UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
_____________________
FORM 10-K/A
(Amendment No. 1)
| x | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934. |
| | For the fiscal year ended June 30, 2011. |
| | |
| | OR |
| | |
| ¨ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934. |
Commission File No. 1-32674
AOXING PHARMACEUTICAL COMPANY, INC.
(Exact Name of Registrant as Specified in its Charter)
| Florida | 65-0636168 |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer ID Number) |
15 Exchange Place, Suite 500, Jersey City, NJ 08302
(Address of principal executive offices)
Issuer's Telephone Number, including Area Code: 646-367-1747
Securities Registered Pursuant to Section 12(b) of the Act:
| Title of Each Class | Name of Exchange Where Registered |
| Common Stock, $.001 par value | NYSE Amex |
Securities Registered Pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 406 of the Securities Act. Yes __ No √
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes __ No √
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Sections 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes √ No __
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files.) Yes ___ No ___
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405) is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X]
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check One)
Large accelerated filer ___ Accelerated filer ___ Non-accelerated filer ___ Small reporting company X
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes __ No √
The aggregate market value of the Registrant’s common stock, $.001 par value, held by non-affiliates as of December 31, 2010, the last business day of the second fiscal quarter, was $70,434,825.
As of September 15, 2011 the number of shares outstanding of the Registrant’s common stock was 49,158,955, $.001 par value.
DOCUMENTS INCORPORATED BY REFERENCE: None.
Explanatory Note
We have determined that, in our Annual Report as originally filed, a deferred tax asset in the amount of $2,614,817 was improperly valued as an asset as of June 30, 2011 and that a valuation allowance for 100% of the balance of the deferred tax asset should be recorded. Upon review, management decided that the Company did not have sufficient competent evidence to support its conclusion that the Company would earn taxable income in the future against which it could realize the benefit of its net operating loss carryforwards.
The restatement has resulted in changes to the financial statements identified in Note 2 to the Consolidated Financial Statements. The restatement has also resulted in the addition of Note 2 (Restatement) and a modification to Note 15 (Taxes) to the Consolidated Financial Statements, as well as appropriate changes to Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” In addition, as a result of discovering the need to restate, we have modified the disclosure in Item 9A, “Controls and Procedures.”
Except as discussed above, and except as required to reflect the effects of the restatement in this Form 10-K/A, we have not modified or updated disclosures presented in the original annual report on Form 10-K. Accordingly, this Form 10-K/A does not reflect events occurring after the filing of our original Form 10-K or modify or update those disclosures affected by subsequent events, except as specifically referenced herein. Information not affected by the restatement is unchanged and reflects the disclosures made at the time of the original filing of the Form 10-K. Accordingly, this Form 10-K/A should be read in conjunction with our periodic filings made with the SEC subsequent to the date of the original filing, including any amendments to those filings, as well as any Current Reports filed on Form 8-K subsequent to the date of the original filing.
Part II - Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations – Restated
You should read the following discussion and analysis of our financial condition and results of operations in conjunction with our combined and consolidated financial statements and the related notes included elsewhere in this Annual Report on Form 10-K/A. The discussion in this section contains forward-looking statements that involve risks and uncertainties. As a result of various factors, including those set forth under “Risk Factors” and elsewhere in this report, our actual future results may be materially different from what we expect.
We are a specialized pharmaceutical company focusing on research, development, manufacturing and marketing of a broad range of narcotics, pain management, and addiction treatment pharmaceutical products. Our broad product line is comprised of prescription and over-the-counter pharmaceutical products. Our pharmaceutical products have been approved by the Chinese State Food and Drug Administration, or SFDA, based on demonstrated safety and efficacy. We sell our products primarily to hospitals, clinics, pharmacies and retail in most of the provinces of China, including rural areas and major cities. More importantly, we are dedicated to bringing the new generation of narcotics and pain medicines into the Chinese market and we have invested significantly in developing our core pipeline products and advancing them into clinical stages.
Results of Operations-Comparison of the year ended June 30, 2011 and 2010
Factors Influencing Pharmaceutical Market in China in 2011
Since the beginning of 2011, the bidding system of the market reform of pharmaceutical products in China has an adverse impact on the general pricing of those drugs that won the bidding to be included on the Essential Drug List. At similar time, raw materials, including those that were used to make certain products, especially the herbal medicines, have experienced inflation. In some instances, the inflation is very significant. In the most severe cases, the combined effect of pricing pressure and rising cost of raw materials made it non-profitable for certain products.
