CHINA KANGTAI CACUTS BIO-TECH, INC.
99 Taibei Road
Limin Economic and Technological Development Zone
Harbin, Heilongjiang Province
People’s Republic China, 150025
November 12, 2009
Mr. Jim B. Rosenberg
Senior Assistant Chief Accountant
United States Securities and Exchange Commission
Division of Corporation Finance
Mail Stop 4720
100 F Street NE
Washington, DC 20549
| Re: | China Kangtai Cactus Bio-Tech, Inc. |
Form 10-K for the Period Ended December 31, 2008
Filed April 15, 2009
Form 10-Q for the Period Ended June 30, 2009
File No. 0-33097
Dear Mr. Rosenberg:
This letter responds to certain comments of the Staff (the “Staff”) of the Securities and Exchange Commission (the “Commission”) contained in the letter from the Staff to China Kangtai Cactus Bio-Tech, Inc. (the “Company”) dated September 22, 2009.
For your convenience, we have included each of the Staff’s comments in italics before each of the Company’s responses. References in this letter to “we,” “our” or “us” mean the Company or its advisors, as the context may require.
Form 10-K for the Period ended December 31, 2008
Note 8 Shareholders’ Equity, page F-11
Staff Comment 1. In accounting for the issuance of the Series A Convertible Preferred stock it does not appear that you recorded the stock and warrants based on a relative allocation of their fair value to the proceeds received nor determined the beneficial conversion feature with reference to the amount allocated to the convertible preferred only. Please tell us how your accounting complies with paragraphs 5 and 6 of EITF 00-27.
Response: We plan to revise the 12/31/08 financial statements (as per attached Exhibit A) in our planned 12/31/08 Form 10-K/A to comply with your comment, which revision we believe complies with EITF 00-27.
Regarding the March 21, 2008 issuance, in accordance with Emerging Issues Task Force ("EITF") Issue No. 00-27, we first determined the fair values of the component parts of the sale, as follows:
Series A Preferred Stock [ 833,333 shares X $.75 = $625,000 ] (a) | | $ | 625,000 | | | | 39.3 | % |
A Warrants [ 1,250,000 shares X $.3818 = $477,250 ] (b) | | | 477,250 | | | | 30.0 | |
B Warrants [ 1,500,000 shares X $.3255 = $488,250 ] (b) | | | 488,250 | | | | 30.7 | |
| Total | | $ | 1,590,500 | | | | 100.0 | % |
(a) The fair value of the convertible preferred stock of $625,000 was estimated based on its conversion feature (the 833,333 shares of the Series A Preferred Stock are convertible into 833,333 shares of Company common stock) and the $0.75 common stock trading price at date of issue on March 21, 2008.
(b) The fair value of the warrants was estimated to be $.3818 for the A Warrants and $.3255 for the B Warrants using the Black-Scholes option pricing model and the following assumptions: the common stock trading price of $ 0.75 per share on March 21, 2008; an exercise price of $0.75 per share for the A Warrants and an exercise price of $1.00 per share for the B Warrants; a term of 3 years for both warrants; an expected common stock price volatility of 74% and risk-free interest rate of 4% for both the A and the B warrants.
Next, we determined a $0.2358 effective conversion price of the Series A Convertible Preferred Stock based upon allocating 39.3%, as tabled above, of the total actual proceeds received for a unit of the Series A Convertible Preferred Stock and the A & B Warrants on March 21, 2008 of $500,000, or $196,500 ($500,000 X 39.3% = $196,500). The adjusted conversion price of $0.2358 was computed by dividing the $196,500 allocated part of the $500,000 of proceeds to the preferred by the 833,333 shares of common stock to be received on conversion of that preferred stock to common stock. Since the Company received $0.75 per unit for combined convertible preferred stock/warrants sold on March 21, 2008, the Company attributed $0.5142 per share of that $0.75 unit price to the convertible preferred stock ( $0.75 per share common stock trading price on March 21, 2008 less the effective conversion price of $0.2358 = $0.5142) as the resultant intrinsic value of the beneficial feature of the conversion option in the preferred stock, or $428,500 (833,333 shares X $0.5142 = $428,500). Thus, the combined fair value of the warrants of $965,500 ($477,250 + $488,250) and intrinsic value of the beneficial conversion feature of the Series A Preferred Stock of $428,500 was $1,394,000. However, the deemed dividend is limited to the $500,000 gross actual proceeds received by the Company, pursuant to EITF Issue 98-5 as amended by EITF Issue No. 00-27.
