period such determination was made.
China
Sky One Medical, Inc. and Subsidiaries
Notes
to Unaudited Condensed Consolidated Financial Statements
13. Income
Taxes (Continued)
Pursuant
to Sections 382 and 383 of the Internal Revenue Code (“IRC”), annual use of the
Company’s net operating losses and tax credit carryforwards may be limited
because of cumulative changes in ownership of more than 50% that have occurred.
As of March 31, 2009, the Company has US net operating loss carryforward’s of
approximately $5.0 million which will begin to expire in 2028. Accordingly, as
mentioned above, any deferred tax asset that would result from these
carryforwards has been fully reserved as of March 31, 2009.
Significant
components of the Company’s deferred tax assets are shown below. Nil valuation
allowance has been established to offset the deferred tax assets, as realization
of such assets is certain per the management valuation.
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.
As
of March 31, 2009, the Company has US net operating loss carryforward’s of
approximately $5.0 million which will begin to expire in 2028.
As of
March 31, 2009, the company has U.S. net operating loss carryforwards of
approximately $5.0 million which will begin to expire in 2028. At March 31,
2009, the Company has recorded a full valuation allowance against these net
operating loss carryforwards.
In 2006,
the Financial Accounting Standards Board (FASB) issued FIN 48, which clarifies
the application of SFAS 109 by defining a criterion that an individual income
tax position must meet for any part of the benefit of that position to be
recognized in an enterprise’s financial statements and provides guidance on
measurement, derecognition, classification, accounting for interest and
penalties, accounting in interim periods, disclosure and transition. In
accordance with the transition provisions, the company adopted FIN 48 effective
January 1, 2007.
The
Company recognizes that virtually all tax positions in the PRC are not free of
some degree of uncertainty due to tax law and policy changes by the state.
However, the Company cannot reasonably quantify political risk factors and thus
must depend on guidance issued by current state officials.
Based on
all known facts and circumstances and current tax law, the company believes that
the total amount of unrecognized tax benefits as of March 31, 2009, is not
material to its results of operations, financial condition or cash flows. The
company also believes that the total amount of unrecognized tax benefits as of
March 31, 2009, if recognized, would not have a material effect on its effective
tax rate. The Company further believes that there are no tax positions for which
it is reasonably possible, based on current Chinese tax law and policy, that the
unrecognized tax benefits will significantly increase or decrease over the next
12 months producing, individually or in the aggregate, a material effect on the
company’s results of operations, financial position or cash flows.
14. Land
Use Rights Purchase Agreement and Construction in Progress
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.
China
Sky One Medical, Inc. and Subsidiaries
Notes
to Unaudited Condensed Consolidated Financial Statements
14. Land
Use Rights Purchase Agreement and Construction in Progress
(Continued)
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 estimated to be
completed by the end of 2009.
|
|
(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.
Management
plans to use the internal generated funds to fund the project. The estimated
additional cost is approximately $5.0 million.
As of
March 31, 2009 and December 31, 2008, the Company has deposits totaling
$8,523,979 and 8,513,284 respectively, related to the land and construction
deposits.
15. 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 is exposed 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 a 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 the Company might be involved
in the future are not expected to have a material adverse effect on the
Company’s financial position, results of operations, or cash flows.
The
rental commitment for the year 2009 is approximately $25,000. The Company is
expecting the corporate headquarters currently under construction to be
completed by 2009. As a result, there is no rental commitment made by the
Company for the year 2010 and thereafter.
Item
2. Management’s Discussion and Analysis of Financial Condition and
Results of Operations
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 our Annual Report for the year
ended December 31, 2008. This quarterly report on Form 10-Q contains
forward-looking statements and is 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 our Annual Report for the year ended December 31, 2008 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.
We
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, 2009, total
revenue was $24,833,692, as compared to $12,413,430 for the three months ended
March 31, 2008, or a 100% increase over the same period in 2008, and net income
was $7,242,838, or $0.43 per share compared to net income of $3,864,911, or
$0.26 per share on a diluted basis in the same period in 2008.
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.
TDR,
formerly known as “Harbin City Tian Di Ren Medical Co.,” was originally formed
in 1994 with 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.
Recent
Developments
On April
3, 2008, TDR completed its acquisition of Heilongjiang Tianlong Pharmaceutical,
Inc., a corporation with a variety of SFDA approved medicines and new medicine
applications, organized under the laws of the PRC (“Tianlong”), which is in the
business of manufacturing external-use pharmaceuticals. TDR previously acquired
the Beijing sales office of Tianlong in mid-2006. TDR acquired 100% of the
issued and outstanding capital stock of Tianlong from its sole stockholder, in
consideration for an aggregate purchase price of approximately $8,300,000,
consisting of (i) $8,000,000 in cash, and (ii) 23,850 shares of our common
stock.