Revenue
Revenues for the year ended June 30, 2011 were $6,651,048, representing an 8.8% increase from the revenues of $6,115,774 that we realized during the fiscal year ended June 30, 2010. The increase in revenue is due to increased product sales of 5.8% and foreign currency translation changes contributed 2.8% to sales growth. We increased our selling efforts from July 2010 and adjusted our marketing strategy, which had a positive effect on our sales. However, there had been a very significant increase in the price of raw materials such that some of our products that have won the bidding to be included in the government’s Essential Drug List had become non-profitable. We therefore stopped promotional efforts on these product lines with unattractive gross margin, which had an adverse impact on our total sales. During 2011, these products accounted for only 6.8% of our total sales.
Cost of Goods Sold
Cost of goods sold was $3,327,723 for the year ended June 30, 2011, which was 42% higher than the $2,341,195 in costs incurred during the year ended June 30, 2010. The gross margin ratio was decreased from 61.7% to 50%. Rising cost of raw materials mentioned above is the primary reason for the decrease in gross margin. Increased cost of labor also had a negative impact on gross margin.
Gross Profit
Gross profit was $3,323,325 for the year ended June 30, 2011, 12% lower than the gross profit of $3,774,579 from previous year, reflecting the combined effects of higher sales and lower gross margin ratio.
Research & Development Expenses
Research and development expenses were $929,598 for the year ended on June 30, 2011, representing a 40% decline from $1,540,744 that incurred from previous year. Our R&D expenses could fluctuate significantly from period to period, reflecting the progress and timing of our various drug development projects.
General and Administrative Expenses
Our General and administrative expenses consist primarily of employee compensation and benefits payable to your general management, finance and administrative staff, professional and legal fees, and bad debt expenses. In the year ended June 30, 2011, our general and administrative expenses were $4,787,346, 982,374 or 25.8% higher than $3,804,972 incurred from previous year. Among the significant contributors to the increase in general and administrative expense were the following:
| | · | In fiscal year 2011 we incurred cash compensation expenses of $902,425 in our subsidiary in China, which is 74.8% higher than $516,258 incurred in fiscal year 2010. There was significant wage inflation across the country during 2011. A strong RMB also contributed to the increase, by 2.8%. The Company increased wages for many employees accordingly, in order for us to attract and retain talented employees. |
| | · | Bad debt expenses. We perform accounts receivable aging analysis of each customer periodically. As a result of our periodic review and continuous efforts to collect our accounts receivable, we had charges of bad debt expense of $917,958 and $216,440 for the year ended June 30, 2011 and 2010, respectively. We sell our products to both distributors and retailers, and the payment terms range from 30 days to 90 days from invoice date or receipt of goods, whichever is late. We evaluate collectability of our accounts receivable periodically and provide a bad debt reserve based on their aging and the results of our collection action. |
Selling Expense
Selling expenses in the amount of $1,603,114 were 17% higher than $1,367,997 spent on selling during the previous fiscal year. The increase was mainly due to expansion of our sales and marketing personnel, which contributed positively to our selling expenses, while decreasing promotion on certain products with unattractive gross margin has the opposite effect.
Depreciation and amortization expense decreased 7.8% from $645,004 in fiscal year 2010 to $594,720 in fiscal 2011. The main reason for the decrease is that we sold the remaining fixed assets after Lerentang relocation during the fiscal year 2010. There was no depreciation expense associated with those assets in 2011.
As a result of these expenses and reduction of gross profit, our loss from operations increased 28% from $3,584,138 incurred in fiscal year 2010 to $4,591,453 in fiscal 2011. The significant increase in the loss was primarily due to lower gross profit, higher general and administrative expenses, and higher selling expenses. Less spending on R&D had a positive impact on loss.
Interest expense was $1,744,735 for fiscal year 2011, 28% lower than the interest expense of $2,427,675 incurred in fiscal 2010. The reduction of interest expense was primarily due to repayment and conversion of a convertible debenture in May 2010.
The volatility in the market price of our common stock has a significant impact on the fair valuation of our outstanding warrant liabilities. During the fiscal year ended June 30, 2011, this value decreased by $1,912,373, primarily due to a decline in the market price of our common stock. The decrease was recorded as other income for the year. In the previous fiscal year ended on June 30, 2010, decline in the market price of our common stock led to a decline of $1,455,368 in the fair value of outstanding warrants and other derivative liabilities, with a corresponding other income in that amount.