Regarding the July 16, 2008 issuance ($250,000 gross actual proceeds), we used the same methodology as used for the March 21, 2008 issuance above and arrived at a combined fair value of the A and B Warrants of $281,580 and intrinsic value of the beneficial conversion feature of the Series A Convertible Preferred Stock of $160,875, or a total of $442,455. However, the total deemed dividend is limited to the $250,000 proceeds pursuant to EITF Issue No. 98-5 as amended by EITF Issue No. 00-27.
Below is a summary of the computations made to arrive at the values attributed to the convertible preferred stock and the A and B Warrants for the July 16, 2008 unit issuances:
| Series A Preferred Stock [ 416,667 shares X $0.689 = $287,083 ](a) | | $ | 287,083 | | | | 50.5 | % |
| A Warrants [ 500,000 shares X $.2856 = $142,800 ](b) | | | 142,800 | | | | 25.1 | |
| B Warrants [ 600,000 shares X $.2313 = $138,780 ](b) | | | 138,780 | | | | 24.4 | |
| Total | | $ | 568,663 | | | | 100.0 | % |
| Gross actual proceeds received by Company allocated as intrinsic value of beneficial conversion feature of convertible preferred stock [50.5% X $250,000= $126,250/ 416,667 = $0.3029; $0.689 - $0.3029 = $0.3861 X 416,667 = $160,875 ] | | $ | 160,875 | |
| Fair value of A & B Warrants [$142,800 + $138,780 = $281,580 ] | | | 281,580 | |
| Total intrinsic value of beneficial conversion feature of convertible preferred stock and fair value of A & B Warrants | | $ | 442,455 | |
| Deemed dividend limited to actual gross proceeds pursuant to EITF 98-5 as amended by EITF 00-27 | | $ | 250,000 | |
Below is a summary of the amounts to be recorded in the financial statements for the year ended December 31, 2008 (as per the attached) in the planned Form 10K/A:
| Aggregated deemed dividend: | | | |
Related to issuance of units on 3/21/08 | | $ | 500,000 | |
Related to issuance of units on 7/16/08 | | | 250,000 | |
Total deemed dividend recorded with corresponding credit to additional paid in capital | | $ | 750,000 | |
Staff Comment 2. Disclose the assumptions used in fair valuing the warrants issued.
Response: We plan to disclose the assumptions used in fair valuing the warrants issued outlined in the response to Staff Comment 1. above (as per attached) in our planned 12/31/08 Form 10-K/A.
Staff Comment 3. Regarding the Series A Convertible Preferred Stock, revise the disclosure to indicate if the performance measures were met for the six months ended June 30, 2008 and the year ended December 31, 2008.
Response: We plan to revise the disclosures (as per attached) to indicate that the performance thresholds that would “trigger” an adjustment to the conversion price for both the six months ended June 30, 2008 and the year ended December 31, 2008 were met and, therefore, no more common shares would be required upon conversion.
As of January 1, 2009, neither the A and B warrants or the embedded conversion feature (included in the sales of the Series A Preferred Stock) provide for cash settlements and are all considered to be indexed to the issuer's common stock pursuant to EITF Issue No. 07-5 and thus, are not required to be classified as liabilities and measured at fair value recognized in earnings.
Since the performance thresholds (which relate to pretax earnings per share before non-cash items for the six months ended June 30, 2008 and the year ended December 31, 2008) were met, there was no adjustment to the conversion price of the Series A Preferred Stock or the exercise price of the warrants. Accordingly, effective December 31, 2008, these instruments no longer contained an exercise contingency and upon conversion or exercise, the settlement amount would equal the difference between the fair value of a fixed number of our equity shares and a fixed conversion or exercise price. Thus, the instruments are considered indexed to our common stock pursuant to EITF Issue
No. 07-5.