On April
18, 2008, TDR consummated its acquisition 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 did 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 Heilongjiang
province 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 us to expand its sales of medicinal products without having to go through
a lengthy license application process. TDR acquired 100% of the issued and
outstanding capital stock of Haina from its three stockholders in consideration
for payment of approximately $437,375. TDR had been overseeing the operations of
Haina Pharmaceutical since January of 2008, as part of our due diligence prior
to closing of this acquisition.
On
September 5, 2008, TDR acquired Peng Lai Jin Chuang Pharmaceutical Company
(“Peng Lai”), a corporation organized under the laws of the PRC, from Peng Lai
Jin Chuang Group Corporation (the “Seller”). Peng Lai, which has received Good
Manufacturing Practice certification from the SFDA, was organized to develop,
manufacture and distribute pharmaceutical, medicinal and diagnostic products in
the PRC. In connection with the acquisition of Peng Lai, TDR acquired all of
Peng Lai’s assets, including, without limitation, franchise, production and
operating rights to a portfolio of twenty (20) medicines approved by the SFDA,
for an aggregate purchase price of approximately $7.1 million, consisting of (i)
approximately $2.5 million in cash, and (ii) 381,606 shares of our common
stock.
Testing
Kits and Other Products in Production
We have
three products: AMI Diagnostic Kit, Human Urinary Albumin Elisa Kit and Early
Pregnancy Diagnostic Kit that 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. Our sales in this product category
increased 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
resulted in continued increased sales of these products in 2008.
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 TDR’s principal executive.
At
present, our ongoing research is divided into five general areas:
|
|
|
the
development of an enzyme linked immune technique to prepare extraneous
diagnostic kits;
|
|
|
|
the
development of an enzyme linked gold colloid technique to prepare
extraneous rapid diagnostic test
strip;
|
|
|
|
the
development of a gene recombination technique to prepare gene
drug;
|
|
|
|
the
development of a biology protein chip for various tumor diagnostic
applications; and
|
|
|
|
the
development of a cord blood stem cell bank, as more fully described in
other reports we filed.
|
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.
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 and
inventories, the salability and recoverability of our products, income taxes and
contingencies and remaining useful lives of our tangible and certain intangible
assets. 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 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 consists of patents and goodwill. Patent costs are amortized over an
estimated life of ten 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 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 costs 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. Certain assets and high
technologies acquired that has a foreseeable future cash flows are capitalized
as intangible assets. Such intangible assets are amortized starting from the
year revenue is generated and amortize over a period of 10
years. Should under any circumstances these capitalized intangible
assets are valued with no future benefit, the Company will charge to expense
immediately.
For the
three months ended March 31, 2009 and 2008, the Company incurred $2,412,780 and
$669,833, respectively, in research and development expenditures.
RESULTS
OF OPERATIONS
For
the three months ended March 31, 2009 as compared to March 31, 2008
Our
principal business operations are conducted through our wholly-owned subsidiary,
TDR, and TDR’s wholly-owned subsidiaries.
|
|
For
the Three Months Ended March 31
|
|
|
2009
|
|
Variance
|
|
2008
|
REVENUES
|
|
|
|
|
|
|
|
|
Product
Sales (net of sales allowance)
|
|
$
|
24,833,692
|
|
162%
|
|
$
|
9,467,414
|
Contract
Sales
|
|
|
-
|
|
-%
|
|
|
2,946,016
|
Total
revenues
|
|
|
24,833,692
|
|
100%
|
|
|
12,413,430
|
|
|
|
|
|
|
|
|
|
COST
OF GOODS SOLD
|
|
|
|
|
|
|
|
|
Cost
of goods sold
|
|
|
6,040,918
|
|
111%
|
|
|
2,860,428
|
Gross
Profit
|
|
$
|
18,792,774
|
|
97%
|
|
$
|
9,553,002
|
Total
revenues increased by 100% during the three months ended March 31, 2009 as
compared to 2008. The $12.4 million increase in revenues in 2009 versus
2008 is primarily attributable to strong performances from our sales
distribution channels and the results of our several successful business
acquisitions in 2008.