Taxes and Effect of Expiration of Net Operating Loss Carrryforward
The Company’s Chinese subsidiaries are governed by income tax laws of the PRC concerning private-run enterprises, which are generally subject to taxes at a statutory rate of 25% on income reported in the statutory financial statements prepared in accordance with PRC GAAP after appropriate tax adjustments. Operating loss can be carryforwarded for five years in China and twenty years in the U.S.
As reflected in the restated financial statements included in this Report, subsequent to the initial filing of our Annual Report on Form 10-K, the Company concluded that it was more likely than not that its operating loss carryforward in China would not be realized, due to the expiration of net operating loss. The write-off of the operating loss carryforward resulted in a non-cash tax expenses that contributed to tax expenses of $3,394,103 for the year ended June 30, 2011, compared to a tax benefit of $63,058 for the year ended June 30, 2010. (Please see note 15 for more details.)
The Company realized a net loss of $7,817,918 for the fiscal year ended June 30, 2011. However, because the Company owns only 95% of Hebei Aoxing, 5% of that company’s income was attributed to the minority interest. Therefore the net loss for the fiscal year attributable to the shareholders of Aoxing Pharmaceutical was $7,410,848. In comparison, during the fiscal year ended June 30, 2010, there was a forgiveness of $3,648,616 debt by Bank of China that we recorded as other income, which helped reduce the net loss to $844,771. After deducting income (loss) attributable to the 5% minority interest in Hebei Aoxing, net loss attributable to shareholders of Aoxing Pharmaceutical was $832,159.
Liquidity and Capital Resources
Liquidity is the ability of a company to generate funds to support its current and future operations, satisfy its obligations and otherwise operate on an ongoing basis.
During fiscal year 2011, the changes in Company’s liquidity and capital resources are mixed. On the negative side, cash and cash equivalent position has decreased by $1,214,966. On the positive side, a debt-to-equity conversion at the end of the fiscal year helped reducing the company’s total debt service obligation by $2,766,511.
Our cash balance on June 30, 2011 was $2,770,744, compared to $3,985,710 on June 30, 2010. The decrease reflected the combined effects of cash use in operating activities ($2,673,141), capital expenditure ($1,373,156), net borrowing, and repayment of loans to unrelated parties.
Working capital deficit on June 30, 2011 was $7,257,567, which is $2,622,080 more than the working capital deficit of $4,635,487 on June 30, 2010. Decrease in current assets, mostly due to a lower cash position, contributed $1,541,911 to the increase in the deficit. Increase in current liabilities contributed $1,080,169 to the deficit. Two main contributors to the increase in current liabilities are higher accrued expenses and other current liabilities ($622,881) and higher bank loan balance ($430,644) entirely due to foreign currency translation of the same amount of loan in RMB, which appreciated about 5.3% from June 30, 2010 to June 30, 2011.
Long term debt has declined by $3,023,013 from $8,551,061 on June 30, 2010 to $5,528,048 on June 30, 2011, primarily due to the debt to equity conversion. On June 26, 2011, the Company reached an agreement with six debt holders, including our Chairman and CEO, Mr. Zhenjiang Yue, to convert certain outstanding debts and accrued interest totaling $6,567,200 into shares of the Company’s common stock at $2.70 per share.
Our total debt service obligation, listed below, was $14,298, 074 on June 30, 2011, $2,766,511 less than the $17,064,585 debt service obligation on June 30, 2010. The decrease in total debts is significantly greater than the decrease either in current assets ($1,541,911) or in cash level (1,214,966).
Our operations during the year ended June 30, 2011 used $2,673,141 in cash, compared to $3,978,718 cash consumed during the year ended June 30, 2010. This change primarily reflected less use of cash for research and development, a more favorable change in inventory levels in comparison to the year ended June 30, 2010.
Our ongoing expansion of operations led us to improve our manufacturing facility by acquiring new machinery and equipment for $1,373,156 during the year ended June 30, 2011. In the previous year, capital expenditure was $1,996,018. Our capital expenditure will fluctuate significantly from one year to another, depending on the need and timing of manufacturing facility expansion or improvements.