Form 10-Q for the Period Ended June 30, 2009
Staff Comment 4. Tell us your consideration of EITF 07-5 as of January 1, 2009 and why the warrants and the embedded conversion feature were not required to be classified as liabilities and measured at fair value recognized in earnings.
Response: Please refer to our response to Staff Comment 3.
The Company acknowledges that:
| | · | The Company is responsible for the adequacy and accuracy of the disclosure in the filing; |
| | · | Staff comments or changes to disclosure in response to staff comments do not foreclose the Commission from taking any action with respect to the filing; and |
| | · | The Company may not assert staff comments as a defense in any proceeding initiated by the Commission or any person under the federal securities laws of the United States. |
We trust that you will find the foregoing responsive to the comments of the Staff. Comments or questions regarding this letter may be directed to the undersigned or Matthew Chang, Company counsel, at (415) 955-8900.
| | | Sincerely, | |
| | | | |
| | /s/ Hong Bu | |
| | | Hong Bu | |
| | | Chief Financial Officer | |
Enclosures
Exhibit A—Proposed Amendment No. 1 to Form 10-K for the Year Ended 12/31/2008
China Kangtai Cactus Bio-Tech Inc. and Subsidiaries
Consolidated Balance Sheets
(Expressed in US Dollars)
| | | December 31, | | | December 31, | |
| | | 2008 | | | 2007 | |
| | | (Audited) | | | (Audited) | |
| ASSETS | | | | | | |
| Current Assets | | | | | | |
| Cash and cash equivalents | | $ | 4,398,897 | | | $ | 509,901 | |
| Accounts receivable, net of allowance for returns and doubtful accounts of $979,700 and $838,736, respectively | | | 3,869,985 | | | | 4,036,169 | |
| Inventories | | | 3,376,635 | | | | 6,093,955 | |
| Other receivables and prepaid expenses | | | 1,005 | | | | 20,237 | |
| Total Current Assets | | | 11,646,522 | | | | 10,660,262 | |
| | | | | | | | | |
| Property and Equipment, net | | | 6,236,914 | | | | 6,290,330 | |
| | | | | | | | | |
| Other Assets | | | | | | | | |
| Intangible assets, net | | | 454,445 | | | | 553,038 | |
| Land use rights, net | | | 8,609,491 | | | | 1,290,141 | |
| Total Assets | | $ | 26,947,372 | | | $ | 18,793,771 | |
| | | | | | | | | |
| LIABILITIES AND STOCKHOLDERS' EQUITY | | | | | | | | |
| Current Liabilities | | | | | | | | |
| Accounts payable and accrued liabilities | | $ | 315,639 | | | $ | 353,091 | |
| Note payable | | | 887,475 | | | | 829,437 | |
| Taxes payable | | | 570,855 | | | | 319,149 | |
| Total current liabilities | | | 1,773,969 | | | | 1,501,677 | |
| | | | | | | | | |
| Commitments and Contingencies | | | - | | | | - | |
| Stockholders' Equity | | | | | | | | |
| Preferred stock, $0.001 par value; authorized 200,000,000 shares, issued and outstanding: 1,150,000 and 0 shares, respectively | | | 1,150 | | | | - | |
| Common stock, $0.001 par value; authorized 200,000,000 shares, issued and outstanding: 17,885,625 and 17,739,625 shares, respectively | | | 17,886 | | | | 17,740 | |
| Additional paid-in capital | | | 8,215,705 8,874,869 | | | | 6,607,848 | |
| Retained earnings | | | | | | | | |
| Appropriated | | | 2,682,345 | | | | 1,844,937 | |
| Unappropriated | | | 11,208,445 10,549,281 | | | | 7,082,943 | |
| Accumulated other comprehensive income | | | 3,047,872 | | | | 1,738,626 | |
| Total stockholders' equity | | | 25,173,403 | | | | 17,292,094 | |
| Total Liabilities and Stockholders' Equity | | $ | 26,947,372 | | | $ | 18,793,771 | |
See notes to consolidated financial statements.
