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PART I. - FINANCIAL INFORMATION | ||||
Item 1. | Financial Statements. |
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Item 2. |
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Item 3. | Quantitative and Qualitative Disclosures About Market Risk. |
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Item 4T | Controls and Procedures. |
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PART II - OTHER INFORMATION | ||||
Item 1. | Legal Proceedings. |
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Item 1A. | Risk Factors. |
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Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds. |
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Item 3. | Defaults Upon Senior Securities. |
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Item 4. | Submission of Matters to a Vote of Security Holders. |
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Item 5. | Other Information. |
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Item 6. | Exhibits. |
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REPORT September 30, December 31, 2008 2007 ASSETS (Unaudited) CURRENT ASSETS: Cash $ 2,656,770 $ 4,557,957 Accounts receivable, net of allowance for doubtful accounts and sale returns 13,882,298 20,430,827 Inventories, net of reserve for obsolete inventory 8,621,880 3,410,739 Prepaid expenses 77,440 1,009,382 Deferred debt costs 563,928 29,340 Total Current Assets 25,802,316 29,438,245 PROPERTY AND EQUIPMENT - Net 7,679,960 6,169,966 OTHER ASSETS Deposit on patent license 2,917,536 — Deposit on land use right 17,120,100 — Intangible assets, net of accumulated amortization 1,266,020 1,291,322 Total Assets $ 54,785,932 $ 36,899,533 LIABILITIES AND SHAREHOLDERS’ EQUITY CURRENT LIABILITIES: Convertible debt, net of debt discount $ — $ 2,561,645 Accounts payable and accrued expenses 1,845,398 764,491 Value-added and service taxes payable 3,303,152 572,200 Advances from customers — 34,531 Unearned revenue 629,084 530,063 Due to related parties 1,355,077 323,178 Total Current Liabilities 7,132,711 4,786,108 LONG-TERM LIABILITIES: Due to related parties 656,446 738,300 Notes payable - related parties 5,055,787 4,738,508 Series A convertible redeemable preferred stock, $.001 par value; 10,000,000 shares authorized; 5,747,118 and -0- shares issued and outstanding at September 30, 2008 and December 31, 2007, respectively 3,559,941 — Total Liabilities 16,404,885 10,262,916 SHAREHOLDERS’ EQUITY: Common stock ($.001 par value; 200,000,000 shares authorized; 42,420,239 and 41,794,200 shares issued and outstanding at September 30, 2008 and December 31, 2007, respectively) 42,420 41,794 Additional paid-in capital 11,277,143 8,095,848 Statutory reserves 3,022,992 2,161,505 Retained earnings 19,883,460 14,355,913 Other comprehensive gain - cumulative foreign currency translation adjustment 4,155,032 1,981,557 Total Shareholders’ Equity 38,381,047 26,636,617 Total Liabilities and Shareholders’ Equity $ 54,785,932 $ 36,899,533 For the Three Months Ended For the Nine Months Ended September 30, September 30, 2008 2007 2008 2007 (As Restated) (As Restated) NET REVENUES: Wholesale $ 13,818,369 $ 11,429,926 $ 40,749,696 $ 25,715,018 Retail 1,203,698 1,643,501 2,606,091 3,244,739 Other revenues 1,681,817 3,480,922 4,442,886 8,689,579 Total Net Revenues 16,703,884 16,554,349 47,798,673 37,649,336 COST OF SALES 8,219,358 9,856,382 25,684,501 22,738,456 GROSS PROFIT 8,484,526 6,697,967 22,114,172 14,910,880 OPERATING EXPENSES: Selling expenses 4,293,704 1,441,950 11,291,590 2,864,746 Research and development 12,448 1,255,844 1,193,916 1,549,132 General and administrative 420,716 912,546 1,589,176 2,631,356 Total Operating Expenses 4,726,868 3,610,340 14,074,682 7,045,234 INCOME FROM OPERATIONS 3,757,658 3,087,627 8,039,490 7,865,646 OTHER INCOME (EXPENSE): Debt issuance costs (99,516 ) (58,679 ) (261,919 ) (146,699 ) Registration rights penalty — — (650 ) (110,000 ) Interest income 9,032 — 11,620 — Interest expense (453,498 ) (807,608 ) (1,399,507 ) (1,508,781 ) Total Other Income (Expense) (543,982 ) (866,287 ) (1,650,456 ) (1,765,480 ) INCOME BEFORE INCOME TAXES 3,213,676 2,221,340 6,389,034 6,100,166 INCOME TAXES — — — — NET INCOME $ 3,213,676 $ 2,221,340 $ 6,389,034 $ 6,100,166 COMPREHENSIVE INCOME: NET INCOME $ 3,213,676 $ 2,221,340 $ 6,389,034 6,100,166 OTHER COMPREHENSIVE INCOME: Unrealized foreign currency translation gain 127,833 180,895 $ 2,173,475 552,815 COMPREHENSIVE INCOME $ 3,341,509 $ 2,402,235 $ 8,562,509 $ 6,652,981 NET INCOME PER COMMON SHARE: Basic $ 0.08 $ 0.05 $ 0.15 $ 0.15 Diluted $ 0.07 $ 0.05 $ 0.13 $ 0.14 WEIGHTED AVERAGE COMMON SHARES OUTSTANDING: Basic 42,420,239 41,356,483 42,269,997 41,317,461 Diluted 48,167,357 44,356,483 48,017,115 44,317,461 For the Nine Months Ended September 30, 2008 2007 (As Restated) CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 6,389,034 $ 6,100,166 Adjustments to reconcile net income from operations to net cash provided by operating activities: Depreciation and amortization 469,455 422,055 Amortization of deferred debt issuance costs 261,545 146,699 Amortization of debt discount 208,355 1,041,774 Amortization of discount on convertible redeemable preferred stock 592,966 — Stock based compensation 392,341 239,200 Warrant repricing 74,593 — Decrease in allowance for doubtful accounts and sales returns (490,310 ) (1,723,258 ) Changes in assets and liabilities: Accounts receivable 8,244,225 (6,327,758 ) Inventories (4,880,418 ) 2,390,052 Prepaid expenses and other current assets 1,080,576 251,225 Accounts payable and accrued expenses 1,032,245 (101,796 ) Value-added and service taxes payable 2,637,331 1,298,344 Unearned revenue 62,225 122,924 Advances from customers (36,086 ) (170,971 ) NET CASH PROVIDED BY OPERATING ACTIVITIES 16,038,077 3,688,656 CASH FLOWS FROM INVESTING ACTIVITIES: Collections from related party advances — 801,238 Deposit on patent right (2,857,608 ) — Deposit on land use right (16,768,445 ) — Purchase of intangible asset (3,429 ) — Purchase of property and equipment (1,430,894 ) (384,198 ) NET CASH (USED IN) PROVIDED BY INVESTING ACTIVITIES (21,060,376 ) 417,040 CASH FLOWS FROM FINANCING ACTIVITIES: Net proceeds (payments) from convertible debt (2,520,000 ) 2,950,000 Proceeds from sale of convertible redeemable peferred stocks 5,000,000 — Payment of debt issuance costs (468,568 ) (231,526 ) Proceeds from related party advances 860,916 — Repayments of related party advances — (863,480 ) Repayments of notes payable - related parties — (1,971,772 ) NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES 2,872,348 (116,778 ) EFFECT OF EXCHANGE RATE ON CASH 248,764 116,228 NET (DECREASE) INCREASE IN CASH (1,901,187 ) 4,105,146 CASH - beginning of period 4,557,957 2,089,156 CASH - end of period $ 2,656,770 $ 6,194,302 SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: Cash paid for: Interest $ 103,250 $ 1,582,393 Income taxes $ — $ — Non-cash investing and financing activities: Warrants issued for prepaid financing costs $ 327,565 $ — Warrants issued for consulting $ 178,187 $ — Common stock issued for compensation $ 318,551 $ — Common stock issued for conversion of convertible debt $ 250,000 $ — Debt discount for grant of warrants and beneficial conversion feature $ 2,033,025 $ — Allowance for doubtful accounts Allowance for sales returns Total Balance - December 31, 2006 $ 539,627 $ 2,297,399 $ 2,837,026 Reductions (26,617) (2,354,720) (2,381,337) Foreign currency translation adjustments 35,073 57,321 92,394 Balance - December 31, 2007 548,083 - 548,083 Reductions (unaudited) (490,310) - (490,310) Foreign currency translation adjustments (unaudited) 26,416 - 26,416 Balance - September 30, 2008 (unaudited) $ 84,189 $ - $ 84,189 The Company did not consider it necessary to record any inventory reserve during the three months ended March 31, 2009 and the year ended December 31, 2008. For the Three Months Ended September 30, 2008 2007 Net income for basic and diluted earnings per share $ 3,213,676 $ 2,221,340 Weighted average shares outstanding - basic 42,420,239 41,356,483 Effect of dilutive securities: Unexercised warrants — — Convertible debentures — 3,000,000 Convertible redeemable preferred shares 5,747,118 — Weighted average shares outstanding- diluted 48,167,357 44,356,483 Earnings per share - basic $ 0.08 $ 0.05 Earnings per share - diluted $ 0.07 $ 0.05 For the Nine Months Ended September 30, 2008 2007 Net income for basic and diluted earnings per share $ 6,389,034 $ 6,100,166 Weighted average shares outstanding - basic 42,269,997 41,317,461 Effect of dilutive securities: Unexercised warrants — — Convertible debentures — 3,000,000 Convertible redeemable preferred shares 5,747,118 — Weighted average shares outstanding- diluted 48,017,115 44,317,461 Earnings per share - basic $ 0.15 $ 0.15 Earnings per share - diluted $ 0.13 $ 0.14 respectively. September 30, 2008 December 31, 2007 Accounts receivable $ 13,966,487 $ 20,978,910 Less: allowance for doubtful accounts (84,189) (548,083) $ 13,882,298 $ 20,430,827 September 30, 2008 December 31, 2007 Raw materials $ 2,163,247 $ 2,312,111 Work in process 0 279,759 Packaging materials 14,414 52,967 Finished goods 6,489,622 808,456 8,667,283 3,453,293 Less: reserve for obsolete inventory (45,403) (42,554) $ 8,621,880 $ 3 ,410,739 Useful Life September 30, 2008 December 31, 2007 Office equipment and furniture 5-8 Years $ 242,688 $ 154,488 Manufacturing equipment 10 - 15 Years 5,571,015 5,032,601 Building and building improvements 20 - 40 Years 3,135,752 2,938,966 Construction in progress 1,181,602 - 10,131,057 8,126,055 Less: accumulated depreciation (2,451,097) (1,956,089) $ 7,679,960 $ 6,169,966 will expire in August 2009. September 30, 2008 December 31, 2007 Manufacturing rights $ 1,264,168 $ 1,187,569 Revenue right 1,312,891 1,230,500 Other 6,419 0 2,583,478 2,418,069 Less: accumulated amortization (1,317,458) (1,126,747) $ 1,266,020 $ 1,291,322 2009 $ 148,117 2010 66,812 2011 66,423 2012 65,644 thereafter 919,024 Total 1,266,020 September 30, 2008 December 31, 2007 Note to Song Guoan, father of Song Zheng Hong, director and spouse of Liu Zhong Yi, due on December 30, 2015 with variable annual interest at 80% of current bank rate (6.26% at September 30, 2008 and December 31, 2007), and unsecured $ 761,794 $ 1,895,424 Note to Zheng Gui Xin, employee, due on December 30, 2015 with variable annual interest at 80% of current bank rate (6.26% at September 30, 2008 and December 31, 2007), and unsecured 1,649,137 1,545,645 Note to Ma Zhao Zhao, employee, due on December 30, 2015 with variable annual interest at 80% of current bank rate (6.26% at September 30, 2008 and December 31, 2007), and unsecured 660,475 619,027 Note to Liu Zhong Yi, officer and director, due on December 30, 2015 with variable annual interest at 80% of current bank rate (6.26% at September 30, 2008 and December 31, 2007), and unsecured 1,405,909 136,244 Note to Song Zheng Hong, director and spouse of the Company chief executive officer, Liu Zhong Yi, due on December 30, 2015 with variable annual interest at 80% of current bank rate (6.26% at September 30, 2008 and December 31, 2007), and unsecured 578,472 542,168 Total notes payable - related parties, long term $ 5,055,787 $ 4,738,508 The Company agreed to undertake to file a resale registration statement within 60 days following the Closing Date mandatory 8% annual dividends. to Adam Wasserman (former CFO) using a fair value of $0.26 per share on the grant date for his services rendered through December 31, 2008 as the Company’s chief financial officer. $416,645 and $156,851, respectively. Shares Average Exercise price per share Warrants outstanding December 31, 2007 1,500,000 0.87 Warrants issued 3,726,999 1.22 Warrants terminated/forfeited - - Warrants exercised (60,000) 0.87 Warrants outstanding, September 30, 2008 5,166,999 1.13 2008 Wholesale and third-party manufacturing Retail Operations Unallocated Total Net Revenues $ 15,193,602 $ 1,420,670 $ 89,612 $ 16,703,884 Cost of Sales (excluding depreciation) 7,428,195 667,774 3,831 8,099,800 Operating expenses (excluding depreciation and amortization) - 4,684,683 4,684,683 Depreciation and Amortization 112,760 6,798 42,185 161,743 Other Expense - 90,484 90,484 Interest Expense - 453,498 453,498 Net Income (Loss) $ 7,652,647 $ 746,098 $ (5,185,069) $ 3,213,676 2007 Wholesale and third-party manufacturing Retail Operations Unallocated Total Net Revenues $ 13,639,037 $ 2,688,918 $ 226,394 $ 16,554,349 Cost of Sales (excluding depreciation) 8,982,872 663,984 8,239 9,655,095 Operating expenses (excluding depreciation and amortization) - - 3,664,769 3,664,769 Depreciation and Amortization 103,527 5,447 37,884 146,858 Other Expense - - 58,679 58,679 Interest Expense - - 807,608 807,608 Net Income (Loss) $ 4,552,638 $ 2,019,487 $ (4,350,785) $ 2,221,340 2008 Wholesale and third-party manufacturing Retail Operations Unallocated Total Net Revenues $ 44,254,921 $ 3,187,557 $ 356,195 $ 47,798,673 Cost of Sales (excluding depreciation) 23,621,393 1,701,382 15,575 25,338,350 Operating expenses (excluding depreciation and amortization) - - 13,951,377 13,951,377 Depreciation and Amortization 325,757 20,394 123,305 469,456 Other Expense 250,949 250,949 Interest Expense 1,399,507 1,399,507 Net Income (Loss) $ 20,307,771 $ 1,465,781 $ (15,384,518) $ 6,389,034 2007 Wholesale and third-party manufacturing Retail Operations Unallocated Total Net Revenues $ 32,769,631 $ 4,316,890 $ 562,815 $ 37,649,336 Cost of Sales (excluding depreciation) 20,826,503 1,592,348 22,441 22,441,292 Operating expenses (excluding depreciation and amortization) - - 6,920,343 6,920,343 Depreciation and Amortization 282,306 14,858 124,891 422,055 Other Expense - - 256,699 256,699 Interest Expense - - 1,508,781 1,508,781 Net Income (Loss) $ 11,660,822 $ 2,709,684 $ (8,270,340) $ 6,100,166 Buildings and leasehold improvement 20 to 40 years Manufacturing equipment 10 to 15 years Office equipment and furniture 5 to 8 years 2008 2007 Wholesale $ 40,749,696 $ 25,715,018 Retail 2,606,091 3,244,739 Other revenues 4,442,886 8,689,579 Total net revenues $ 47,798,673 $ 37,649,336 For the For the For the 2008 2007 Leasing revenues $ 581,238 $ 619,541 Third-party manufacturing 3,505,225 7,054,613 Advertising revenues 229 452,610 Research and development and lab testing services 356,194 562,815 Total other revenues $ 4,442,886 $ 8,689,579 We sublease certain portion our retail stores and counter spaces to various other vendors and generate leasing revenue. The leasing revenue remained materially consistent with prior year same period. The slight For third-party manufacturing, customers supply the raw materials and we are paid a fee for manufacturing their products. We had less large manufacturing contracts during the We performed research and development and lab testing projects for various third parties and performed drug testing and analysis. We preformed less R&D testing services and drug testing and analysis work for third parties during the products. March 31, 2009. Nine months ended September 30, 2008 2007 Salaries and related benefits $ 965,682 $ 1,311,215 Amortization and depreciation expenses 123,305 127,533 Rent 133,336 227,997 Travel and entertainment 49,609 273,074 Professional fees 329,211 167,766 Bad debt recovery (490,310) - Other 478,343 523,771 Total $ 1,589,176 $ 2,631,356 Salaries and related benefits decreased Depreciation on our fixed assets and amortization of our intangible assets Travel and entertainment expenses Professional fees increased Other For the For the 2008 2007 Wholesale $ 13,818,369 $ 11,429,926 Retail 1,203,698 1,643,501 Other revenues 1,681,817 3,480,922 Total net revenues $ 16,703,884 $ 16,554,349 2008 2007 Leasing revenues $ 216,959 $ 179,926 Third-party manufacturing 1,375,233 2,917,335 Advertising revenues - 157,267 Research and development and lab testing services 89,625 226,394 Total other revenues $ 1,681,817 $ 3,480,922 Three months ended June 30, 2008 2007 Salaries and related benefits $ 421,228 $ 484,252 Amortization and depreciation expenses 42,185 77,416 Rent 54,387 94,485 Travel and entertainment 12,570 179,045 Professional fees 143,593 19,506 Bad debt recovery (490,310) - Other 237,063 57,842 Total $ 420,716 $ 912,546 Liquidity and Capital Resources China $ 2,649,898 USA 6,872 Total $ 2,656,770 $0.13 million. 