Product
sales increased by 162% during the three months ended March 31, 2009, to
$24,833,692 from $9,467,414 in 2008. This growth in sales is attributable
to volume and our efforts to continue to develop our distribution channels by
hiring additional 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.
In the
fourth quarter of fiscal 2008, management determined that contract sales were no
longer within our strategic plans. Therefore, effective as of January 1, 2009,
we discontinued sales of products manufactured by other
companies.
Sales
by Product Line
A
break-down of our sales by product line for each of the three months ended March
31, 2009 and 2008 is as follows:
|
|
|
|
For the Three Months Ended March
31,
|
|
|
|
|
|
2009
|
|
|
2008
|
|
Product
|
|
Subsidiary
|
|
Sales
|
|
|
%
of Sales
|
|
|
Sales
|
|
|
%
of Sales
|
|
Patch
|
|
TDR
|
|
$ |
9,121,961 |
|
|
|
37 |
% |
|
$ |
3,797,989 |
|
|
|
30 |
% |
Ointment
|
|
TDR
& TL
|
|
|
5,081,978 |
|
|
|
20 |
% |
|
|
1,487,146 |
|
|
|
12 |
% |
Spray
|
|
TDR
& TL
|
|
|
2,902,074 |
|
|
|
12 |
% |
|
|
1,863,371 |
|
|
|
15 |
% |
Bio-Engineering
|
|
First
|
|
|
3,100,775 |
|
|
|
12 |
% |
|
|
1,825,615 |
|
|
|
15 |
% |
Contract
Sales
|
|
|
|
|
- |
|
|
|
- |
|
|
|
2,946,016 |
|
|
|
24 |
% |
Others
|
|
TDR
& TL & PL
|
|
|
4,626,904 |
|
|
|
19 |
% |
|
|
493,293 |
|
|
|
4 |
% |
Total
|
|
|
|
$ |
24,833,692 |
|
|
|
100 |
% |
|
$ |
12,413,430 |
|
|
|
100 |
% |
There
were various changes in the break-down of sales among our product lines over the
three months ended March 31, 2009 as we continue to develop new products and
expand into new markets. As shown in the table above, sales volume for all
products increased as compared to the three months ended March 31, 2008. To
maintain our competitiveness in the PRC markets, unit selling prices
were reduced in 2008. However, the Company was able to negotiate a lower
purchase price from our suppliers which negated the decrease in the selling
prices of our products. For the three months ended March 31, 2008, $2,946,016,
representing 24% of our total sales, was attributable to Contract Sales. Since
early 2009, the Company began to discontinue its contract sales as part of its
strategic goals. For the three months ended March 31, 2009, the Company did not
have any contract sales. Overall, the Company’s product gross margins were at
76% and 77% during the three months ended March 31, 2009 and 2008,
respectively.
Cost
of Goods Sold and Product Gross Margin
|
|
For
the Three Months ended March 31
|
|
|
|
2009
|
|
Variance
|
|
2008
|
|
Total
revenue
|
|
$
|
24,833,692
|
|
100
|
%
|
$
|
12,413,430
|
|
Cost
of goods sold
|
|
$
|
6,040,918
|
|
111
|
%
|
$
|
2,860,428
|
|
Products
gross margin
|
|
|
76
|
%
|
|
|
|
77
|
%
|
Operating
Expenses
The
following table summarizes the changes in our operating expenses from $4,702,976
to $9,685,066 for each of the three months ended March 31, 2008 and 2009,
respectively:
|
|
For
the Three Month ended March 31
|
|
|
2009
|
|
Variance
|
|
|
2008
|
Operating
expenses
|
|
|
|
|
|
|
|
|
|
Selling,
general and administrative
|
|
$ |
6,877,468
|
|
74
|
%
|
|
$ |
3,956,795
|
Depreciation
and amortization
|
|
|
451,372
|
|
491
|
%
|
|
|
76,348
|
Research
and development
|
|
|
2,412,780
|
|
260
|
%
|
|
|
669,833
|
Total
operating expenses
|
|
$
|
9,741,620
|
|
107
|
%
|
|
$
|
4,702,976
|
Selling,
general and administrative expenses for the three months ended March 31, 2009
increased approximately $2.9 million or 74% over the same period in 2008. The
higher selling, general and administrative expenses were primarily attributable
to the increased costs of marketing our products from approximately $3.4 million
in the three month period ended March 31, 2008, to $6.2 million in the same
period in 2009.
Depreciation
and amortization expenses in the first quarter of 2009 were $451,372, an
increase of $375,024 , or 491%, from $76,348 in the same period in the prior
year. The increase was the result of the three business acquisitions we
consummated in fiscal 2008.