China Kangtai Cactus Bio-Tech Inc. and Subsidiaries
Consolidated Statements of Operations and Comprehensive Income
(Expressed in US Dollars)
| | | December 31, | | | December 31, | |
| | | 2008 | | | 2007 | |
| | | (Audited) | | | (Audited) | |
| | | | | | | |
| Net Sales | | $ | 20,300,583 | | | $ | 14,240,655 | |
| | | | | | | | | |
| Cost of Sales | | | (12,307,303 | ) | | | (9,629,251 | ) |
| | | | | | | | | |
| Gross Profit | | | 7,993,280 | | | | 4,611,404 | |
| | | | | | | | | |
| Operating Expenses | | | | | | | | |
| Selling expenses | | | 214,285 | | | | 279,303 | |
| General and administrative expenses | | | 648,644 | | | | 1,151,534 | |
| Depreciation | | | 77,015 | | | | 70,589 | |
| Amortization of land use rights | | | 73,761 | | | | 35,983 | |
| Amortization of intangible assets | | | 134,924 | | | | 123,704 | |
| Total operating expenses | | | 1,148,629 | | | | 1,661,113 | |
| Income from Operations | | | 6,844,651 | | | | 2,950,291 | |
| | | | | | | | | |
| Other Income (Expenses) | | | | | | | | |
| Interest income | | | 838 | | | | 603 | |
| Imputed interest | | | (52,326 | ) | | | (47,796 | ) |
| Loss on disposal of property and equipment | | | (14,323 | ) | | | - | |
| Other income (expense) - net | | | | | | | (171 | ) |
| Total Other Income (Expenses) | | | (65,811 | ) | | | (47,364 | ) |
| Income before Income Taxes | | | 6,778,840 | | | | 2,902,927 | |
| Income Tax Expense | | | (1,065,930 | ) | | | (603,227 | ) |
| Net Income | | | 5,712,910 | | | | 2,299,700 | |
| Deemed dividend relating to the beneficial conversion feature and the value of the warrants included in the sale of the | | | | | | | | |
| Series A preferred stock | | | (750,000) (1,409,164 | ) | | | - | |
| Net income attributable to common stockholders | | $ | 4,962,910 4,303,746 | | | $ | 2,299,700 | |
| Net income per common share | | | | | | | | |
| Basic | | $ | 0.28 0.24 | | | $ | 0.13 | |
| Diluted | | $ | 0.27 0.23 | | | $ | 0.13 | |
| | | | | | | | | |
| Weighted average number of common shares outstanding | | | | | | | | |
| Basic | | | 17,767,461 | | | | 17,739,625 | |
| Diluted | | | 18,597,561 | | | | 17,739,625 | |
| | | | | | | | | |
| Comprehensive income: | | | | | | | | |
| Net income | | $ | 5,712,910 | | | $ | 2,299,700 | |
| Foreign currency translation adjustment | | | 1,309,246 | | | | 1,047,589 | |
| Total | | $ | 7,022,156 | | | $ | 3,347,289 | |
See notes to consolidated financial statements.