2008. Included in this change were a decrease of $589,397 in raw materials and a decrease of $2,097 in packing materials offset by increase in finished goods of $529,820. We expect to maintain slight higher raw materials, packaging materials and finished goods inventory levels to accommodate for anticipated future sales growth and productions. on March 31, 2009. it began March 2008. $1,231,730 at December 31, 2008, an increase of $7,653,616. The increase was primarily attributable to purchase of a new drug certificate and intellectual property right. China. $35,197 and the add back of net income of $996,099, depreciation and amortization of $148,884, amortization of debt issuance costs of $62,512 and amortization of debt discount of $208,355 and amortization of discount on convertible redeemable preferred stock of $84,709, increase in allowance for doubtful accounts and sales return of $53,305, offset by increase in taxes payable of $41,792 and increase in unearned revenue of $217,749. $0. March 31, 2008. refundable if the Chinese local government would not grant it land use rights certificate. Shares. The total of contractual obligations and commitments does not include any payments made by us. Payments Due by Period Total Less than 1 year 1-3 Years 3-5 Years 5 Years + Contractual Obligations: Related Parties Indebtedness $ 5,843,522 $ 131,289 $ 656,446 $ - $ 5,055,787 Patent Purchase Obligations $ 7,002,086 $ 2,625,782 $ 4,376,304 $ - $ - Construction Obligations $ 58,517,017 $ 8,918,907 $ 49,598,110 $ - $ - Total Contractual Obligations: $ 71,362,625 $ 11,675,978 $ 54,630,860 $ 0 $ 5,055,787 We have increased efforts to prevented or detected. No. Description Rule 13a-14(a)/ 15d-14(a) Certification of Chief Executive Officer Rule 13a-14(a)/ 15d-14(a) Certification of Chief Financial Officer Section 1350 Certification of Chief Executive Officer Section 1350 Certification of Chief Financial Officer By: Date: By: East’sEast's strategic initiatives, economic, political and market conditions and fluctuations, U.S. and Chinese government and industry regulation, interest rate risk, U.S., Chinese and global competition, and other factors. Most of these factors are difficult to predict accurately and are generally beyond our control. You should consider the areas of risk described in connection with any forward-looking statements that may be made herein. Readers are cautioned not to place unduesubstantial reliance on these forward-looking statements and readers should carefully review this report in its entirety together with our Annual Report on Form 10-K for the year ended December 31, 20072008 as filed with the SEC, including the risks described in Item 1A. Risk Factors. Except for our ongoing obligations to disclose material information under the Federal securities laws, we undertake no obligation to release publicly any revisions to any forward-looking statements, to report events or to report the occurrence of unanticipated events. These forward-looking statements speak only as of the date of this report, and you should not rely on these statements without also considering the risks and uncertainties associated with these statements and our business.www.lotuseast.com.www.lotuspharma.com. Information on this web site is not a part of this report.PROSPECTUS•“"Lotus,” “" "we,” “" "us,” “" "our,”" the “"Company,”" and similar terms refer to Lotus Pharmaceuticals, Inc., a Nevada corporation formerly known as S.E. Asia Trading Company, Inc., and its subsidiary,· •“"Lotus International”" refers to Lotus Pharmaceutical International, Inc., a Nevada corporation and a subsidiary of Lotus,•“"Lotus Century”" refers to Lotus Century Pharmaceutical (Beijing) Technology co., Ltd., a wholly foreign-owned enterprise (WFOE) Chinese company which is a subsidiary of Lotus,· •“"Liang Fang”" refers to Beijing Liang Fang Pharmaceutical Co., Ltd., a Chinese limited liability company formed on June 21, 2000 and an affiliate of En ZheZe Jia Shi,· •“"En ZheZe Jia Shi”" refers to Beijing En ZheZe Jia Shi Pharmaceutical Co., Ltd., a Chinese limited liability company formed on September 17, 1999 and an affiliate of Liang Fang,· •“"Lotus East”" collectively refers to Liang Fang and En ZheZe Jia Shi,· •“"Consulting Services Agreements”" refers to the Consulting Services Agreements dated September 20, 2006 between Lotus and Lotus East.· •“"Operating Agreements”" refers to the Operating Agreements dated September 20, 2006 between Lotus, Lotus East and the stockholders of Lotus East,· •“"Equity Pledge Agreements”" refers to the Equity Pledge Agreements dated September 20, 2006 between Lotus, Lotus East and the stockholders of Lotus East,· •“"Option Agreements”" refers to the Option Agreements dated September 20, 2006 between Lotus, Lotus East and the stockholders of Lotus East,· •“"Proxy Agreements”" refers to the Proxy Agreements dated September 20, 2006 between Lotus, Lotus East and the stockholders of Lotus East,· •“"Contractual Arrangements”" collectively refers to the Consulting Services Agreements, Operating Agreements, Equity Pledge Agreements, Option Agreements and the Proxy Agreements,· •“"China”" or the “"PRC”" refers to the People’sPeople's Republic of China, and· •“"RMB”" refers to the renminbi which is the currency of mainland PRC of which the yuan is the principal currency. March 31, December 31, 2009 2008 (Unaudited) ASSETS CURRENT ASSETS: Cash $ 1,228,769 $ 1,278,808 Accounts receivable, net of allowance for doubtful accounts 1,395,054 6,132,912 Other receivable 15,777 15,757 Other receivable-employee 730,396 - Other receivable-related party - 2,027,954 Inventories, net of reserve for obsolete inventory 3,726,128 3,787,802 Prepaid expenses and other assets 77,380 121,274 Deferred debt costs 364,894 398,067 Total Current Assets 7,538,398 13,762,574 PROPERTY AND EQUIPMENT - Net 9,591,554 7,554,817 OTHER ASSETS Deposit on patent license 2,921,585 2,917,919 Installments on intangible assets 35,301,508 38,175,134 Intangible assets, net of accumulated amortization 8,885,346 1,231,730 Deferred debt costs - 66,344 Total Assets $ 64,238,391 $ 63,708,518 LIABILITIES AND SHAREHOLDERS' EQUITY CURRENT LIABILITIES: Accounts payable and accrued expenses $ 856,345 $ 2,170,165 Taxes Payable 1,994,388 5,015,908 Unearned revenue 794,516 565,629 Due to related parties 1,715,742 1,588,689 Series A convertible redeemable preferred stock, $.001 par value; 10,000,000 shares authorized; 6,206,890 and 5,747,118 shares issued and outstanding at March 31, 2009 and December 31, 2008, respectively, net 4,341,124 - Total Current Liabilities 9,702,115 9,340,391 LONG-TERM LIABILITIES: Due to related parties 460,150 525,225 Notes payable - related parties 5,062,803 5,056,451 - 3,652,341 Total Liabilities 15,225,068 18,574,408 SHAREHOLDERS' EQUITY: Common stock ($.001 par value; 200,000,000 shares authorized; 43,377,932 and 42,420,239 shares issued and outstanding at March 31, 2009 and December 31, 2008, respectively) 43,378 42,420 Additional paid-in capital 11,802,423 11,554,381 Statutory reserves 4,167,174 3,750,529 Retained earnings 28,708,994 25,557,537 Other comprehensive gain - cumulative foreign currency translation adjustment 4,291,354 4,229,243 Total Shareholders' Equity 49,013,323 45,134,110 Total Liabilities and Shareholders' Equity $ 64,238,391 $ 63,708,518 For the Three Months Ended March 31, 2009 2008 NET REVENUES: Wholesale $ 8,940,405 $ 8,437,298 Retail 2,137,188 2,016,547 Other revenues 746,694 1,255,332 Total Net Revenues 11,824,287 11,709,177 COST OF SALES 5,186,158 7,768,425 GROSS PROFIT 6,638,129 3,940,752 OPERATING EXPENSES: Selling expenses 1,701,799 1,122,337 Research and development - 710,225 General and administrative 747,206 626,417 Total Operating Expenses 2,449,005 2,458,979 INCOME FROM OPERATIONS 4,189,124 1,481,773 OTHER INCOME (EXPENSE): Debt issuance costs (99,517 ) (62,886 ) Interest income 1,319 561 Interest expense (448,097 ) (423,349 ) Total Other Income (Expense) (546,295 ) (485,674 ) INCOME BEFORE INCOME TAXES 3,642,829 996,099 INCOME TAXES 74,727 - NET INCOME $ 3,568,102 $ 996,099 COMPREHENSIVE INCOME: NET INCOME 3,568,102 996,099 OTHER COMPREHENSIVE INCOME: Unrealized foreign currency translation gain 62,111 1,454,203 COMPREHENSIVE INCOME $ 3,630,213 $ 2,450,302 NET INCOME PER COMMON SHARE: Basic $ 0.08 $ 0.02 Diluted $ 0.07 $ 0.02 WEIGHTED AVERAGE COMMON SHARES OUTSTANDING: Basic 43,048,060 42,035,958 Diluted 49,254,950 47,783,076 For the Three Months Ended March 31, 2009 2008 CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 3,568,102 $ 996,099 Adjustments to reconcile net income from operations to net cash provided by (used in) operating activities: Depreciation and amortization 362,467 148,884 Amortization of deferred debt issuance costs 99,517 62,512 Amortization of debt discount - 208,355 Amortization of discount on convertible redeemable preferred stock 288,783 84,709 Amortization of prepaid expense attributable to warrants 14,849 - Increase in allowance for doubtful accounts - 53,305 Changes in assets and liabilities: Accounts receivable 4,744,877 (115,927 ) Inventories 66,423 (3,161,360 ) Prepaid expenses and other current assets 1,329,083 (2,012,656 ) Accounts payable and accrued expenses (666,522 ) (98,515 ) Taxes payable (3,027,383 ) 41,792 Unearned revenue 228,143 217,749 Advances from customers - (35,197 ) NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES 7,008,339 (3,610,250 ) CASH FLOWS FROM INVESTING ACTIVITIES: Installments on intangible assets 2,921,162 - Purchase of intangible asset (7,887,138 ) - Purchase of property and equipment (2,153,243 ) - NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES (7,119,219 ) - CASH FLOWS FROM FINANCING ACTIVITIES: repayment of convertible debt - (2,520,000 ) Proceeds from sale of convertible redeemable peferred stocks - 5,000,000 Payment of debt issuance costs - (468,568 ) Proceeds from related party advances 59,314 357,382 NET CASH PROVIDED BY FINANCING ACTIVITIES 59,314 2,368,814 EFFECT OF EXCHANGE RATE ON CASH 1,527 272,856 NET (DECREASE) INCREASE IN CASH (50,039 ) (968,580 ) CASH - beginning of period 1,278,808 4,557,957 CASH – end of period $ 1,228,769 $ 3,589,377 SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: Cash paid for: Interest $ - $ - Income taxes $ - $ - Non-cash investing and financing activities: Warrants issued for prepaid financing costs and consulting expense $ - $ 505,752 Common stock issued for prior compensation $ 249,000 $ - Common stock issued for conversion of convertible debt $ - $ 250,000 Debt discount for grant of warrants and beneficial conversion feature $ - $ 2,033,025 Preferred stock issued for dividend payable $ 400,000 $ - UNAUDITED CONSOLIDATED FINANCIAL STATEMENTSSEPTEMBER 30,6,28, 2006, the Company entered intopursuant to a definitive Share Exchange Agreement with Lotus Pharmaceutical International, Inc. (“Lotus International”), whereby the Company acquired all of the outstanding common stock of Lotus International from the Lotus International shareholders in exchange for newly-issued stock of the Company to Lotus International’s shareholders. On September 28, 2006 (the closing date),Company. Lotus International became a wholly-owned subsidiary of the Company and Lotus International’s shareholders became the owners of the majority of the Company’s voting stock. The acquisition of Lotus International by the Company was accounted for as a reverse merger because on a post-merger basis, the former shareholders of Lotus International hold a majority of the outstanding common stock of the Company on a voting and fully-diluted basis. As a result, Lotus International is deemed to be the acquirer for accounting purposes.ZheZe Jia Shi Pharmaceutical Co., Ltd. (“En Zhe Jia”Ze Jia Shi”), both of which are pharmaceutical companies headquartered in the PRC and organized under the laws of the PRC (hereinafter, referred to together as “Lotus East”). Lotus International has contractual arrangements with Lotus East and its shareholders pursuant to which Lotus International will provide technology consulting and other general business operation services to Lotus East. Through these contractual arrangements, Lotus International also has the ability to substantially influence Lotus East’s daily operations and financial affairs, appoint its senior executives and approve all matters requiring shareholder approval. As a result of these contractual arrangements, which enable Lotus International to control Lotus East, Lotus International is considered the primary beneficiary of Lotus East. Accordingly, the consolidated financial statements include the accounts of Lotus Pharmaceuticals, Inc. and its wholly-owned subsidiary, Lotus International and companies under its control (Lotus East).On 6, 2006, Lotus International entered into the following contractual arrangements:LOTUS PHARMACEUTICALS, INC. AND SUBSIDIARIESNOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTSSEPTEMBER 30, 2008September 30, 2008,March 31, 2009, Liang Fang owns and operates 10 drug stores throughout Beijing, China. These drugstores sell Western and traditional Chinese medicines, and medical treatment accessories.ZheZe Jia Shi is a Chinese limited liability company and was formed under laws of the People’s Republic of China on September 17, 1999. En ZheZe Jia Shi is the sole manufacturer for Liang Fang and maintains facilities for the production of medicines, patented Chinese medicine, as well as the research and production of other new medicines. LOTUS PHARMACEUTICALS, INC. AND SUBSIDIARIESNOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTSSEPTEMBER 30, 200820072008 included in its Annual Report on Form 10-K. Interim financial results are not necessarily indicative of the results that may be expected for a full year.“Consolidation"Consolidation of Variable Interest Entities” (“Entities" ("FIN 46R”46R"), an Interpretation of Accounting Research Bulletin No. 51. FIN 46R requires a Variable Interest Entity (VIE) to be consolidated by a company if that company is subject to a majority of the risk of loss for the VIE or is entitled to receive a majority of the VIE’sVIE's residual returns. VIEs are those entities in which the Company, through contractual arrangements, bears the risks of, and enjoys the rewards normally associated with ownership of the entities, and therefore the Company is the primary beneficiary of these entities. As a VIE, Lotus East’s revenues are included in the Company’s total revenues, its income from operations is consolidated with the Company’s, and the Company’s net income includes all of Lotus East’s net income.Zhe Jia)Ze Jia Shi). All significant inter-company balances and transactions have been eliminated.20082009 and 20072008 include the allowance for doubtful accounts, the allowance for obsolete inventory, the useful life of property and equipment and intangible assets, fair value of warrants and beneficial conversion features related to the convertible notes, fair value of warrants granted and accruals for taxes due.tofrom related parties approximate their fair market value based on the short-term maturity of these instruments.$100,000$250,000 at each bank.LOTUS PHARMACEUTICALS, INC. AND SUBSIDIARIESNOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTSSEPTEMBER 30, 2008for the periods ended September 30, 2008at March 31, 2009 and December 31, 2007 are2008 is as follows: Total Balance- December 31, 2007 $ 548,083 - 548,083 Additions (Reductions) (575,781 ) - (575,781 ) Foreign currency translation adjustments 27,698 - 27,698 Balance- December 31, 2008 - - - Additions (Reductions) - - - Foreign currency translation adjustments - - - Balance- March 31, 2009 $ - - - weightedmoving average method. An allowance is established when management determines that certain inventories may not be saleable. If inventory costs exceed expected market value due to obsolescence or quantities in excess of expected demand, the Company will record reserves for the difference between the cost and the market value. These reserves are recorded based on estimates and reflected in cost of sales.2007 and during the nine months ended September 30, 2008.LOTUS PHARMACEUTICALS, INC. AND SUBSIDIARIESNOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTSSEPTEMBER 30, 2008Advances from customersAdvances from customers at September 30, 2008 and December 31, 2007 of $0 and $34,531, respectively, consist of prepayments from third party customers to the Company for merchandise that had not yet shipped. The Company will recognize the deposits as revenue as customers take delivery of the goods, in compliance with its revenue recognition policy. 