As a result of the several debt refinancing and the debt-to-equity conversion mentioned above during fiscal 2011, our debt service obligations on June 30, 2011 were:
| | | | | | Less than | | | | | | | | | | | | After 5 |
| Contractual Obligations | | Total | | | 1 Year | | | 1-2 Years | | | 2-3 Years | | | 3-4 Years | | 4-5 Years | Years |
| Short term Borrowing | | $ | 232,055 | | | $ | 232,055 | | | | | | | | | | | | |
| Banks | | | 8,508,663 | | | | 8,508,663 | | | | | | | | | | | | |
| Affiliates | | | 3,702,003 | | | | 5,793 | | | $ | 1,286,219 | | | $ | 2,180,142 | | | $ | 229,849 | | | |
| Others | | | 1,855,353 | | | | 23,515 | | | | | | | | | | | | 1,831,838 | | | |
| TOTAL | | $ | 14,298,074 | | | $ | 8,770,026 | | | $ | 1,286,219 | | | $ | 2,180,142 | | | $ | 2,061,687 | | | |
On June 30, 2011, we had cash of $2.77 million in our bank accounts. In April 2011, we obtained GMP certification for tincture and pill formulation facilities and have resumed production for some products that we were not able to manufacture before. For our next fiscal year, we anticipate our cash flow from operations to improve, due to more products available for sale. Presently, the Company does not anticipate large capital expenditure projects in the next 12 months. As a result, the Company will be able to operate at much lower cash burn rates, if needed, without major impact on its operations. The Company does anticipate that its current cash position will be insufficient to support the Company's operations at current capacity for the next 12 month period and, therefore, will need to seek additional financing of its operations. The Company may also want to seek financing to fund expansion of our operations, extend our reach to broader markets, or to acquire additional entities. We may rely on bank borrowing as well as capital raises. We are actively exploring various proposals and alternatives in order to secure sources of financing and improve our financial position. We may raise such additional capital through the issuance of our equity securities, which may result in significant dilution to our current investors. Other options considered include issuance of convertible debt, a new bridge loan, and arrangement to out-license intellectual property. We are also exploring potential strategic partnerships, which could provide a capital infusion to the Company.
Application of Critical Accounting Policies
In preparing our financial statements we are required to formulate working policies regarding valuation of our assets and liabilities and to develop estimates of those values. In our preparation of the financial statements for fiscal year 2011 and 2010, there were three estimates made which were (a) subject to a high degree of uncertainty and (b) material to our results. These were:
| | · | the determination, described in Note 2 to our restated Consolidated Financial Statements, to record a valuation allowance for 100% of the balance of our deferred tax asset. The determination was based on our review of Company’s prospects for taxable income and our assessment that it was more likely than not that our net operating loss carryforward in China would expire before being realized. |
| | · | the determination, described in Note 3 to our Consolidated Financial Statements, to record an allowance for doubtful accounts in the amount of $543,697 and $2,575,177 for the year ended June 30, 2011 and 2010, respectively. The determination was based on our review of the credit history of the relevant customers and the results of our collection efforts. |
| | · | The calculation, described in Notes 3 and 13 to the Financial Statements, of the implicit value of our outstanding warrants and derivative liabilities. The determination was based on comparison with market-valued derivative instruments. |
We made no material changes to our critical accounting policies in connection with the preparation of financial statements for fiscal year 2011.
Impact of Accounting Pronouncements
New accounting rules and disclosure requirements can significantly impact the comparability of our financial statements.
There are no recent accounting pronouncements that have had a material effect on our financial statements.
Off-Balance Sheet Arrangements
We do not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition or results of operations.
Part II - Item 8. Financial Statements and Supplementary Data
Index to the Consolidated Financial Statements
| Page | |
| F-1 | Report of Independent Registered Public Accounting Firm. |
| | |
| F-2 | Restated Consolidated Balance Sheets as of June 30, 2011 and 2010. |
| | |
| F-3 | Restated Consolidated Statements of Operations and Other Comprehensive Loss for the Fiscal Years Ended June 30, 2011 and 2010. |
| | |
| F-4 | Restated Consolidated Statements of Changes in Stockholders’ Equity for the Fiscal Years Ended June 30, 2011 and 2010. |
| | |
| F-5 | Restated Consolidated Statements of Cash Flows for the Fiscal Years Ended June 30, 2011 and 2010. |
| | |
| F-6 to F-21 | Notes to Restated Consolidated Financial Statements. |
REPORT OF INDEPENDENT REGISTERED ACCOUNTING FIRM
Board of Directors
Aoxing Pharmaceutical Co., Inc. and Subsidiaries
We have audited the accompanying consolidated balance sheets of Aoxing Pharmaceutical Co., Inc. and subsidiaries as of June 30, 2011 and 2010 and the related consolidated statements of operations and comprehensive loss, changes in stockholders’ equity and cash flows for the years then ended. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit.
We conducted our audit in accordance with auditing standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Aoxing Pharmaceutical Co., Inc. and subsidiaries as of June 30, 2011 and 2010, and the results of its operations and its cash flows for the years then ended in conformity with accounting principles generally accepted in the United States.