China Kangtai Cactus Bio-Tech Inc. and Subsidiaries
Consolidated Statements of Stockholders' Equity
(Expressed in US Dollars)
| | | Preferred Stock $0.001 par | | | Common Stock $0.001 par | | | Additional | | | Unappropriated | | | Appropriated | | | Accumulated other | | | | |
| | | value | | | value | | | paid-in | | | retained | | | retained | | | comprehensive | | | | |
| | | Shares | | �� | Amount | | | Shares | | | Amount | | | capital | | | earnings | | | earnings | | | income | | | Total | |
| Balance at December 31, 2006 | | | - | | | $ | - | | | | 17,739,625 | | | $ | 17,740 | | | $ | 6,558,082 | | | $ | 5,266,815 | | | $ | 1,361,365 | | | $ | 691,037 | | | $ | 13,895,039 39 | |
| Imputed interest on note payable | | | - | | | | - | | | | - | | | | - | | | | 49,766 | | | | - | | | | - | | | | - | | | | 49,766 | |
| Transfer to statutory and staff welfare reserves | | | - | | | | - | | | | - | | | | - | | | | - | | | | (483,572 | ) | | | 483,572 | | | | - | | | | - | |
Net income for the year ended December 31, 2007 | | | - | | | | - | | | | - | | | | - | | | | - | | | | 2,299,700 | | | | - | | | | - | | | | 2,299,700 | |
| Currency translation adjustment | | | - | | | | - | | | | - | | | | - | | | | - | | | | - | | | | - | | | | 1,047,589 | | | | 1,047,589 | |
| Balance at December 31, 2007 | | | - | | | | - | | | | 17,739,625 | | | | 17,740 | | | | 6,607,848 | | | | 7,082,943 | | | | 1,844,937 | | | | 1,738,626 | | | | 17,292,094 | |
| Sale of Series A preferred stock | | | 1,250,000 | | | | 1,250 | | | | - | | | | - | | | | 719,672 | | | | - | | | | - | | | | | | | | 720,922 | |
| Deemed dividend | | | - | | | | - | | | | - | | | | - | | | | 750,000 1,409,164 | | | | (750,000 (1,409,164 | ) ) | | | - | | | | | | | | - | |
Issuance of shares in consideration for the waiver of liquidated damages | | | - | | | | - | | | | 46,000 | | | | 46 | | | | 26,634 | | | | - | | | | - | | | | - | | | | 26,680 | |
| Conversion of Series A Preferred Stock | | | (100,000 | ) | | | (100 | ) | | | 100,000 | | | | 100 | | | | - | | | | - | | | | - | | | | - | | | | - | |
| Stock option expense | | | - | | | | - | | | | - | | | | - | | | | 59,225 | | | | | | | | - | | | | | | | | 59,225 | |
| Imputed interest on note payable | | | - | | | | - | | | | - | | | | - | | | | 52,326 | | | | - | | | | - | | | | - | | | | 52,326 | |
| Transfer to statutory and staff welfare reserves | | | - | | | | - | | | | - | | | | - | | | | - | | | | (837,408 | ) | | | 837,408 | | | | - | | | | - | |
Net income for the year ended December 31, 2008 | | | - | | | | - | | | | - | | | | - | | | | - | | | | 5,712,910 | | | | - | | | | - | | | | 5,712,910 | |
| Currency translation adjustment | | | - | | | | - | | | | - | | | | - | | | | - | | | | - | | | | - | | | | 1,309,246 | | | | 1,309,246 | |
| Balance at December 31, 2008 | | | 1,150,000 | | | $ | 1,150 | | | | 17,885,625 | | | $ | 17,886 | | | $ | 8,215,705 8,874,869 | | | $ | 11,208,445 | | | $ | 2,682,345 | | | $ | 3,047,872 | | | $ | 25,173,403 | |
See notes to consolidated financial statements.
Note 8. Stockholders’ Equity
Restricted Net Assets
Relevant PRC statutory laws and regulations permit payments of dividends by Harbin Hainan Kangda and Taishan Kangda only out of their retained earnings, if any, as determined in accordance with PRC accounting standards and regulations. In addition, PRC laws and regulations require that annual appropriations of after-tax income should be set aside prior to payments of dividends as a reserve fund. As a result of these PRC laws and regulations Harbin Hainan Kangda and Taishan Kangda are restricted in their ability to transfer a portion of their net assets in the form of dividends, loans or advances, which restricted portion amounted to $10,185,183 and $8,745,639 at December 31, 2008 and 2007, respectively.