2009 2008 (Unaudited) (Unaudited) Net income for basic and diluted earnings per share $ 3,568,102 $ 996,099 Weighted average shares outstanding – basic 43,048,060 42,035,958 Effect of dilutive securities: Unexercised warrants - - Convertible debentures 6,206,890 5,747,118 Weighted average shares outstanding– diluted 49,254,950 47,783,076 Earnings per share – basic $ 0.08 $ 0.02 Earnings per share – diluted $ 0.07 $ 0.02 LOTUS PHARMACEUTICALS, INC. AND SUBSIDIARIESNOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTSSEPTEMBER 30, 2008September 30,March 31, 2009 and 2008, and 2007, a total of 5,166,999 and 1,500,0005,227,000 outstanding warrants have not been included in the calculation of diluted earnings per shares as the effect would be anti-dilutive. The closing market price of all outstanding warrants of the Company on September 30,March 31, 2009 and 2008 and 2007 was lower than the exercise price of all outstanding warrants. Because of that, the Company assumes that none of the outstanding warrants at that date would have been exercised and therefore none were included in the computation of the diluted earnings per share for period ended September 30, 2008at March 31, 2009 and 2007.2008. Accordingly, the Company has excluded any effect of outstanding warrants as their effect would be anti-dilutive.” “ as amended by SAB No. 104 (together, “SAB 104”), and Statement of Financial Accounting Standards (SFAS) No. 48 “Revenue Recognition When Right of Return Exists.” “ SAB 104 states that revenue should not be recognized until it is realized or realizable and earned. In general, the Company records revenue when persuasive evidence of an arrangement exists, services have been rendered or product delivery has occurred, the sales price to the customer is fixed or determinable, and collectability is reasonably assured., by establishing an accrual in an amount equal to its estimate of sales recorded for which the related products are expected to be returned. The Company determines the estimate of the sales return accrual primarily based on historical experience regarding sales returns, but also by considering other factors that could impact sales returns. These factors include levels of inventory in the distribution channel, estimated shelf life, product discontinuances, and price changes of competitive products, introductions of generic products and introductions of competitive new products. In general, for wholesale sales, the Company provides credit for product returns that are returned six months prior to and up to six months after the product expiration date. Upon sale, the Company estimates an allowance for future product returns. The Company provides additional reserves for contemporaneous events that were not known and knowable at the time of shipment. In order to reasonably estimate future returns, the Company analyzed both quantitative and qualitative information including, but not limited to, actual return rates, the level of product manufactured by the Company, the level of product in the distribution channel, expected shelf life of the product, current and projected product demand, the introduction of new or generic products that may erode current demand, and general economic and industry wide indicators. The Company also utilizes the guidance provided in SAB 104 in establishing its return estimates. TheHistorically, approximately 49% of our total revenues consist of sales of four principal products and product returns from these principal products, as well as the Company’s allowance for salesother products, have been immaterial. Accordingly, based upon the Company’s experience, it historically does not record a reserve at the time of sale and there have been no accounting entries related to its product return was zero both at September 30, 2008 and December 31, 2007. LOTUS PHARMACEUTICALS, INC. AND SUBSIDIARIESNOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTSSEPTEMBER 30, 2008the Company iswe are paid a fee for manufacturing their product and revenue is recognized at the completion of the manufacturing job. The Company recognizes revenues from leasing of space and advertising revenues as earned from contracting third parties. The Company recognizes revenues upon performance of any research or lab testing jobs. Revenues received in advance are reflected as deferred revenue on the accompanying balance sheet. Additionally, the Company receives income from the sale of developed drug formulas. Income from the sale of drug formulas are recognized upon performance of all of the Company’s obligations under the respective sales contract and are included in other income on the accompanying consolidated statement of operations.Shipping costs NOTE 1 - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)Shipping costs related to costs of goods sold were included in selling expenses with a total of $208,997 and $590,000 for the nine months ended September 30, 2008 and 2007, respectively.generalselling expenses and administrative expenses amounted to $175,086$6,500 and $964,448$153,295 for the ninethree months ended September 30,March 31, 2009 and 2008, and 2007, respectively.Company’sCompany's products and fees paid to third parties. For the ninethree months ended September 30,March 31, 2009 and 2008, and 2007, the Company expensed $1,193,916$0 and $1,549,132$710,225 as research and development expense, respectively, and paid for future research and development services in the amount of $0 and $769,742 at September 30, 2008 and December 31, 2007, respectively, which has been included in prepaid expenses on the accompanying balance sheets. The December 31, 2007 prepaid research and development expense has been fully expensed during the period ended September 30, 2008.Translation adjustments resulting from the process of translating the local currency financial statements into U.S. dollars are included in determining comprehensive income. The cumulative translation adjustment for the nine months ended September 30, 2008 and 2007 was $4,155,032 and $1,981,557, respectively. Transaction gains and losses that arise from exchange rate fluctuations on transactions denominated in a currency other than the functional currency are included in the results of operations as incurred.LOTUS PHARMACEUTICALS, INC. AND SUBSIDIARIESNOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTSSEPTEMBER 30, 2008at September 30, 2008on March 31, 2009 and December 31, 20072008 were translated at 6.85516.8456 RMB to $1.00 USD and at 7.31416.8542 RMB to $1.00 USD, respectively. Equity accounts were stated at their historical rate. The average translation rates applied to income statements for the nine monthsthree month ended September 30,March 31, 2009 and 2008 and 2007 were 6.998866.84659 RMB and 7.675767.1757 RMB to $1.00 USD, respectively. In accordance with Statement of Financial Accounting Standards No. 95, “Statement"Statement of Cash Flows,”" cash flows from the Company’sCompany's operations is calculated based upon the local currencies using the average translation rate. As a result, amounts related to assets and liabilities reported on the statement of cash flows will not necessarily agree with changes in the corresponding balances on the balance sheet.As of September 30,For the three months ended March 31, 2009 and 2008, unrealized foreign currency translation gain was $62,111 and December 31, 2007, accumulated other comprehensive income was $4,155,032 and $1,981,557,$1,454,203, respectively.Reclassifications Certain accounts and amounts in the period ended September 30, 2007 financial statements have been reclassified in order to conform to the period ended September 30, 2008 presentation. These reclassifications have no effect on net income.February 2007,March 2008, the FASB issued SFAS No. 159,”The Fair Value Option for Financial Assets and Financial Liabilities, Including an Amendment of FASB Statement No. 115” , under which entities will now be permitted to measure many financial instruments and certain other assets and liabilities at fair value on an instrument-by-instrument basis. This Statement is effective as of the beginning of an entity’s first fiscal year that begins after November 15, 2007. Early adoption is permitted as of the beginning of a fiscal year that begins on or before November 15, 2007, provided the entity also elects to apply the provisions of SFAS 157. The adoption of this interpretation did not have an impact on the Company’s financial position, results of operations, or cash flows.In December 2007, the FASBAccounting Standards Board issued Statement of Financial Accounting Standards No. 141R, Business Combinations (SFAS 141R) and Statement of Financial Accounting Standards No. 160, Accounting and Reporting of Non-controlling Interests in Consolidated Financial Statements, an amendment of ARB No. 51 (SFAS 160). These two standards must be adopted in conjunction with each other on a prospective basis. The most significant changes to business combination accounting pursuant to SFAS 141R and SFAS 160 are the following: (a) recognize, with certain exceptions, 100 percent of the fair values of assets acquired, liabilities assumed and non-controlling interests in acquisitions of less than a 100 percent controlling interest when the acquisition constitutes a change in control of the acquired entity, (b) acquirers’ shares issued in consideration for a business combination will be measured at fair value on the closing date, not the announcement date, (c) recognize contingent consideration arrangements at their acquisition date fair values, with subsequent changes in fair value generally reflected in earnings, (d) the expensing of all transaction costs as incurred and most restructuring costs, (e) recognition of pre-acquisition loss and gain contingencies at their acquisition date fair values, with certain exceptions, (f) capitalization of acquired in-process research and development rather than expense recognition, (g) earn-out arrangements may be required to be re-measured at fair value and (h) recognize changes that result from a business combination transaction in an acquirer’s existing income tax valuation allowances and tax uncertainty accruals as adjustments to income tax expense. Should we decide to enter future business combinations, these new standards will significantly affect the Company’s accounting for future business combinations following adoption on January 1, 2009.In March 2008, the FASB issued SFAS No. 161, Disclosures "Disclosures about Derivative Instruments and Hedging Activities (“SFAS 161”) - an amendment of FASB Statement No. 133" (FASThis statement requires companies to provide enhancedFAS 161 amends and expands disclosures about (a) how and why they use derivative instruments, (b) how derivative instruments and related hedged items are accounted for under Statement 133hedging activities. FAS 161 required qualitative disclosures about the objectives and its related interpretations,strategies of derivative instruments, quantitative disclosures about the fair value amounts of and (c) howgains and losses on derivative instruments, and related hedged items affect a company’s financial position, financial performance, and cash flows. SFASdisclosures of credit-risk-related contingent features in hedging activities. FAS 161 is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008.2008 and will be effective for the Company in fiscal year 2010. Early adoption is prohibited; however, presentation and disclosure requirements must be retrospectively applied to comparative financial statements. The Company has not yet determined the effect, if any, that the adoption of this standard will adopt the new disclosure requirementshave on its financial position or before the required effective date and thus will provide additional disclosures in its consolidated financial statements when adopted.LOTUS PHARMACEUTICALS, INC. AND SUBSIDIARIESNOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTSSEPTEMBER 30, 2008Warrants .Warrants. Additionally, FSP APB 14-1 specifies that issuers of such instruments should separately account for the liability and equity components in a manner that will reflect the entity’s nonconvertible debt borrowing rate when interest cost is recognized in subsequent periods. FSP APB 14-1 is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years. We will adopt FSP APB 14-1 beginning in the first quarter of fiscal 2010, and this standard must be applied on a retrospective basis. We are evaluating the impact the adoption of FSP APB 14-1 will have on our consolidated financial position and results of operations.Principles .Principles. This standard is intended to improve financial reporting by identifying a consistent framework, or hierarchy, for selecting accounting principles to be used in preparing financial statements that are presented in conformity with generally accepted accounting principles in the United States for non-governmental entities. SFAS No. 162 is effective 60 days following approval by the U.S. Securities and Exchange Commission (“SEC”) of the Public Company Accounting Oversight Board’s amendments to AU Section 411, The Meaning of Present Fairly in Conformity with Generally Accepted Accounting Principles .Principles. We do not expect SFAS No. 162 to have a material impact on the preparation of our consolidated financial statements.finalFinal Staff Position (“FSP”) No. EITF 03-6-1, Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities” to address the question of whether instruments granted in share-based payment transactions are participating securities prior to vesting. The FSP determines that unvested share-based payment awards that contain rights to dividend payments should be included in earnings per share calculations. The guidance will be effective for fiscal years beginning after December 15, 2008. We are currently evaluatingThe Company does not expect the requirementsadoption of EITF 03-6-1 will have a material impact on its financial condition or results of operation.No. EITF 03-6-1.99-20-1 did not have a material impact on our consolidated financial statements.September 30, 2008March 31, 2009 and December 31, 2007,2008, accounts receivable consisted of the following:
(Unaudited) March 31, 2009 December 31, 2008 Accounts receivable $ 1,395,054 $ 6,132,912 Less: allowance for sales returns - - Less: allowance for doubtful accounts - - $ 1,395,054 $ 6,132,912 March 31, 2009 December 31, 2008 Raw materials $ 2,294,695 $ 2,884,092 Work in process - - Packaging materials 14,003 16,100 Finished goods 1,417,430 887,610 3,726,128 3,787,802 Less: reserve for obsolete inventory - - $ 3,726,128 $ 3,787,802 UNAUDITED CONSOLIDATED FINANCIAL STATEMENTSSEPTEMBER 30,NOTE 3 - INVENTORIESAt September 30, 2008 and December 31, 2007, inventories consisted of the following:
(Unaudited)45 - PROPERTY AND EQUIPMENTSeptember 30, 2008March 31, 2009 and December 31, 2007,2008, property and equipment consist of the following:
(Unaudited)For the nine months ended September 30, 2008, Useful Life March 31, 2009 December 31, 2008 Office equipment and furniture 3-8 Years $ 243,025 $ 228,673 Manufacturing equipment 10 – 15 Years 5,578,746 5,585,793 Building and building improvements 20 – 40 Years 3,140,104 3,136,164 Construction in progress 3,336,797 1,181,757 12,298,672 10,132,387 Less: accumulated depreciation (2,707,118 ) (2,577,570 ) $ 9,591,554 $ 7,554,817 $1,181,602,$3,336,797, representing construction for a new manufacturing plant located in Cha Ha Er Industrial Garden District in Inner Mongolia, China. The amount included costs for road, electrical, sewage, heating and water pipes constructions.ninethree months ended September 30,March 31, 2009 and 2008, and 2007, depreciation expense amounted to $356,556$126,291 and $315,000$112,302 of which $346,151$119,775 and $301,850$91,058 is included in cost of sales, respectively.5 - 6 – DEPOSITEDDEPOSIT ON PATENT AND INSTALLMENT ON INTANGIBLE ASSETSThe has made a deposit to acquire a Chinese Class I drug patent. Accordingly, the Company recorded $2,921,585 as deposit on patent in accordance with a technology transfer agreementas of March 31, 2009.Company’ entered into in April 2008.Company has made an installment on the Chinese Class I drug patent to obtain the patent according to the signed contract. Therefore, the Company recorded $2,629,426 as installment on intangible assets as of March 31, 2009. The Company will need to make additional installment paymentsinstallments of approximately $4,382,000 to obtain the patent. Accordingly,Company recorded $2,917,536 as deposit on patent as of September 30, 2008.NOTE 6 - DEPOSIT ON LAND USE RIGHT The Company has recorded as a depositChinese SFDA for clinical trial evaluations in the next 21 to 27 months.forto property in the amounts paid to aCha Ha Er Industrial Park ( See note 13), located in Inner Mongolia. The amount has reflected as an installment payment on intangible assets on its balance sheet at March 31, 2009. The installment payment is refundable if the Chinese local government agency in Cha You in Inner Mongolia to acquire a long-term interest to utilize certain land to construct a new manufacture plant. The Company will need to make additional payments to obtain the fullwould not grant it land use right and construct the new facility. The Company has not received the full land use right title and has reflected amounts paid of approximately $17.1 million as of September 30, 2008 as a deposit on land use rights.The deposit is non-refundable in the event the Company decides not to construct the manufacture facility. UNAUDITED CONSOLIDATED FINANCIAL STATEMENTSSEPTEMBER 30,ASSETASSETSCompany’s intangible assets primarily consisted ofCompany purchased manufacturing rights for two approved drugs’drugs. The manufacturing rights and a revenue right. The manufacturing rightsissued are in connection with the Company’s products Valsartan and Brimonidine. The manufacturing rights for Valsartan became effective in November 2000 and had a life of 6.5 years, and fully amortized.which expired in 2007. The manufacturing rights for Brimonidine became effective on August 27, 2005 and have a life of 5 years.$4,376,000$4,382,000 for the construction of a hospital ward in Inner Mongolia, China. In exchange for agreeing to lend to Wu Lan the funds, Wu Lan agreed that the Company will be the exclusive provider for all medicines and disposable medical treatment apparatus to Wu Lan for a period of twenty (20) years. In October 2006, the Company’s chief executive officer, Mr. Liu, lent these funds to Wu Lan on behalf of the Company. The Company entered into an assignment agreement whereby the Company assigned all of its rights, obligations, and receipts under the Loan Agreement to Mr. Liu, except for the rights to revenues from the sale of medical and disposable medical treatment apparatus which will remain with the Company. As compensation to Mr. Liu for accepting the assignment under the loan agreement including all of the risks and obligations and for Liu not accepting the rights to revenues from the sale of medical and disposable medical treatment apparatus which will remain with the Company, the Company agreed to pay Mr. Liu an aggregate of approximately $1,313,000$1,315,000 in 5 equal annual installments of approximately $263,000. Accordingly, the Company recorded an intangible asset of approximately $1,313,000$1,315,000 related to exclusive rights to provide all medicines and disposable medical treatment apparatus to Wu Lan for a period of twenty (20) years. The Company will amortize this exclusive right over a term of 20 years.September 30, 2008March 31, 2009 and December 31, 2007,2008, intangible assets consist of the following:
(Unaudited) March 31, 2009 December 31, 2008 Manufacturing rights $ 1,265,923 $ 1,264,334 Revenue rights 1,314,713 1,313,064 Intellectual rights 7,888,278 - Software 10,810 10,796 10,479,724 2,588,194 Less: accumulated amortization (1,594,378 ) (1,356,464 ) $ 8,885,346 $ 1,231,730 $112,900 and $107,055$236,176and $36,582 for the ninethree months ended September 30,March 31, 2009 and 2008, and 2007, respectively.forto future periods is as follows:Period ending September 30:Period ending March 31: Expense 2010 $ 894,788 2011 857,193 2012 855,610 2013 854,564 Thereafter 5,423,191 Total $ 8,885,346 UNAUDITED CONSOLIDATED FINANCIAL STATEMENTSSEPTEMBER 30, Note to Song Guoan, father of Song Zheng Hong, director and spouse of Liu Zhong Yi, due on December 30, 2015 with variable annual interest at 80% of current bank rate (4.75% and 4.75% at March 31, 2009 and December 31, 2008, respectively), and unsecured $ 762,851 $ 761,894 Note to Zheng Gui Xin, employee, due on December 30, 2015 with with variable annual interest at 80% of current bank rate (4.75% and 4.75% at March 31, 2009 and December 31, 2008, respectively), and unsecured 1,651,426 1,649,354 Note to Ma Zhao Zhao, employee, due on December 30, 2015 with variable annual interest at 80% of current bank rate (4.75% and 4.75% at March 31, 2009 and December 31, 2008, respectively), and unsecured 661,392 660,562 Note to Liu Zhong Yi, officer and director, due on December 30, 2015 with variable annual interest at 80% of current bank rate (4.75% and 4.75% at March 31, 2009 and December 31, 2008, respectively), and unsecured 1,407,860 1,406,094 Note to Song Zheng Hong, director and spouse of the Company chief executive officer, Liu Zhong Yi, due on December 30, 2015 with variable annual interest at 80% of current bank rate (4.75% and 4.75% at March 31, 2009 and December 31, 2008, respectively), and unsecured 579,274 578,547 Total notes payable – related parties, long term $ 5,062,803 $ 5,056,451 Severalninethree months ended September 30,March 31, 2009 and 2008, and 2007, the Company repaid approximately $0 and $119,000did not repay any of these advances, respectively.advances. At September 30, 2008March 31, 2009 and December 31, 2007, the Company had a payable to these employees amounting to $489,770 and $323,178, respectively. These advances are short-term in nature and non-interest bearing.The chief executive officer of the Company and his spouse, from time to time, provided advances to the Company for operating expenses. During the nine months ended September 30, 2008, and 2007, the Company repaid approximately $0 and $744,480 of these advances, respectively. At September 30, 2008 and December 31, 2007, the Company had a payable to the chief executive officer and his spouse and these employees amounting to $865,307$719,439 and $0,$718,536, respectively. These advances are short-term in nature and non-interest bearing.(“("Wu Lan”Lan"), whereby the Company agreed to lend to Wu Lan approximately $4,376,000$4,382,000 for the construction of a hospital ward in Inner Mongolia, China. In exchange for agreeing to lend to Wu Lan the funds, Wu Lan agreed that the Company will be the exclusive provider for all medicines and disposable medical treatment apparatus to Wu Lan for a period of twenty (20) years. In October 2006, the Company’sCompany's chief executive officer, Mr. Liu, lent these funds to Wu Lan on behalf of the Company. Accordingly, the Company entered into an assignment agreement whereby the Company assigned all of its rights, obligations, and receipts under the Loan Agreement to Mr. Liu, except for the rights to revenues from the sale of medical and disposable medical treatment apparatus which will remain with the Company. As compensation to Mr. Liu for accepting the assignment under the loan agreement including all of the risks and obligations and for Mr. Liu not$1,313,000$1,315,000 to be paid in 5 equal$1,313,000$1,315,000 related to exclusive rights to provide all medicines and disposable medical treatment apparatus to Wu Lan for a period of twenty (20) years and a corresponding related party liability. For the ninethree months ended September 30, 2008March 31, 2009 and for the year ended December 31, 2007,2008, the Company paid approximately $0 and $195,000did not pay any of this related party liability, respectively.liability. At September 30, 2008March 31, 2009 and December 31, 2007,2008, amounts due under this assignment agreement amounted to $787,735$1,032,323 and $966,198$1,031,028 of which $656,446$460,150 and $ 738,300$525,225 is included in long-term liabilities and has been included in due to related parties on the accompanying balance sheets, respectively.LOTUS PHARMACEUTICALS, INC. AND SUBSIDIARIESNOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTSSEPTEMBER 30,Notes the Company has recorded accrued interest relating to notes payable - related partiesNotes payable - of $424,130 and $364,350, respectively, which have been included in due to related parties consisted ofon the following at September 30, 2008accompanying balance sheets.2007:
(Unaudited)For the nine months ended September 30, 2008, and 2007, interest expensea summary of activities in due to related to these related loans amounted to $233,704 and $154,547, respectively.NOTE 9 - CONVERTIBLE DEBTThe convertible debenture liabilityparties is as follows at December 31, 2007:Convertible debentures payable$2,770,000 Less: unamortized discount on debentures(208,355)Convertible debentures, net$2,561,645 In January 2008, the Company issued 250,000 shares of its common stock in connection with the conversion of $250,000 of convertible debt. In February 2008, in connection with a private placement (See Note 10), the remaining $2,520,000 of convertible debt and any unpaid interest was repaid in full. The Company amortized the remaining $208,355 in discount on debentures in the nine months ended September 30, 2008. As of September 30, 2008, the balance of the convertible debt is $0. Balance - December 31, 2007 $ 966,198 34,072 61,208 1,061,478 Additions - 682,179 299,036 981,215 Payments made - - - - Foreign currency fluctuations 64,830 2,285 4,106 71,221 Balance - December 31, 2008 $ 1,031,028 718,536 364,350 2,113,914 Additions - - 59,322 59,322 Payments made - - - - Foreign currency fluctuations 1,295 903 458 2,656 Balance - March 31, 2009 $ 1,032,323 719,439 424,130 2,175,892 LOTUS PHARMACEUTICALS, INC. AND SUBSIDIARIESNOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTSSEPTEMBER 30, 2008109 - CONVERTIBLE REDEEMABLE PREFERRED STOCKSentered intosold, pursuant to a Convertible Redeemable Preferred Share and Warrant Purchase Agreement (the “Purchase Agreement”) by and among the Company, Dr. Liu Zhong YiZhongyi and Mrs. Song Zhenghong (the “Founders”proxi matel y $46 9,000), and accredited investors (each a “Purchaser” and collectively, the “Purchasers”), 5,747,118 shares of the Company’s series A convertible redeemable preferred stock (the “Preferred Stock”) and warrants (the “Warrants”) to purchase 2,873,553 shares of the Company’s common stock, in c asha private placement (the “February 2008 Private Placement”) pursuant to Regulation D under the Securities Act of 1933, for the aggregate purchase price of $5 million (the “Transaction”). Net proceeds, exclusive of expenses of the transaction were $4.6 million in cash, after the Company paid fees of approximately $469,000 in cash of which $400,000 was paid to Maxim Group, LLC, the placement agent for the Transaction. The Company recorded the approximately $796,000 in fees, of which $327,565 was related to value of the warrants granted to placement agent, as a deferred debt cost and amortized approximately $232,205$ 99,517 and $33,172 of the deferred cost during the ninethree months ended September 30, 2008.at March 31, 2009 and 2008, respectively. The Company has presented the convertible redeembableredeemable preferred stocks as long termstock is deemed debt due to the mandatory redeemable feature of the preferred stocks.willhas at contrary to use the remainder of the net proceeds for working capital and general corporate purposes.The Purchase Agreement includes customary representations and warranties by each party thereto. The following is a brief description of the terms and conditions of the Purchase Agreement and the transactions contemplated there under that are material to the Company:Pursuant to the Purchase Agreement, the Company issued to the Purchasers an aggregate of 5,747,118 shares of the Company’s series A convertible redeemable preferred stock, par value $0.001 per share, at a price equal to $0.87 per share (the “Preferred Shares”). may be convertedis convertible into one share of the Company’s common stock par value $0.001 per share (as adjusted for stock splits, stock dividends, reclassification and the like). The Preferred Shares pay, pays an 8% dividend annually, which is payable in additional Preferred Shares.Convertible Preferred Shares and also paypays any dividend to be paid on the common shares on an as convertedas-converted basis. For a period of 90 days after FebruaryUntil May 25, 2010, thesethe Preferred Shares may also be redeemed at the option of the Purchasers at the redemption price of $0.87 per share (as adjusted for stock splits, stock dividends, reclassification and the like), and no other capital stock of the Company may be redeemable prior to the Preferred Shares. Holders of Preferred Shares may not convert Preferred Shares to common shares if the conversion would result in the holder beneficially owning more than 4.99% of the Company’s outstanding common shares. That limitation may be waived by a holder of Preferred Shares on not less than 61 days written notice to the Company. In addition, the Company issued to the Purchasers warrants to purchase up to 2,873,553 shares of the Company’s common stock in the aggregate. warrantsWarrants have an initial exercise price of $1.20 (subject to adjustment pursuant to the terms of the warrants). The warrants, are exercisable for a period of five (5) years from the Closing Date. Holders of the warrantsand may not exercise the warrantsbe exercised if the exercise would result in the holder beneficially owning more than 4.99% of the Company’s outstanding common shares. That limitation may be waived by a holder of the warrants on not less than 61 days written notice to the Company.LOTUS PHARMACEUTICALS, INC. AND SUBSIDIARIESNOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTSSEPTEMBER 30, 2008in order to registerregistering the maximum number of shares common stock issuable fromupon conversion of the Preferred Shares and underlyingexercise of the warrants that is allowable under applicable federal securities regulations. The Company is also obligated to have the registration statement declared effective within 120 days following the Closing Date. If the Company iswas informed by the SEC that there arewere no comments to the registration statement, then the registration statement mustwas required to be declared effective within five (5) business days thereafter or on the 60th day after the filing date, whichever is sooner. TheIf the SEC issued comments to the registration statement, mustthen the registration statement was required to be declared effective by the 120th day after its filing ifit was filed. If the SEC has comments. Otherwise,registration statement was not declared effective by the applicable date, the Company iswould be subject to liquidated damages, equal to 1% of the total conversion price and exercise price for the common stock being registered under the registration statement, for every 30-day period following the date that the registration statement should have been effective, prorated for any period less than 30 days, until either all of common shares registered under the registration statement have been sold or all such common shares may be sold in any three (3) month period pursuant to Rule 144 promulgated under the Securities Act, whichever is earlier. The Company must also pay the liquidated damages if sales cannot be made