Research
and development expenses were $2,412,780 in the three months ended March 31,
2009 compared to $669,833 for 2008. The increased R&D expenses of
approximately $1.7 million in 2009 versus 2008 were primarily due to additional
clinical trials and development of patents to generate continued sales
growth.
Liquidity
and Capital Resources
The
following table summarizes our cash and cash equivalents position, our working
capital, and our cash flow activity as of March 31, 2009 and 2008 and for each
of the three months then ended:
|
|
2009
|
|
|
2008
|
|
As
of March 31:
|
|
|
|
|
|
|
Cash,
cash equivalents and marketable securities
|
|
$ |
48,788,597 |
|
|
$ |
38,237,994 |
|
Working
capital
|
|
$ |
65,883,670 |
|
|
$ |
43,563,886 |
|
Inventories
|
|
$ |
1,320,295 |
|
|
$ |
794,730 |
|
Three
Months Ended March 31:
|
|
|
|
|
|
|
|
|
Cash
provided by (used in):
|
|
|
|
|
|
|
|
|
Operating
activities
|
|
$ |
8,492,650 |
|
|
$ |
5,197,579 |
|
Investing
activities
|
|
$ |
(69,799 |
) |
|
$ |
(1,105,700 |
) |
Financing
activities
|
|
$ |
29,169 |
|
|
$ |
24,227,551 |
|
As of
March 31, 2009, cash and cash equivalents were approximately $48.8 million as
compared to $38.2 million at March 31, 2008. The increased cash and cash
equivalents position of approximately $10.6 million at March 31, 2009 was
primarily due to our cash flows provided by operating activities in 2009 of
approximately $8.5 million and reduced investing activities for the purchase of
fixed assets and intangible assets.
Our
corporate headquarters is expected to be completed in 2009 at an additional
estimated cost of approximately $5.0 million. The Company plans to fund our
corporate headquarters construction project using internal funds.
The
Company’s current ratio was 10.54 versus 9.77 and the quick ratio was 9.11
versus 9.60 at March 31, 2009 and 2008, respectively. 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.
At March
31, 2009, there are no restrictive bank deposits pledged as
security.
Cash
flows provided by operating activities was approximately $8.5 million for the
three months ended March 31, 2009, compared to $5.2 million for the same period
in 2008. The increase in cash provided by operating activities of approximately
$3.3 million is primarily attributable to the increased net income of
approximately $7.2 million in the three months ended March 31, 2009 versus $3.9
million in the same period of 2008.
Our
working capital position at March 31, 2009 was approximately $65.9 million,
compared to $43.6 million at March 31, 2008. Our increased working capital
position in 2009 resulted principally from the cash flows generated from our
operating activities of approximately $8.5 million in the three months ended
March 31, 2009. Management considers current working capital and
borrowing capabilities adequate to cover our current operating and capital
requirements for the full year 2009.
In the
first quarter of fiscal 2008 we received aggregate net proceeds of $23.5 million
from the consummation of a private placement of our securities. The net proceeds
from the private offering were used to fund three business acquisitions we
completed in fiscal 2008 and other working capital needs. There was no similar
financing in the three month period ended March 31, 2009.
Currency
Exchange Fluctuations
All of
Company’s revenues and majority of the expenses during the three months ended
March 31, 2009 were denominated primarily in Renminbi (“RMB”), the currency of
China, and was converted into US dollars at the exchange rate of 6.84659 RMB to
1 U.S. Dollar. In the third quarter of 2005, the Renminbi began to rise against
the US dollar. The exchange rate as of December 31, 2007 and 2008 was 7.3141 and
6.8542 RMB to 1 U.S. Dollar respectively. The exchange rate as of March 31, 2008
was 7.0222 RMB to 1 U.S. 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.
We are a
smaller reporting company as defined by Rule 12b-2 of the Securities Exchange
Act of 1934 and are not required to provide the information under this
item.
Item
4. Controls and Procedures.
Disclosure
Controls and Procedures
Our
management, with the participation of our chief executive officer and interim
chief financial officer, evaluated the effectiveness of our disclosure controls
and procedures pursuant to Rule 13a-15 under the Securities Exchange Act of 1934
as of March 31, 2009. In designing and evaluating the disclosure controls
and procedures, management recognizes that any controls and procedures, no
matter how well designed and operated, can provide only reasonable assurance of
achieving the desired control objectives. In addition, the design of disclosure
controls and procedures must reflect the fact that there are resource
constraints and that management is required to apply its judgment in evaluating
the benefits of possible controls and procedures relative to their
costs.