Series A Convertible Preferred Stock
On March 21, 2008, the Company entered into a Preferred Stock Purchase Agreement (the “Purchase Agreement”) with T Squared Investments LLC (the “Investor”) to sell in a private placement to the Investor for an aggregate purchase price of $500,000, (i) 833,333 shares of the Company’s newly designated Series A Convertible Preferred Stock, par value $0.001 per share (the “Series A Preferred Stock”) for $0.60 per share (the “Shares”), (ii) warrants to purchase up to 1,250,000 shares of Company’s common stock exercisable for a period of three years at an exercise price of $0.75 per share (the “A Warrants”) or an aggregate exercise price of $937,500 if all of the A Warrants were exercised, and (iii) warrants to purchase up to 1,500,000 shares of Company’s common stock exercisable for a period of three years at an exercise price of $1.00 per share (the “B Warrants”), or an aggregate exercise price of $1,500,000 if all the B Warrants were exercised. The Company issued the Shares, the A Warrants and B Warrants on the same day. Westernking Financial Service acted as the sole placement agent in the transaction and received a fee of $30,000 (6% of the gross proceeds).
The Company also entered into a Registration Rights Agreement with the Investor, pursuant to which the Company is obligated to file and have declared effective by the SEC a registration statement registering the resale of the Shares and Common Stock issuable upon the Conversion of the Series A Preferred Stock and the exercise of the A Warrants and B Warrants. If the registration statement is not declared effective by the SEC by August 28, 2008, the Registration Rights Agreement provides for the Company to issue to the Investor as liquidated damages an additional 1,000 shares of Series A Preferred Stock for each day thereafter not declared effective (subject to a maximum of 250,000 shares). On October 17, 2008, the SEC declared effective the Company’s registration statement on Form S-1. On October 15, 2008, the Company issued 46,000 shares of common stock to the Investor in consideration for the waiver of liquidated damages.
The Series A Preferred Stock has no voting or dividend rights, is entitled to a liquidation preference of $0.60 per share, and each share is convertible into one share of Company common stock at the option of the holder (which was adjustable to more shares if certain “defined” EPS performance thresholds were not met for the six months ended June 30, 2008 or the year ended December 31, 2008; however, the performance thresholds were met).
The Company recorded as a $500,0001,090,500 deemed dividend and as a $500,0001,090,500 increase in additional paid-in capital the total of the intrinsic value of the beneficial conversion feature ($428,500125,000) and the estimated fair value of the A Warrants ($477,250) and the B Warrants ($488,250), which recording is limited to the gross actual proceeds ($500,000) pursuant to Emerging Issues Task Force Consensus (“EITF”) No. 98-5 as amended by EITF No. 00-27. The fair value of the warrants was estimated using the Black-Scholes option pricing model and the following assumptions: stock price of $0.75 per share, exercise price of $0.75 per share for the A warrants, exercise price of $1.00 per share for the B warrants, term of 3 years, expected volatility of 74%, and risk-free interest rate of 4%.
On July 16, 2008, the Company sold the Investor, for an aggregate purchase price of $250,000, an additional 416,667 shares of Series A Preferred Stock, warrants to purchase up to 500,000 shares of Company common stock exercisable for a period of three years at an exercise price of $0.9375 per share, and warrants to purchase up to 600,000 shares of Company common stock exercisable for a period of three years at an exercise price of $1.25 per share. The Company recorded as a $250,000318,664 deemed dividend and as a $250,000318,664 increase in additional paid-in capital, based upon the total of $442,155 the intrinsic value of the beneficial conversion feature ($160,87537,084) and the estimated fair value of the warrants ($281,580), which recording is limited to the gross actual proceeds ($250,000) pursuant to Emerging Issues Task Froce Consensus (“EITF”) No. 98-5 as amended by EITF No. 00-27. The fair value of the warrants was estimated using the Black-Scholes option pricing model and the following assumptions: stock price of $0.689 per share, exercise prices of $0.9375 and $1.25 per share, term of 3 years, expected volatility of 71.4%, and risk-free interest rate of 4%.
On October 27, 2008, the Company issued 100,000 shares of common stock to the Investor for the conversion of 100,000 shares of Series A Preferred Stock.