pursuant to the registration statement for any reason (excepting market conditions). The maximum amount of liquidated damages is $500,000.earningnet income targets in fiscal years 2007, 2008 and 2009. The $8.5 million net income target for 2007 was $8.5 million in net income whichachieved; as was achieved. The target for 2008 is 95% of $13.8 million in net income and thetarget for 2008. The net income target for 2009 is 95% of $17.5 million inof net income, both after eliminating the effect of non-cash charges associated with the Transaction and adjusting for differences in the exchange rate between Chinese Renminbi and US dollars used in the Company’s financial statements and an exchange rate of RMB 7.30 to USD 1.00. TheseA portion of the Escrow Shares will be transferred to the Purchasers if the Company does not meet the earning targets, and released back to the Fou ndersFounders if the Company does. Anotherdoes; another portion of the Escrow Shares is being held in escrow subject to the Company listing on the NASDAQ Stock Market within 18 months following the Closing Date. These Escrow Shares will be transferred to the Purchasers if the listing is not completed within that time period, and released back to the Founders if it is. In addition, two-thirds of the Escrow Shares are held in escrow to ensure that the Purchasers receive their full redemption payments if they choose to redeem their Preferred Shares. Each Preferred Share may be redeemed for $0.87 per share (adjusted for stock splits, stock dividends, reclassification and the like). If a Purchaser receives less than the full redemption amount for each Preferred Share being redeemed, the Purchaser will receive a number of Escrow Shares to make up the difference, based on the then-current market price of the common shares. Following the end of the redemption period, these Escrow Shares, less those transferred to any Purchasers that red eemedredeemed their Preferred Shares, will be released back to the Founders.series A convertible redeemable preferred stockPreferred Shares and warrants to purchase 2,873,553 shares of the Company’s common stock,Warrants, the Company recorded a total debt discount of $2,033,025$ 2,310,263 to be amortized over the term of thisthe Purchase Agreement. For the ninethree months ended September 30,March 31, 2009 and 2008, amortization of debt discount amounted to $592,966$ 288,783 and has$84,709, respectively, have been included in interest expense.For the nine months ended September 30, 2008, theevaluated whether or notclassified the series A convertibleConvertible redeemable preferred stock contain embedded conversion options, which meetas liability because of its mandatory redeemable feature according to SFAS 150.definitionCompany issued 459,772 additional shares of derivatives under SFAS 133 “AccountingSeries A Preferred Stock to the holders of Series A Preferred Stock for Derivative Instruments and Hedging Activities” and related interpretations. The Company concluded that since the series A convertible redeemable preferred stock had a fixed redemption price of $0.87, the convertible redeemable preferred stock was not a derivative instrument. The Company analyzed this provision under EITF 05-04 and therefore it qualified as equity under EITF 00-19.follows at September 30, 2008:follows:Series A convertible redeemable preferred stock$5,000,000 Less: unamortized discount(1,440,059)Series A convertible redeemable preferred stock, net$3,559,941 March 31, 2009 December 31, 2008 (Unaudited) Series A convertible redeemable preferred stock $ 5,400,000 $ 5,000,000 Less: unamortized discount (1,058,876 ) 1,347,659 Series A convertible redeemable preferred stock, net $ 4,341,124 $ 3,652,341 UNAUDITED CONSOLIDATED FINANCIAL STATEMENTSSEPTEMBER 30, March 31, 2009 December 31, 2008 (Unaudited) Value added taxes $ 1,716,963 $ 5,015,908 Income taxes 74,738 - Other taxes 202,687 - Total $ 1,994,388 $ 5,015,908 January 2008,February 2009, the Company issued 250,000842,308 shares of its common in connection with the conversion of $250,000 of convertible debt.In April 2008, the Company issued in aggregate 331,668 shares of restricted common stock to the several directors, consultantsMr. Liu Zhongyi, Chairman and officersCEO of the Company, for his services rendered.rendered through December 31, 2008 as the Company’s chief executive officer. The Companystock was valued these common shares at the fair market value of $0.26 per share on the date of grant at $0.87 per share or $288,551 in total. date.connection with issuance of these shares, the Company recorded prepaid stock-based expenses of $288,551. As of September 30, 2008, the Company recorded amortization on prepaid stock-based expenses of approximately $243,550 related to those issuances.In April 2008, in connection with a cashless exercise of 60,000 warrants,February 2009, the Company issued 9,07767,308 shares of common stock accordingly.June 2008,February 2009, the Company issued 35,294 shares of restricted common stock to a consultant for services rendered to the Company. The Company valued these common shares at the fair market value on the date of the grant at $0.85 per share or $30,000 in total. The Company recorded stock-based compensation expenses of $30,000 for the nine months ended September 30, 2008 accordingly.Stock warrantsIn January, 2008, the Company granted 250,000 stock warrants to a consulting company at an exercise price of $1.50 per share in connection with a one year contract. The warrants are not vested until January 2009. The Company valued these warrants utilizing the Black-Scholes options pricing model at approximately $0.71 per warrant or $178,187 in total and recorded a prepaid consulting expense of $178,187 for the period ended September 30, 2008. Those warrants will expire in January 2012. For the nine months ended September 30, 2008, the Company recorded amortization expenses of $118,791 related to the consulting contract.In connection with the preferred share financing (See Note 10), the Company granted 2,873,553 warrants to investors purchase up to 2,873,55348,077 shares of common stock to Mel Rothberg using a fair value of $0.26 per share on the grant date for his services as an independent director from January 1, 2008 to April 15, 2008 and consulting services rendered through November 30, 2008.CompanyPRC ("PRC GAAP"). Appropriations to the statutory surplus reserve is required to be at least 10% of the after tax net income determined in accordance with PRC GAAP until the reserve is equal to 50% of the entities' registered capital. Appropriations to the discretionary surplus reserve are made at the discretion of the Board of Directors.exercise priceappropriation to this reserve for fiscal year 2009.$1.20 per share. The Warrants have a term of 5 years after the issue date of February 12, 2007. Additionally,incorporation, the Company granted 603,446 stock warrantsis to an investment banking firm at an exercise priceappropriate 10% of $1.21 per share. The Company valued these warrants utilizingits net profits as statutory surplus reserve. For the Black-Scholes options pricing model at approximately $0.54 per warrant or $327,565 in totalthree months ended March 31, 2009 and recorded a deferred financing costs of $327,565. Those warrants will expire in February 2013.On February 25, 2008, pursuant to a Convertible Redeemable Preferred Share and Warrant Purchase Agreement (See Note 10), the exercise price of the 1,500,000 warrants granted in February 2007 were reduced and repriced to $0.87 per share. As a result of the repricing, the Company recorded an interest expenseappropriated to the statutory surplus reserve in the amount of $74,593 for the nine months ended September 30, 2008.ninethree months ended September 30, 2008March 31, 2009 (unaudited) are as follows: Shares Average Exercise price per share Warrants outstanding on December 31, 2008 5,166,999 $ 1.13 Warrants issued - - Warrants terminated/forfeited - - Warrants exercised - - Warrants outstanding on March 31, 2009 5,166,999 $ 1.13 UNAUDITED CONSOLIDATED FINANCIAL STATEMENTSSEPTEMBER 30,ForIn the ninethree months ended September 30,March 31, 2009 and 2008, and 2007, the Company operated in two reportable business segments - (1) the manufacture and distribution of pharmaceutical products and examination of other companies’ products and (2) the retailing of traditional and Chinese medicines and supplies through ten drug stores located in Beijing China and other ancillary revenues generated from retail location such as advertising income rental income, and examinationrental income. The Company’sCompany's reportable segments are strategic business units that offer different products. They are managed separately based on the fundamental differences in their operations.September 30,March 31, 2009 and 2008 and 2007 is as follows: Unallocated Total Net revenues $ 9,488,971 2,137,188 198,128 - 11,824,287 Cost of sales 3,665,352 1,509,909 10,897 - 5,186,158 Operating expenses - - - 2,449,005 2,449,005 Other expense (income) - - - 546,295 546,295 Income tax - - - 74,727 74,727 Net income $ 5,823,619 627,279 187,231 (3,070,027 ) 3,568,102 Unallocated Total Net revenues $ 9,512,895 2,016,547 179,735 - 11,709,177 Cost of sales 6,558,497 1,209,928 - - 7,768,425 Operating expenses - - - 2,458,979 2,458,979 Other expense (income) - - - 485,674 485,674 Income tax - - - - - Net income $ 2,954,398 806,619 179,735 (2,944,653 ) 996,099 UNAUDITED CONSOLIDATED FINANCIAL STATEMENTSSEPTEMBER 30,Information with respect to these reportable business segments for the nine months ended September 30, 2008 and 2007 is as follows:all of its operatingselling and general and administrative expenses to its reportable segments, because these activities are managed at a corporate level.LOTUS PHARMACEUTICALS, INC. AND SUBSIDIARIESNOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTSSEPTEMBER 30, 200813 - RESTATEMENTFor the six months ending June 30, 2007, the Company revised certain accounting treatment related to the recording of an intangible asset and a corresponding related party liability associated with an assignment agreement and exclusive revenue rights as described in Note 7. The Company initially did not record the value of the intangible asset and corresponding liability and treated payment due under the assignment agreement as a periodic payment of interest expense to the Company’s chief executive officer. Subsequently, the Company determined that an intangible asset and a corresponding related party liability should have been recorded. Accordingly, the adjustments to the financial statements for this adjustment were as follows:1. Balance Sheet:a) Intangible assets increased by $1,136,096 to $1,309,551 from $173,455 and total assets increased by $1,136,096. This increase reflects the addition of an intangible asset of approximately $1,165,000 offset by an increase in accumulated amortization of approximately $29,000.b) Due to related parties increased by $1,003,304 which increased total current liabilities by $236,071 and long-term liabilities by $767,233. This increase reflects the addition of a related party payable of approximately $1,119,000 offset by the repayment of this payable of approximately $116,000. Stockholders’ equity increased $87,198 which reflect the changes made to the balance sheet and statement of operations as well as an increase in comprehensive income of $1,486.2. Statement of Operations:a) For the six months ended June 30, 2007, general and administrative expenses decreased by $87,323 which reflects an increase in depreciation and amortization expenses of $29,108 offset by a decrease in assignment fee expenses of $116,431 due to the reversal of the periodic assignment fee expense previously recorded.3. Statement of Cash Flows:a) For the six months ended June 30, 2007, net cash flows provided by operating activities increased by $116,431 and net cash provided by financing activities decreased by $116,431.NOTE 14 - 13—COMMITMENTS AND CONTINGENCIESBiologicalsBiological Medicine LTD (“Dong Guan”) pursuant to which Dong Guan agreed to transfer the technology material, new medicine research and rights to the Chinese patent of the anti-asthma new medicine R-BM to En Ze Jia Shi on an exclusive basis in exchange for a transfer technology fee of approximately $7 million (RMB 48 million) to be paid at various intervals. Under the terms of the agreement, En Ze Jia Shi is obligated to:•complete the filing with the Chinese State Food and Drug Administration (SFDA) of the medicine’s clinical research ratification document,•complete the clinical research,•complete the medicine’s trial production, and•providing raw materials and formulation related documentation and apply for the new medicine certification and production approval.LOTUS PHARMACEUTICALS, INC. AND SUBSIDIARIESNOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTSSEPTEMBER 30, 2008•Approximately $1.5 million is due by the 15th business day following the receipt of the processing notice of the receipt of the clinical application and all related material from SFDA is received,•Approximately $1.2 million (RMB 8 million) is due by the 10th business day after the receipt of the medicine’s clinical ratification document,•Approximately $1.5 million (RMB 10 million) is due by the 15th business day after the medicine’s Phase I clinical study is completed and ratification from the SFDA is obtained, and•Approximately $2.9 million (RMB 20 million) is due by the 10th business day after the medicine’s Phase II clinical study is completed and ratification from the SFDA is obtained.$2.9$2.92 million (RMB 20 million) in April 2008 which is to be returned to En Ze Jia Shi within 10 days after the transfer technology fee is fully paid. In the event Dong Guan should be unable to timely return the deposit, it will pay En Ze Jia Shi a late fee and En Ze Jia Shi is entitled to damages for Dong Guan’s failure to timely return the deposit.September 30, 2008,March 31, 2009, the Company has not received any government grant. The agreement can be terminated by Dong Guan if En Ze Jia Shi should fail to make any of the aforedescribed payments in which event the patent rights would revert to Dong Guan and it is entitled to transfer the project rights to a third party.ad ditio nal p harma ceuti cals,additional pharmaceuticals, will require a total investment of RMB 500623.66 million, or approximately $83.4$91 million. The construction began on the project in August 2008 and the Company anticipates that it will take between 12 to 30 months to complete the construction. As of September 30, 2008,March 31, 2009, the Company has incurred approximately $1.2$3.3 million related to this project and the amount has been included as construction in progress in the consolidated financial statements.$26.3$32.7 million (RMB 180223.66 million) which iswas paid off to Cha You. Other components of the project include construction costs of approximately $23.3$17.5 million (RMB 160120 million) costs associated with the various production lines estimated at approximately $26.5$33.6 million (RMB 182230 million) and working capital of approximately $7.3 million (RMB 50 million).LOTUS PHARMACEUTICALS, INC. AND SUBSIDIARIESNOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTSSEPTEMBER 30, 20081815 months under a specified schedule ending in December 2010. As of September 30, 2008,March 31, 2009, Liang Fang has paid approximately $17.3$36 million (approximately RMB 118.9246.5 million) of the total investment. Liang Fang, however, has not secured either the bank loans or government grants and does not have sufficient working capital to complete this project without securing substantial funds from those third party sources. Liang Fang has already commenced construction the new facility in Inner Mongolia. 1514 - OPERATING RISKCompany’sCompany's ability to operate the PRC subsidiaries and controlled entities could be affected.Management’s Management's Discussion and Analysis of Financial Condition and Results of Operations.East’sEast's results, assets and liabilities in our financial statements. The creditors of Lotus East, however, do not have recourse to any assets we may have.