Based
on our evaluation, our chief executive officer and interim chief financial
officer concluded that our disclosure controls and procedures are designed at a
reasonable assurance level and are effective to provide reasonable assurance
that information we are required to disclose in reports that we file or submit
under the Exchange Act is recorded, processed, summarized and reported within
the time periods specified in Securities and Exchange Commission rules and
forms, and that such information is accumulated and communicated to our
management, including our chief executive officer and interim chief financial
officer, as appropriate, to allow timely decisions regarding required
disclosure.
Changes
in Internal Control Over Financial Reporting
There was
no change in our internal control over financial reporting that occurred during
our first quarter of fiscal 2009, that has materially affected, or is reasonably
likely to materially affect, our internal control over financial
reporting.
PART
II - OTHER INFORMATION
Item
1. Legal Proceedings.
We are
not a party to any material pending legal proceedings.
Item
1A. Risk Factors.
We are a
smaller reporting company as defined by Rule 12b-2 of the Securities Exchange
Act of 1934 and are not required to provide the information under this
item.
Item
2. Unregistered Sales of Equity Securities and Use of
Proceeds.
In the
three-month period ended March 31, 2009, and subsequent period through the date
hereof, we did not engage in any unregistered sales of equity securities other
than as set forth below:
As of
January 20, 2009, warrants to purchase 8,334 shares of our common stock, which
we issued to “accredited” investors in connection with the private offering we
completed in October 2006, were exercised at a price of $3.50 per share, for an
aggregate of $29,169.
As of
January 22, 2009, warrants to purchase an aggregate of 150,000 shares of our
common stock, which we issued to a consultant in consideration for services
rendered in connection with the share exchange transaction we consummated in May
2006, were exercised on a cashless basis. In connection with the cashless
exercise, the warrant holder was deemed to have paid an amount equal to the
difference between the exercise price ($2.00 per share) and the average closing
price of a share of our common stock during the ten (10) trading days ending on
the date of exercise ($16.62 per share). As a result of such cashless exercise,
we issued an aggregate of 131,949 shares of our common stock to the warrant
holder. Following this exercise, the warrant holder still held warrants to
purchase an additional 150,000 shares of our common stock, could be exercised in
whole, or in part, for cash, or on a cashless basis.
As of
April 29, 2009, the warrant holder referred to in the preceding paragraph
exercised his remaining 150,000 warrants to purchase shares of our common stock,
on a cashless basis. In connection with the cashless exercise, the warrant
holder was deemed to have paid an amount equal to the difference between the
exercise price ($2.00 per share) and the average closing price of a share of our
common stock during the ten (10) trading days ending on the date of exercise
($14.75 per share). As a result of such cashless exercise, we issued an
aggregate of 129,661 shares of our common stock to the warrant
holder.
We
believe that these transactions are exempt from registration under the
Securities Act of 1933, as amended, pursuant to Section 4(2), or Regulation D
promulgated thereunder, as transactions by an issuer not involving a public
offering.
Item
3. Defaults Upon Senior Securities.
In the
three-month period ended March 31, 2009, and subsequent period through the date
hereof, we did not default upon any senior securities.
Item
4. Submission of Matters to a Vote of Security Holders.
In the
three-month period ended March 31, 2009, and subsequent period through the date
hereof, we did not submit any matters to a vote of our
stockholders.
Item
5. Other Information.
There was
no information we were required to disclose in a report on Form 8-K during the
three-month period ended March 31, 2009, or subsequent period through the date
hereof, which was not so reported.
Item
6. Exhibits
Exhibit No.
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Description of Exhibit |
31.1
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Certification
of Principal Executive Officer pursuant to Rule 13a-14 and Rule 15d-14(a),
promulgated under the Securities and Exchange Act of 1934, as
amended*
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31.2
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Certification
of Interim Principal Financial and Accounting Officer pursuant to Rule
13a-14 and Rule 15d-14(a), promulgated under the Securities and Exchange
Act of 1934, as amended*
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32.1
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Certification
pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002 (Principal Executive
Officer)*
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32.2
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Certification
pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002 (Interim Principal Financial and Accounting
Officer)*
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* Filed
herewith
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SIGNATURES
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 13, 2009
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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 13, 2009
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By:
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/s/ Liu Yan Qing
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Stanley
Hao
Interim
Chief Financial Officer
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