“we,” “us,” “ours,”"we," "us," "ours," and similar terms includes Lotus and its subsidiary Lotus International as well as Lotus East.“Accounting"Accounting for the Impairment or Disposal of Long-Lived Assets”Assets", we examine the possibility of decreases in the value of fixed assets when events or changes in circumstances reflect the fact that their recorded value may not be recoverable.In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities, Including an Amendment of FASB Statement No.115”, under which entities will now be permitted to measure many financial instruments and certain other assets and liabilities at fair value on an instrument-by-instrument basis. This Statement is effective as of the beginning of an entity’s first fiscal year that begins after November 15, 2007. Early adoption is permitted as of the beginning of a fiscal year that begins on or before November 15, 2007, provided the entity also elects to apply the provisions of SFAS 157. The adoption of SFAS 159 did not have a material impact on our financial statements.In December 2007, the FASB issued Statement of Financial Accounting Standards No. 141R, Business Combinations (SFAS 141R) and Statement of Financial Accounting Standards No. 160, Accounting and Reporting of Non-controlling Interests in Consolidated Financial Statements, an amendment of ARB No. 51 (SFAS 160). These two standards must be adopted in conjunction with each other on a prospective basis. The most significant changes to business combination accounting pursuant to SFAS 141R and SFAS 160 are the following: (a) recognize, with certain exceptions, 100 percent of the fair values of assets acquired, liabilities assumed and non-controlling interests in acquisitions of less than a 100 percent controlling interest when the acquisition constitutes a change in control of the acquired entity, (b) acquirers’ shares issued in consideration for a business combination will be measured at fair value on the closing date, not the announcement date, (c) recognize contingent consideration arrangements at their acquisition date fair values, with subsequent changes in fair value generally reflected in earnings, (d) the expensing of all transaction costs as incurred and most restructuring costs, (e) recognition of pre-acquisition loss and gain contingencies at their acquisition date fair values, with certain exceptions, (f) capitalization of acquired in-process research and development rather than expense recognition, (g) earn-out arrangements may be required to be re-measured at fair value and (h) recognize changes that result from a business combination transaction in an acquirer’s existing income tax valuation allowances and tax uncertainty accruals as adjustments to income tax expense. Should we decide to enter into future business combinations, these new standards will significantly affect our accounting for future business combinations following adoption on January 1, 2009.“Disclosures"Disclosures about Derivative Instruments and Hedging Activities-- an amendment of FASB Statement No. 133” (“133" ("FAS 161”161"). FAS 161 changes the disclosure requirements for derivative instruments and hedging activities. Entities are required to provide enhanced disclosures about (a) how and why an entity uses derivative instruments, (b) how derivative instruments and related hedged items are accounted for under Statement 133 and its related interpretations, and (c) how derivative instruments and related hedged items affect an entity’sentity's financial position, financial performance, and cash flows. The guidance in FAS 161 is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008, with early application encouraged. This Statement encourages, but does not require, comparative disclosures for earlier periods at initial adoption. We are currently assessing the impact of FAS 161. . FSP APB 14-1 clarifies that convertible debt instruments that may be settled in cash upon either mandatory or optional conversion (including partial cash settlement) are not addressed by paragraph 12 of APB Opinion No. 14, Accounting for Convertible Debt and Debt issued with Stock Purchase Warrants. Additionally, FSP APB 14-1 specifies that issuers of such instruments should separately account for the liability and equity components in a manner that will reflect the entity’s nonconvertible debt borrowing rate when interest cost is recognized in subsequent periods. FSP APB 14-1 is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years. We will adopt FSP APB 14-1 beginning in the first quarter of fiscal 2010, and this standard must be applied on a retrospective basis. We are evaluating the impact the adoption of FSP APB 14-1 will have on our consolidated financial position and results of operations. Nine Months and Three Months Ended September 30,March 31, 2009 versus Three Months Ended March 31, 2008 and Ended September 30, 2007Nine Months ended September 30, 2008 Compared to Nine Months ended September 30, 2007ninethree months ended September 30, 2008March 31, 2009 were $47,798,673$11,824,287 as compared to total revenues of $37,649,336$11,709,177 for the ninethree months ended September 30, 2007,March 31, 2008, an increase of $10,149,337$115,110 or approximately 26.96%comparable period in 2007.0.98%. For the ninethree months ended September 30,March 31, 2009 and 2008, and 2007, net revenues consisted of the following:
(Unaudited)
(Unaudited) 2009 2008 (Unaudited) (Unaudited) Wholesale $ 8,940,405 $ 8,437,298 Retail 2,137,188 2,016,547 Other revenues $ 746,694 $ 1,255,332 Total 11,824,287 11,709,177 · •ninethree months ended September 30, 2008,March 31, 2009, wholesale revenues increased by $15,034,678$503,107 or 58%5.96%. For the three months ended March 31, 2009, While the unit price sold for our wholesale drugs decreased by an average of approximately 38% compared to the three months ended March 31, 2008, the increase in the total wholesale revenue was primarily attributable to the increase by approximately 67% of our wholesale quantities compared to three months ended March 31, 2008. For our long term growth perspective and the purpose to incentivize our distributors, we lowered our average wholesale drugs price in a planned way. The significant increase in tangible product revenues is mainly attributed to strong sales in Valsartan Capsules, Brimonidine Tartrate Eye Drops and third party manufactured drugs included Recombinant Human Granulocyte Colony, Recombinant Human Interleukin-2 for Injection, Recombinant Human Erythropoietin Injection, Deproteinized Calfblood Extractives Injection, Octreotide Acetate Injection, Cervus and Cucumis and Polypeptide Injection Cefrotaxime Sodium for Injection. The increase in revenue was offset by the decrease in sales in Levofloxacin Lactate for Injection, Recombinant Human Granulocyte Colony Stimulating Factor Injection and Valsartan Capsules. During the nine months ended September 30, 2007, the Company also collected approximately $1.9 million that was previously recorded as allowance for sales returns at December 31, 2006. The collection of sales return allowance had the effect of increasing the Company’s net revenues for the nine months ended September 30, 2007 by approximately $1.9 million, even though the sales of these products were actually made during the fourth quarter of fiscal 2006.Deproteinized Calfblood Extractives Injection. The significant increased sales in Valsartan Capsules and Brimonidine Tartrate Eye Drops were primarily due to our strong marketing and sales effort on promoting this drug. The substantial increased sales in Octreotide Acetate Injection were attributable to our acquirement of the drug’s distribution channels, including sales representatives, in phases by purchase of the drug’s certificate and intellectual property right. In December 2008, we entered into a new drug certificate and intellectual property right transfer contract with Beijing Yipuan Bio-Medical Technology, Co., Ltd. related to the drug of Octreotide Acetate Injection. Octreotide Acetate Injection is a highly effective and stable octreotide acetate injection solution and used to treat the symptoms of gastric ulcers and hemorrhages of the upper digestive tract. We paid off the purchase amount in first quarter of fiscal 2009. So, we own all intellectual property rights associated with the drug. In late 2007, we obtained exclusive distribution rights from a third party Beijing based pharmaceutical company for four drugs: Octreotide Acetate Injection, Recombinant Human Erythropoietin Injection, Recombinant Human Granulocyte Colony-stimulating Factor Injection, and Recombinant Human Interleukin-2 for Injection. In 2008, we obtained exclusive distribution rights for Cervus and Cucumis Polypeptide Injection. Additionally, we also strengthen our relationships with the several large drug manufacturers in 2008. As a result, we experienced a significant increase in our third party manufactured drug sales during the ninethree months ended September 30, 2008.March 31, 2009. As majority of our wholesale products are prescription drugs that are in demand by patients in China, we believe the demand for our wholesale products will not be impacted by the overall softening economy. We expect the sales will continue to have steady growth in the remainingour rest fiscal year of 2008.· •ninethree months ended September 30, 2008,March 31, 2009, retail revenues decreasedincreased by $638,648$120,641 or 20%5.98%. The decreaseincrease is primarily attributable to the slowdown in economy growthour continuous efforts to diversify products carried by our retail stores to provide more varieties as well as better quality products and the impact from 2008 Olympic heldfavorable RMB currency appreciation which converted our revenue in Beijing. The slowdown in the economy growth resulted in less non-essential health supplements being purchases. The Company also experienced a reduction in the sale ofRMB into higher priced drugs in 2008.US dollar amounts. As a result, the Company generated less per store revenue. Additionally, during the 2008 Olympics, the Beijing government restricted the city traffic and limited local roads used by locals. Consequentially, the Company’sour retail stores received less visits from its customers.revenue increased. We expect our fourth quarter retail revenue will slightlystably increase from previous quarters in 2008 as we are approaching flu season.· •ninethree months ended September 30, 2008,March 31, 2009, other revenues decreased by $4,246,693$508,638 or 49%40.52%. The decrease in other revenues is attributed to the following:
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(Unaudited) 2009 2008 (Unaudited) (Unaudited) Leasing revenues $ 198,128 $ 179,523 Third-party manufacturing 513,651 908,890 Advertising revenues - 212 Research and development and lab testing services 34,915 166,707 Total other revenues $ 746,694 $ 1,255,332 · •decreaseincrease was primarily due to less counter space being leased to third parties due to less demand forthe favorable RMB currency appreciation which converted our counter spaces during the three months ended September 30, 2008.revenue in RMB into higher US dollar amounts. We expect our leasing revenue to remain flat in the remaining part of the 2009 fiscal year.· •ninethree months ended September 30, 2008March 31, 2009 as the demand for the third-party manufacturing decreased as compared to the same period in 2007. Several2008. Many of our historical, large third party manufacturingprior customers have built their own facilities and started manufacturingcan manufacture their products onat lower costs in their own in 2008 and we were unable to find new customers to replace them.factories. As a result, our third-party manufacturing revenue decreased. We anticipate the third-party manufacturing revenue will continue to decrease forin the remainderremaining part of fiscal 20082009 as we do not expect to have new customers with large third party manufacturing contracts.· •A large advertisement contract whereby weWe receive approximately $50,000 per monthadvertising fee for the lease of counter and other space at our retail locations ended in December 2007. Accordingly, ourBeijing. We do not have any advertising revenues decreasedrevenue during the ninethree months ended September 30, 2008 as compared to the same period in 2007. AsMarch 31, 2009. Because the local government tightens the advertising rules and regulations in the pharmaceutical industry, we do not anticipate signing similarany advertisement contracts in the near future.· •ninethree months ended September 30, 2008March 31, 2009 as compared to the same period in 2007.2008. Some of our historical customers for these services were able to find other companies that providepurchased relative machinery and they can do similar R&D and lab testing servesin their own labs at a lower price and decided not to use our services in 2008.2009. We expect the revenue from R&D and lab testing will maintain at its current level with minimal growth in the remaining part of 2008. and manufacturing costs, which includes allocated portion of overhead expenses such as Labor fee, utilities and depreciation directly related to product production.production, and related taxes. For the ninethree months ended September 30, 2008,March 31, 2009, cost of sales amounted to $25,684,501$5,186,158 or approximately 53.73%44% of total net revenues as compared to cost of sales of $22,738,456$7,768,425 or approximately 60.40%66% of total net revenues for the ninethree months ended September 30, 2007. The collections on the previously reserved allowance for sales return of approximately $1.9 million in 2007 mentioned above had the effect of decreasing the Company’s cost of sales as a percentage of total revenue by 6% for the nine months ended September 30, 2007 as the Company recorded the costs associated with these products in its cost of sales during fiscal 2006 and the revenue was recognized in the second quarter of 2007.March 31, 2008. The decrease in cost of sales as a percentage of total net revenue was primarily due to better purchase pricing management and more efficient production cost controls.ninethree months ended September 30, 2008March 31, 2009 was $22,114,172$6,638,129 or 46.27%56% of total net revenues, as compared to $14,910,880$3,940,752 or 39.6%34% of total net revenues for the ninethree months ended September 30, 2007. The collections on the previously reserved allowance for sales return of approximately $1.9 million in 2007 mentioned above had the effect of increasing the Company’s profit margin by approximately $1.9 million for the nine months ended September 30, 2007, even though the sales of these products were actually made during the fourth quarter of fiscal 2006. As the costs associated with these products was recorded in our cost of sales during fiscal 2006, both the Company’s gross profit margin and income from operations for the nine months ended September 30, 2007 increased by approximately $1.9 million.March 31, 2008. The increase in gross profit was attributable to the decrease in cost of sales as a percentage of revenue. The decrease in cost of sales as a percentage of revenue was primarily contributed to better managed raw material and third party manufactured finished goods purchase prices and more efficient control in labor fees. Although we recognized higher than average gross profits during the ninethree months ended September 30, 2008,March 31, 2009, there could be no assurance that we will continue to recognize similar gross profit margin in the future.ninethree months ended September 30, 2008March 31, 2009 were $14,074,682, an increase$2,449,005, a decrease of $7,029,448$9,974 or 99.78%0.41% from total operating expenses in the ninethree months ended September 30, 2007March 31, 2008 of $7,045,234.$2,458,979. This increasedecrease included the following:ninethree months ended September 30, 2008,March 31, 2009, selling expenses amounted to $11,291,590$1,701,799 as compared to $2,864,746$1,122,337 for the ninethree months ended September 30, 2007,March 31, 2008, an increase of $8,426,844$579,462 or 294.16%51.63% from the comparable period in fiscal 2007.2008. This increase is primarily attributable to anthe increase of approximately $5.9 million in commission paid to our sales representatives on sales generated to provide greater incentives; we have significantly increasedrevenues and the sales commission percentage in 2008. Additionally, we paid bonuses to our collection personnelimprovement of approximately $2.5 million to improve our collections on accounts receivables and cash flows. Because we expect to continue paying commission on sales to increase our sales and provide bonuses based on the collection personnel’s performanceIn order to generate sufficient cash to meet our near term capital commitments such as new manufacture plant construction project, purchase of new drug certificate and intellectual property right of Octreotide Acetate Injection and acquiring Chinese Class I drug patent, wemanagement incentivized our sales and collection personnel’s performance. We expect our selling expenses to increase as our revenues increase. As a result, the significant increase in the selling expenses negatively impactedand expect to spend increased funds on advertising and promotion of our net income.ninethree months ended September 30, 2008,March 31, 2009, we do not have any research and development costs amounted to $1,193,916costs. So, as compared to $1,549,132$710,225 for the ninethree months ended September 30, 2007,March 31, 2008, a decrease of $355,216$710,225 or 22.93%100% from the comparable period in 2007.2008. In late 2007, we entered into several research and development agreements with third parties for the design, research and development of designated pharmaceutical projects. We fulfilled these research and development agreements on June 30, 2008. We did not enter into any new research and development agreement in the thirdsecond half of fiscal 2008 and in the first quarter of 2008.fiscal 2009. As a result, expenses related to those research and development projects decreasedproject is zero during the ninethree months ended September 30, 2008.ninethree months ended September 30, 2008,March 31, 2009, general and administrative expenses were $1,589,176$747,206 as compared to $2,631,356$626,417 for the ninethree months ended September 30, 2007, a decreaseMarch 31, 2008, an increase of $1,042,180$120,789 or 39.61%19.28% from the comparable period in fiscal 2007.2008. These changes are summarized below:
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(Unaudited) Three Months Ended March 31, 2009 2008 (Unaudited) (Unaudited) Salaries and related benefits $ 172,100 $ 269,468 Amortization and depreciation expenses 242,692 57,826 Rent 75,355 51,168 Travel and entertainment 165,651 19,762 Professional fees 41,709 39,980 Other 49,699 188,213 Total $ 747,206 $ 626,417 ninethree months ended September 30, 2008March 31, 2009 as compared to the ninethree months ended September 30, 2007March 31, 2008 included the following:•$345,533$97,368 or 26.35%36.13% primarily due to a decrease in bonuses paid to administrative personnel. The bonuses paid in 2007 were paid to several key employees and management and determined by meeting various individuals’ as well as overall Company’s operational goals. As weWe continue our efforts to control corporate spending, starting in 2008, we no longer provided certain benefits that were provided to employees in the 2007 including insurance, car allowances and other fringe benefits.spending. As a result, the salaries and related benefits costs decreased accordingly.· •decreasedincreased by $4,228$184,866 or approximately 3.32%319.69% which is primarily attributable to the certainpurchase of new intangible assets used in our office were fully depreciated in earlier partthe first quarter of 2008.· •Bad debt recovery income Rent increased $490,310 or 100% primarily due to our strong effort on accounts receivable collection.Rent decreased by $94,661$24,187 or approximately 41.52%47.27% which is primarily reflectsattributable to the RMB currency appreciation which converted our ability to renegotiate a portion of our leases at reduced rent rates on a short term basis.•decreasedincreased by $223,465$145,889 or 81.83% as a result of corporate738.23% which is primarily attributable to the increased spending control effort.· •$161,445$1,729 or 96.23%4.33% due to increase in investor relationthe RMB currency appreciation which converted our professional fees legal expenses related to February 2008 financing and a stock based compensations paid to a technology consultant for consulting services provided to the Company.· • selling, general and administrative expenses, which includes utilities,postage, office suppliesexpenses, other management fees, officers’ car insurance and training and other officemeeting expenses, decreased by $45,428$138,514 or approximately 8.67%73.59% reflecting efforts at reducing non-sales related corporate training and other activities as well as stricter controls on corporate spending.$8,039,490$4,189,124 for the ninethree months ended September 30, 2008March 31, 2009 as compared to income from operations of $7,865,646$1,481,773 for the ninethree months ended September 30, 2007,March 31, 2008, an increase of $173,844$2,707,351 or approximately 2.21%182.71%.ninethree months ended September 30, 2008,March 31, 2009, total other expense amounted to $1,650,456$546,295 as compared to other expense of $1,765,480$485,674 for the ninethree months ended September 30, 2007, a decreaseMarch 31, 2008, an increase of $115,024$60,621 or 6.52%12.48% from the comparable period in 2007.2008. This change is primarily attributable to:•ninethree months ended September 30, 2008,March 31, 2009, our debt issuance costs of $261,919$99,517 compared to $146,699$62,886 for the ninethree months ended September 30, 2007,March 31, 2008, an increasedincrease of $115,220$36,631 or approximately 78.54%58.25%, due to the debt issuance costs on our recentFebruary 2008 funding during the nine months offor which we began our amortization in March 2008.· •ninethree months ended September 30, 2008,March 31, 2009, we recorded registration rights penaltiesinterest income of $650 related to the late filing of our registration statement on Form SB-2$1,319 as compared to $110,000$561 for the ninethree months ended September 30, 2007, a decreaseMarch 31, 2008, an increase of $109,350$758 or 99.41%.•For the nine months ended September 30, 2008, interest expense was $1,399,507 as compared to $1,508,781 for the nine months ended September 30, 2007, a decrease of $109,274 or 7.24%135.12% which is primarily attributable to the favorable RMB currency appreciation which converted our interest income in RMB into higher US dollar amounts.· For the three months ended March 31, 2009, interest expense was $448,097 as compared to $423,349 for the three months ended March 31, 2008, an increase of $24,748 or 5.85% which is primarily attributable to our February 2008 financing for which we began our amortization of the debt discount and to accrue the dividend on certain debt which was fully amortized earlierpreferred stock in March 2008.$6,389,034$3,568,102 for the ninethree months ended September 30, 2008March 31, 2009 as compared to net income of $6,100,166$996,099 for the ninethree months ended September 30, 2007.March 31, 2008. This translates to basic and diluted net income per common share of $0.15, $0.13$0.08, $0.07 and $0.15, $0.14$0.02, $0.02 for the ninethree months ended September 30,March 31, 2009 and 2008, and 2007, respectively.ninethree months ended September 30, 2008,March 31, 2009, our unrealized gain on foreign currency translation of $2,173,475, an increase$62,111, a decrease of $1,620,660,$1,392,092, or approximately 293.16%95.73%, from the same period in 2007.2008. We report in U.S. dollars, but the functional currency of Lotus East is the RMB. Translation adjustments result from the process of translating the local currency financial statements into U.S. dollars, with the average translation rates applied to our income statement of 6.998866.84659 RMB to $1.00 during the ninethree months ended September 30, 2008.March 31, 2009. As a result of this non-cash gain, we reported comprehensive income of $8,562,509$3,630,213 for the ninethree months ended September 30, 2008March 31, 2009 as compared to $6,652,981$2,450,302 for the same period in 2007.Three Months ended September 30, 2008 compared to three months ended September 30, 2007Total Net RevenuesTotal revenues for the three months ended September 30, 2008 were $16,703,884 as compared to total revenues of $16,554,349 for the three months ended September 30, 2007, an increase of $149,535 or approximately 0.9%. For the three months ended September 30, 2008 and 2007, net revenues consisted of the following:•For the three months ended September 30, 2008, wholesale revenues increased by $2,388,443 or 21%. The significant increase in tangible product revenues is mainly attributed to strong sales of Brimonidine Tartrate Eye Drops, Valsartan Capsules and third party manufactured drugs included Recombinant Human Granulocyte Colony, Recombinant Human Interleukin-2 for Injection, Deproteinized Calfoblood Extractives Injection, and Cervus and Cucumis Polypeptide Injection. and Nicergoline offset by the decrease in sales in Nicergoline, Levofloxacin Lactate for Injection and third party manufactured drug Recombinant Human Erythropoietin Injection. The significant increased sales in Brimonidine Tartrate Eye Drops and Valsartan Capsules were primarily due to our strong marketing and sales effort on promoting those drugs. In late 2007, we obtained exclusive distribution rights from a third party Beijing based pharmaceutical company for four drugs: Octreotide Acetate Injection, Recombinant Human Erythropoietin Injection, Recombinant Human Granulocyte Colony-stimulating Factor Injection, and Recombinant Human Interleukin-2 for Injection. As a result, we experienced a significant increase in our third party manufactured drug sales during the three months ended September 30, 2008. As set forth above, as majority of our wholesale products are prescription drugs that are in demand by patients in China, we believe the demand for our wholesale products will not be impacted by the overall softening economy. We expect the sales will continue to have steady growths in the remaining of 2008.•For the three months ended September 30, 2008, retail revenues decreased by $1,239,933 or 75.44%. The decrease is primarily attributable to the slowdown in economy growth and the impact from 2008 Olympic held in Beijing. The slowdown in the economy growth resulted in less non-essential health supplements being purchases. The Company also experienced a reduce in higher priced drugs sales in 2008. As a result, the Company generated less per store revenue. Additionally, during the 2008 Olympic period, Beijing government restricted the city traffic and limited local roads used by locals. Consequentially, the Company’s retail stores received less visits from its customers. Although we believe our retail revenue in the fourth quarter will increase from the third quarter as we are approaching flu season, we do not believe the retail revenue will increase from the same period in 2007 as the economy continues to soften.For the three months ended September 30, 2008, other revenues decreased by $1,799,105 or 51.68%. The decrease in other revenues is attributed to the following:•We sublease certain portion our retail stores and counter spaces to various other vendors and generate leasing revenue. The slight increase was primarily due to the favorable RMB currency application which converted our leasing revenue in RMB into higher US dollar amounts and slightly more counter spaces being leased to third party vendors during the three months ended September 30, 2008. As set forth above, we anticipate that our leasing revenues will remain flat for the balance of 2008.•For third-party manufacturing, customers supply the raw materials and we are paid a fee for manufacturing their products. We had less large manufacturing contracts during the three months ended September 30, 2008 as the demand for the third-party manufacturing decreased as compared to the same period in 2007. Several of our old large third party manufacturing customers have built their own facilities and started manufacturing products on their own in 2008 and we were unable to find new customers to replace them. As a result, our third-party manufacturing revenue decreased. We anticipate the third-party manufacturing revenue will continue to decrease for the remainder of fiscal 2008 as we do not expect to have new customers with large third party manufacturing contracts.•A large advertisement contract whereby we receive approximately $50,000 per month for the lease of counter and other space at our retail locations ended in December 2007. We did not receive any advertising revenue in the three months ended September 30, 2008. As the local government tightens the advertising rules and regulations in the pharmaceutical industry, we do not anticipate signing similar advertisement contracts in the near future.•We performed research and development and lab testing projects for various third parties and performed drug testing and analysis. We preformed less R&D testing services and drug testing and analysis work for third parties during the three months ended September 30, 2008 as compared to the same period in 2007. Some of our old customers were able to find other companies that provide similar R&D and lab testing serves at a lower price and decided not to use our services in 2008. We expect the revenue from R&D and lab testing will maintain at its current level with minimal growth in the remaining of 2008.Cost of SalesCost of sales includes raw materials, packing materials, shipping, and manufacturing costs, which includes allocated portion of overhead expenses such as utilities and depreciation directly related to product production. For the three months ended September 30, 2008, cost of sales amounted to $8,219,358 or approximately 49.21% of total net revenues as compared to cost of sales of $9,856,382 or approximately 59.54% of total net revenues for the three months ended September 30, 2007. The collections on the previously reserved allowance for sales return of approximately $1.9 million in 2007 mentioned above had the effect of decreasing the Company’s cost of sales as a percentage of total revenue by 9% for the six months ended September 30, 2007as the Company recorded the costs associated with these products in its cost of sales during fiscal 2006 and the revenue was recognized in the second quarter of 2007. The decrease in cost of sales as a percentage of total revenue was primarily due to better purchase pricing management and more efficient production cost controls.Gross ProfitGross profit for the three months ended September 30, 2008 was $8,484,526 or 50.79% of total revenues, as compared to $6,697,967 or 40.46% of revenues for the three months ended September 30, 2007. The collections on the previously reserved allowance for sales return of approximately $1.9 million in 2007 mentioned above had the effect of increasing the Company’s profit margin by approximately $1.9million for the three months ended September 30, 2007, even though the sales of these products were actually made during the fourth quarter of fiscal 2006. As the costs associated with these products was recorded in our cost of sales during fiscal 2006, both the Company’s gross profit margin and income from operations for the three months ended September 30, 2007 increased by approximately $1.9 million. The increase in gross profit was attributable to the decrease in cost of sales as a percentage of revenue. Although we recognized higher than average gross profits during the three months ended September 30, 2008, there could be no assurance that we will continue to recognize similar gross profit margin in the future.Operating ExpensesTotal operating expenses for the three months ended September 30, 2008 were $4,726,868, an increase of $1,116,528 or 30.93%, from total operating expenses in the three months ended September 30, 2007 of $3,610,340. This increase included the following:For the three months ended September 30, 2008, selling expenses amounted to $4,293,704 as compared to $1,441,950 for the three months ended September 30, 2007, an increase of $2,851,754 or 197.77%. This increase is primarily attributable to an increase of commission paid on sales to our sales representatives to provide better incentives.. We expect our selling expenses to increase as our revenues increase and we continue to pay out commission to our sales representatives to increase sales and collections. As a result, the significant increase in the selling expenses negatively impacted of our net income. We expect to continue paying commission on sales to increase our sales and provide bonuses based on the collection personnel’s performance to generate sufficient cash to meet our near term capital commitments such as new facility construction project and acquiring Chinese Class I drug patent.For the three months ended September 30, 2008, research and development costs amounted to $12,448 as compared to $1,255,844 for the three months ended September 30, 2007, a decrease of $1,243,396 or 99.01%. In late 2007, we entered into several research and development agreements with third parties for the design, research and development of designated pharmaceutical projects and these agreements were fulfilled on June 30, 2008. We do not incur any research and development activities in third quarter 2008. There is an exchange rate effect in third quarter 2008 about research and development. As a result, expenses related to those research and development projects decreased during the three months ended September 30, 2008.For the three months ended September 30, 2008, general and administrative expenses were $420,716 as compared to $912,546 for the three months ended September 30, 2007, a decrease of $491,830 or 53.90% as summarized below:The changes in these expenses from the three months ended September 30, 2008 as compared to the three months ended September 30, 2007 included the following:•Salaries and related benefits decreased $63,024 or 13.01% primarily due to decrease bonuses paid to administrative personnel and decreased use of part time employees. The bonuses in 2007 were paid to several key employees and management and determined by meeting various individuals’ as well as overall Company’s operational goals. As set forth above, continuing our efforts to control corporate expenses, starting in 2008, we no longer provided certain benefits such as insurance and car allowance and other fringe benefits that were provided to employees in the 2007. As a result, the salaries and related benefits costs decreased accordingly.•Depreciation on fixed assets and amortization of our intangible assets decreased by $35,231 or approximately 45.51% which is primarily attributable to the completion of depreciation and amortization about our two items which were used in our office.•Bad debt recovery income increased by $490,310 or 100% which is primarily attributable to our effort on collection.•Rent decreased by $40,098 or approximately 42.44% which primarily because we renegotiated a portion of our leases and were able to reduce the rent rates on a short term basis.•Travel and entertainment expenses decreased by $166,475 or 92.98% as a result of corporate spending control effort.•Professional fees increased $124,087 or 636.15% primarily due to increase in investor relation professional fees, legal fees related to February 2008 financing.•Other selling, general and administrative expenses, which includes utilities, office supplies and training and other office expenses increased by $179,221 or approximately 309.85% which is primarily attributable to the increase on our sales revenue, as a result, we increased in corresponding general and administrative expenses.Income from OperationsWe reported income from operations of $3,757,658 for the three months ended September 30 2008 as compared to income from operations of $3,087,627 for the three months ended September 30, 2007, an increase of $670,031 or approximately 21.7%.Other ExpenseFor the three months ended September 30, 2008, total other expense amounted to $543,982 as compared to other expense of $866,287 for the three months ended September 30, 2007, a decrease of $322,305 or 37.21%. This change is primarily attributable to:•For the three months ended September 30, 2008, we recorded debt issuance costs related to amortization on debt issuance costs of $99,516 compared to $58,679 for the three months ended September 30, 2007 due to our recent funding during the three months of 2008.•For the three months ended September 30, 2008, interest expense was $453,498 as compared to $807,608 for the three months ended September 30, 2007, a decrease of $354,110 or 43.85% This decrease is primarily attributable to the amortization of discount on some debt was finished in 2008.NET INCOME, OTHER COMPREHENSIVE INCOME AND COMPREHENSIVE INCOMEAs a result of these factors, we reported net income of $3,213,676 for the three months ended September 30, 2008 as compared to net income of $2,221,340 for the three months ended September 30, 2007. This translates to basic and diluted net income per common share of $0.08, $0.07 and $0.05, $0.05 for the three months ended September 30, 2008 and 2007, respectively.During the three months ended September 30, 2008, we reported an unrealized gain on foreign currency translation of $127,833, a decrease of $53,062 or approximately 29.33%, from the same period in 2007. These gains are non-cash items. As described elsewhere herein, our functional currency is the Chinese Renminbi; however the accompanying consolidated financial statements have been translated and presented in U.S. dollars using period-end rates of exchange for assets and liabilities, and average rates of exchange for the period for revenues, costs, and expenses. Net gains and losses resulting from foreign exchange transactions are included in the consolidated statements of operations and can have a significant effect on our financial statements. As a result of this non-cash gain, we reported comprehensive income of $3,341,509 for the three months ended September 30, 2008 as compared to $2,402,235 for the same period in 2007.September 30, 2008,March 31, 2009, we had a cash balance of $2,656,770.$1,228,769. These funds are located in financial institutions located as follows:China $ 1,228,346 USA 423 Total $ 1,228,769 $5,982,532$6,585,900 to $18,669,605$ (2,163,717) at September 30, 2008March 31, 2009 from $24,652,137$4,422,183 at December 31, 2007.2008. This decrease in working capital is primarily attributable to a decrease in accounts receivable net of allowance of approximately $6,548,529, a decrease in cash of approximately $1.9$4.74 million, a decrease in prepaid expenseother receivable- related party of $931,942, an increaseapproximately $2.03 million, a decrease in accounts payable and accrued expenses of $1,080,907,approximately $1.31 million, a decrease in taxes payable of approximately $3.02 million, an increase in tax payableother receivable-employee of $2,730,952,approximately $0.73 million, an increase in unearned revenue of approximately $99,021$0.23 million and an increase in due to related parties of approximately $1,031,899 offset by an increase of approximately $5,211,141 in inventories, an increase in deferred debt costs of $534,588 and a decrease in convertible debt of $2,561,645.September 30, 2008, our inventories of raw materials, work in progress, packaging materials and finished goods totaled $8,621,880, an increased of approximately $5.2 million, or 152.79%, from DecemberMarch 31, 2007. Included in this change was an increase of $5,681,166 in finished goods offset by decreases in raw materials of $148,864 and work in progress of $279,759. We expect to maintain higher finished goods inventory levels to accommodate for anticipated future sales growth, new products development and productions as well as a wider variety of products.At September 30, 2008,2009, our accounts receivable, net of allowance for doubtful accounts, was $13,882,298$1,395,054 as compared to $20,430,827$6,132,912 at December 31, 2007,2008, a decrease of $6,548,529.$4,737,858. The decrease was primarily due to our strong collection effort which significantly improved our accounts receivable aging days.At September 30, 2008, we maintained an allowance for doubtful accounts on We expect our accounts receivable balanceswill maintain at the current level.$84,189$730,396. This is a loan made to our employee. In May 2009, the employee paid back the money to the Company. We did not have any other receivable-employee on December 31, 2008.$548,083$2,027,954 at December 31, 2007,2008, a decrease of $463,894 reflects$2,027,954. The decrease was attributable to one loan made to our best estimateCEO to register a subsidiary in Inner Mongolia. After a few days, in January 2009, our CEO paid back the money to the Company.probable losses. In determining the allowanceraw materials, work in progress, packaging materials, finished goods and reserve for doubtful accounts, our management reviews our accounts receivable aging as well as the facts and circumstances of specific customers which may indicate the collection of specific amounts are at risk. Our terms of sale generally require payment within four months to a year, which is considerably longer than customary terms offered in the United States, however, we believe that our terms of sale are customary among our competitors for a company in our size within our industry. As described elsewhere herein, in 2008 we began paying a bonus to certain employees who are involved in the collection of accounts receivable to generate sufficient cash to meet our near term capital commitments such as new manufacture plant construction project and acquiring Chinese Class I drug patent. At September 30, 2008, these bonusesobsolete inventories totaled $2.5 million. We also occasionally offer established customers longer payment terms on new products as an incentive to purchase these products, which has served to further increase the average days outstanding for accounts receivable. As the market for these new products is established, we will discontinue offering this sales incentive. Occasionally we will request a customer to prepay an order prior to shipment. At September 30, 2008, our balance sheet reflected advances from customers of $0,$3,726,128, a decrease of $34,531, or 100%,approximately $61,674 from December 31, 2007.September 30, 2008,March 31, 2009, we have a prepaid expenses and other assets of $77,440$77,380 as compared to $1,009,382$121,274 at DecemberMarch 31, 2007,2008, a decrease of $ 931,942.$43,894. The decrease was primarily due to the completion of our research and development contracts. The total amount of the prepaid expense for researchcontracts which were recorded as a prepayment on March 31, 2008 and development contracts was approximately $ 1 million at December 31, 2007. Although we did not makehave similar research and development contract prepayments in 2008, we expect to incur approximately $14.5 million expenses related to our Laevo-Bambuterodrug that was recently accepted by the Chinese SFDA for clinical trial evaluations in the next 24 to 30 months.September 30, 2008,March 31, 2009, we have a deferred debt cost of $563,928$364,894 as compared to $29,340$464,411 at December 31, 2007, an increase2008, a decrease of $ 534,588.99,517. The increasedecrease was primarily attributed to the issuance of the series A convertible redeemable preferred stock and warrants to purchase 2,873,553 shares of the company’s common stock.stock in February 2008 financing. We recorded a total deferred debt cost of $796,133 to beand amortized over the term of our purchase agreement.September 30, 2008,March 31, 2009, we have a deposit on patent of $2,917,536$2,921,585 as compared to $2,917,919 at December 31, 2008, an increase of $3,666. We made the deposit on patent in order to acquire a new Chinese Class I anti-asthma medicine drug patent in accordance with a technology transfer agreement the Company entered into in April 2008. Additionally, in accordance withThe increase is attributable to the agreement we entered into in June 2008, we also have afavorable RMB currency appreciation which converted our deposit on land use rightpatent in RMB into higher US dollar amounts.$17,120,100 for the amounts paid$35,301,508 as compared to a local government agency in Cha You to acquire a long-term interest to utilize certain land to construct a new manufacture facility. We did not have the two deposit amounts$38,175,134 at December 31, 2007. We will need2008, a decrease of $2,873,626. The decrease was primarily attributable to make additional payments totaling approximately $62.6 millionthe transfer of our installments in the future. As described later in this section,a new drug certificate and intellectual property right-- Yipubishan (common name: Octreotide Acetate Injection) to intangible assets.do not have sufficient fundsan intangible assets, net of accumulated amortization, of $8,885,346 as compared to satisfy these obligations.September 30, 2008,March 31, 2009, we have an accounts payable and accrued expenses of $1,845,398$856,345 as compared to $764,491$2,170,165 at December 31, 2007, an increase2008, a decrease of $1,080,907.$1,313,820. The increasedecrease was primarily attributed to the increase ofdecrease in payables for construction in progress for our new facility in Inner Mongolia.September 30, 2008,March 31, 2009, we have a value-added and services taxes payable of $3,303,152$1,994,388 as compared to $572,200$5,015,908 at December 31, 2007.2008, a decrease of $3,021,520. The amounts are related to accrued but unpaid value added and services taxes for the nine months ended September 30, 2008. The increasedecrease in the taxes payable is primarily due to increaseour payments for accrued unpaid taxes made to taxes authority in our revenues during the nine months ended September 30, 2008 and the tax payment timing differences.September 30, 2008,March 31, 2009, also reflects a balance due to related parties of $1,355,077$2,175,892 which was a working capital advancesadvance made to us by our president, vice-president and an officer of the Company and a Board member as well as an amount payable of approximately $131,289$1 million related to an assignment agreement as discussed elsewhere in this report. These advances are non-interest bearing and are due on demand. We are currently repaying these balances as operating cash become available.September 30, 2008March 31, 2009 also reflects notes payable to related parties of approximately $5 million due on December 30, 2015 which is a working capital loan made to us in December 31, 2005 by the Company’s Chief Executive Officer, two employees of the Company and a Board member. These loans bear a variable annual interest at 80% of current bank rate and are unsecured. During the three months ended September 30, 2008,March 31, 2009, we did not repay any portion of these loan balances.September 30, 2008March 31, 2009 and December 31, 20072008 and does necessarily reflect changes in assets and liabilities reflected on our cash flow statement, which we use the average foreign exchange rate during the period to calculate these changes.ninethree months ended September 30, 2008March 31, 2009 was $16,038,077$7,008,339 as compared to net cash provided byused in operating activities of $3,688,656$3,610,250 for the ninethree months ended September 30, 2007.March 31, 2008. For the ninethree months ended September 30, 2008,March 31, 2009, net cash provided by operating activities was attributable primarily to decrease in accounts receivable of $8,244,225, increase in value-added and service taxes payable of 2,637,331, an$4,744,877, decrease in inventories of $66,423, decrease in prepaid expenses and other current assets of $1,080,576, an$1,329,083 and increase in unearned revenue of $62,225, an increase in accounts payable and accrued expenses of $1,032,245$228,143 and the add back of net income of $6,389,034,$3,568,102, depreciation and amortization of $469,455, amortization of debt discount of $208,355,$362,467, amortization of debt issuance costs of $261,545, stock based compensation of $392,341, the$99,517, amortization of discount on convertible redeemable preferred stock of $592,966 and warrant repricing$288,783, amortization of $74,593prepaid expense attributable to warrants of $14,849 offset by an increase in inventories of $4,880,418, a decrease in allowance for doubtful accounts payable and accrued expenses of $490,310$666,522 and a decrease in advances from customerstaxes payable of $36,086. Net cash provided by operating activities for$3,027,383. For the ninethree months ended September 30, 2007 was $3,688,656. For the nine months ended September 30, 2007,March 31, 2008, net cash provided byused in operating activities was attributable primarily to our net income of $6,100,166, the add back of depreciation and amortization of $422,055, amortization of debt issuance costs of $146,699, amortization of debt discount of $1,041,774, stock issued for compensation of 239,200 and decrease in allowance for doubtful accounts and sales returns of 1,723,258 and an increase in accounts receivable of $6,327,758, an$115,927, increase in value-added and service taxes payableinventories of $1,298,344, and an$3,161,360, increase in unearned revenues of $122,924 offset by an decrease in inventory balance of $2,390,052, an decrease in prepaid expenses and other current assets of $251,225, a$2,012,656, decrease in accounts payable and accrued expenses of $101,796$98,515 and a decrease in advances from customers of $170,971.ninethree months ended September 30, 2008March 31, 2009 amounted to $21,060,376.$7,119,219. For the ninethree months ended September 30, 2008,March 31, 2009, net cash used in investing activities was attributable to the deposit on patent rightpurchase of $2,857,608, the deposit on land use rightintangible assets of $16,768,445$7,887,138 and the purchase of property and equipment of $1,430,894.$2,153,243 offset by the decrease in installments on intangible assets of $2,921,162. Net cash provided byused in investing activities for the ninethree months ended September 30, 2007 was $417,040 attributableMarch 31, 2008 amounted to the purchase of property and equipment of $384,198 offset by payment received on due from related parties of $801,238. $2,872,348$59,314 for the ninethree months ended September 30,March 31, 2009 and was attributable to the proceeds from related party advances of $59,314. Net cash provided by financing activities was $2,368,814 for the three months ended March 31, 2008 and was attributable to the receipt of net proceeds of $5,000,000 from our private financing and proceeds from related party advances of $860,916$357,382 offset by payments on convertible debt of $2,520,000 and debt issuance costs of $468,568. Net cash used in financing activities was $116,778 for the nine months ended September 30, 2007 and was primarily attributable to the receipt of net proceeds of $2,950,000 from our debt financing offset by payments on related party advances and notes of $2,835,252 and the payment of debt issuance costs of $231,526.ninethree months ended September 30, 2008March 31, 2009 of $1,901,187$50,039 as compared to a net increasedecrease in cash of $4,105,146$968,580 for the ninethree months ended September 30, 2007.lentmade advanced approximately $2 million to Lotus East which it used as working capital. We obtained the funds to make the loan out of the net proceeds received from the sale of $3 million principal amount our convertible debt to Lotus East, which they used as working capital.in February 2008. These advances are unsecured and interest free. During the first quarter of 2008, we used a portion of the proceeds from the sale of equityPreferred Shares to satisfy these notes, lent Lotus East an additional $1.6 million and retained the balance to fund our operating expenses. We have no operations other than the Contractual Arrangements with Lotus East and, accordingly, we are dependent upon the quarterly service fees due us to provide cash to pay our operating expenses. Such payments have not been tendered to us and those funds are being retained by Lotus East to fund their operations. At September 30, 2008,March 31, 2009, Lotus East owned us approximately $17.6$21.96 million for such fees and we do not know when such funds will be paid to us. Our CEO is also the CEO and principal shareholder of Lotus East. Accordingly, we are solely reliant upon his judgment to ensure that the funds advanced to Lotus East are repaid to us. If these funds should not be repaid, or if Lotus East should continue to withhold payment ofuse the funds for options and not pay the quarterly service fee due us under the Contractual Arrangement, it is possible that we will not have sufficient funds to pay our operating expenses in future periods.unless Lotus East pays usand we estimate that we will require additional working capital of at least $350,000 to fund our current operations for the amounts due to us.next 12 months. Lotus East has historically funded its capital expenditures from their working capital and has advised us that they believe this capital is sufficient for their current needs. Lotus East has contractual commitments for approximately $65.5$62.81 million related to a Technology Transfer Agreement and the construction of the new manufacturing facility. While it intends to fund the costs associated with the Technology Transfer Agreement and a portion of the construction of the new manufacturing facility with its existing working capital, it is dependent upon the continued growth of its operations and prompt payment of outstanding accounts receivables by its customers to ensure that it has sufficient cash for these commitments. In addition, its ability to fully fund the costs associated with the new manufacturing facility is materially dependent upon its ability to secured bank financing and/or government grants. As the banking industry is tightening the credit/lending policy, we expect the bank financing will become more challenging and the time to obtain the bank funding might be longer than expected. Although the Chinese government has recently announced an economic simulation plan, there is no guarantee that we will successfully be awarded the government grant. As it has no firm commitments for either, while its management believes the company will be successful in securing the necessary funding through its increasing revenue, quicker collections on receivables, current discussions with various commercial banks there are no assurances the funding will be available in the amounts or at the time required to meet Liang Fang’sFang's commitment. In the event Lotus East is not successful in obtaining the funds it needs for the Technology Transfer Agreement, it is possible that it could default under the terms of the agreement and forfeit any funds paid to date. If Lotus East is not successful in obtaining all of the funding necessary to complete the construction of the new facility, which is estimated to be approximately $58 million, it would lose theget back approximately $17,219,000$36,009,000 spent to date, including the $17,000,000$32,672,081 for the deposit on the land use rights which is non-refundable.removed fromeligible for quotation on the OTC Bulletin Board. In this event (i) the ability of our stockholders to liquidate their investment in our company would be adversely impacted and it is possible that an event of default(ii) would occurcould be deemed to have defaulted on our obligations under various agreements we are a party to with the purchasespurchasers of our Series A Convertible Redeemable Preferred Stock and common stock purchase warrants.September 30, 2008,March 31, 2009, and the effect these obligations are expected to have on our liquidity and cash flows in future periods. Payments due by period Contractual obligations: Total 1-3 Years 5+ Years Series A convertible redeemable preferred stock $ 5,400,000 $ 5,400,000 $ - $ - $ - Related parties indebtedness $ 7,238,695 $ 1,715,742 $ 460,150 $ - $ 5,062,803 Patent purchase obligations $ 4,382,377 $ 1,460,792 $ 2,921,585 $ - $ - Construction obligations $ 58,431,693 $ 17,529,508 $ 40,902,185 $ - $ - Total contractual obligations $ 75,452,765 $ 26,106,042 $ 44,283,920 $ - $ 5,062,803 “off-balance"off-balance sheet arrangement”arrangement" generally means any transaction, agreement or other contractual arrangement to which an entity unconsolidated with us is a party, under which we have: (i) any obligation arising under a guarantee contract, derivative instrument or variable interest; or (ii) a retained or contingent interest in assets transferred to such entity or similar arrangement that serves as credit, liquidity or market risk support for such assets.. Ourincludinghas carried out an evaluation, with the participation and under the supervision of our Chief Executive Officer and our Chief Financial Officer, has evaluatedof the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered by this report. Based on such evaluation,March 31, 2009. As discussed in more detail below, our Chief Executive Officer and our Chief Financial Officer have concluded that as of the end of the period covered by this report, our disclosure controls and procedures wereare ineffective as of March 31, 2009, due to material weaknesses that we identified in internal control over financial reporting in our annual report on Form 10-K for the fiscal year ended December 31, 2008 (the “Form 10-K).effective:limited to, the following initiatives, which have been implemented, or are in the process of implementation, as of the date of filing of this interim report:•give reasonable assurance thatenforce internal control procedures. We have also reorganized the information requiredstructure of our China financial department and clarified the responsibilities of each key personnel in order to be disclosed by us in reports that we file under the Securities Exchange Act of 1934 is recorded, processed, summarizedincrease communications and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and•to ensure that information required to be disclosed in the reports that we file or submit under the Securities Exchange Act of 1934 is accumulated and communicated to our management, including our CEO and our CFO, to allow timely decisions regarding required disclosure.Our internal accounting staff was primarily engaged in ensuring compliance with PRC accounting and reporting requirements for our operating affiliates and their U.S. GAAP knowledge was limited. As a result, majority of our internal accounting staff, on a consolidated basis, is relatively inexperienced with U.S. GAAP and the related internal control procedures required of U.S. public companies. Although our accounting staff is professional and experienced in accounting requirements and procedures generally accepted in the PRC, management has determined that they require additional training and assistance in U.S. GAAP matters. Management has determined that our internal audit function is also significantly deficient due to insufficient qualified resources to perform internal audit functions. Finally, management determined that the lack of an Audit Committee of our Board of Directors also contributed to insufficient oversight of our accounting and audit functions.In order to correct the foregoing weaknesses, we have taken the following remediation measures:•In first quarter of 2008, underWe have recruited and will continue to bring in additional qualified financial personnel for the accounting department to further strengthen our CEOChina financial reporting function.3. We continually review and CFO’s supervision, we have started a new accounting system implementation project to improve our financial reporting process. We intend to rely on our CFO, a senior financial executive from the U.S. with extensive experience in internal control and U.S. GAAP, and together with our CEO to oversee and manage the financial reporting process. In connection with the new accounting system implementation, we also plan to increase trainingstandardization of our accounting staff both accounting systemmonthly and U.S. GAAP related knowledge. Thequarterly data collection, analysis, and reconciliation procedures. To further improve the timeliness of data collection, we are selecting and will install new accounting system implementation project is currently completed. point of sale systems and enterprise resource planning systems for our wholesale and retail operations.4. We plan on significantly increasing the level of communication and interaction among our China management, independent auditors, our directors of the Board, and other external advisors. 5. We are currently in the process of evaluating the result of the accounting system implementation.•We have started searching for an independent director qualified internal control consultants to serve on an audit committeehelp us be in compliance with internal control obligations, including Section 404. We also plan to be established by our Board of Directors and we anticipate that our Board of Directors will also establish a compensation committeededicate sufficient resources to be headed by one of an independent director. As of the date of this report, we have not selected a suitable candidate for the independent director.our operational needs andthe nature of the business, segregation of all conflicting duties may not alwaysthese material weaknesses in our internal control over financial reporting, there is more than a remote likelihood that misstatements which could be possible and maymaterial to our annual or interim financial statements could occur that would not be economically feasible. However, to the extent possible, we will implement procedures to assure that the initiation of transactions, the custody of assets and the recording of transactions will be performed by separate individuals.Reporting. ThereReportinglastfirst fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.Lotus Pharmaceuticals, Inc.Lotus Pharmaceuticals, Inc. Date: November 14, 2008May 15, 2009/s/ Liu Zhong Yi Liu Zhong Yi Chief Executive Officer and President, principal executive officer Liu Zhong YiChief Executive Officer and President, principal executive officerNovember 14, 2008/s/ Adam WassermanYan ZengYan Zeng Chief Financial Officer, principal financial and accounting officer Adam WassermanChief Financial Officer, principal financial and accounting officer