Accompanying consolidated financial statements for the year ended June 30, 2011 has been restated as discussed in Note 2.
/s/ Paritz & Company, P.A.
Hackensack, New Jersey
September 27, 2011, except for Note 2 and Note 15 which are dated September 21, 2012
| AOXING PHARMACEUTICAL CO., INC. AND SUBSIDIARIES | |
| CONSOLIDATED BALANCE SHEETS | |
| | |
| | | June 30, | | | June 30, | |
| | | 2011 | | | 2010 | |
| | | (Restated) | | | | |
| ASSETS | | | | | | |
| | | | | | | |
| CURRENT ASSETS: | | | | | | |
| Cash | | $ | 2,770,744 | | | $ | 3,985,710 | |
| Accounts receivable, net of allowance for doubtful accounts of $543,697 and $2,575,177, respectively | | | 2,008,024 | | | | 1,723,198 | |
| Inventory | | | 1,469,417 | | | | 1,564,975 | |
| Prepaid expenses and other current assets | | | 1,130,010 | | | | 1,646,223 | |
| TOTAL CURRENT ASSETS | | | 7,378,195 | | | | 8,920,106 | |
| | | | | | | | | |
| LONG-TERM ASSETS: | | | | | | | | |
| Property and equipment, net of accumulated depreciation | | | 26,669,156 | | | | 25,569,782 | |
| Deferred income tax | | | - | | | | 3,394,103 | |
| Goodwill | | | 19,916,128 | | | | 19,012,321 | |
| Other intangible assets | | | 1,388,704 | | | | 1,431,182 | |
| Investment in joint venture | | | 521,541 | | | | - | |
| TOTAL LONG-TERM ASSETS | | | 48,495,529 | | | | 49,407,388 | |
| | | | | | | | | |
| TOTAL ASSETS | | $ | 55,873,724 | | | $ | 58,327,494 | |
| | | | | | | | | |
| LIABILITIES AND SHAREHOLDERS' EQUITY | | | | | | | | |
| | | | | | | | | |
| CURRENT LIABILITIES: | | | | | | | | |
| Short-term borrowings | | $ | 232,055 | | | $ | 293,746 | |
| Accounts payable | | | 2,659,727 | | | | 2,458,941 | |
| Loan payable - bank | | | 8,508,663 | | | | 8,078,019 | |
| Current portion of loan payable - related parties | | | 5,793 | | | | 94,760 | |
| Current portion of loan payable - other | | | 23,515 | | | | 46,999 | |
| Accrued expenses and other current liabilities | | | 3,206,009 | | | | 2,583,128 | |
| TOTAL CURRENT LIABILITIES | | | 14,635,762 | | | | 13,555,593 | |
| | | | | | | | | |
| LONG-TERM LIABILITIES: | | | | | | | | |
| Loan payable - related parties | | | 3,696,210 | | | | 6,329,118 | |
| - others | | | 1,831,838 | | | | 2,221,943 | |
| Warrant and derivative liabilities | | | 1,161 | | | | 1,913,534 | |
| TOTAL LONG-TERM LIABILITIES | | | 5,529,209 | | | | 10,464,595 | |
| | | | | | | | | |
| Common stock, par value $0.001, 100,000,000 shares authorized, | | | | | | | | |
| 49,158,955 and 46,494, 903 shares issued | | | | | | | | |
| and outstanding on June 30, 2011 and 2010, respectively | | | 49,159 | | | | 46,495 | |
| Additional paid in capital | | | 57,382,109 | | | | 49,594,553 | |
| Accumulated deficit | | | (23,009,448 | ) | | | (15,598,600 | ) |
| Other comprehensive income | | | 1,885,531 | | | | 525,555 | |
| TOTAL SHAREHOLDERS' EQUITY OF THE COMPANY | | | 36,307,351 | | | | 34,568,003 | |
| | | | | | | | | |
| NONCONTROLLING INTEREST IN SUBSIDIARIES | | | (598,598 | ) | | | (260,697 | ) |
| TOTAL EQUITY | | | 35,708,753 | | | | 34,307,306 | |
| | | | | | | | | |
| TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY | | $ | 55,873,724 | | | $ | 58,327,494 | |
See notes to financial statements
| AOXING PHARMACEUTICAL CO., INC. AND SUBSIDIARIES | |
| CONSOLIDATED STATEMENTS OF OPERATIONS AND OTHER COMPREHENSIVE LOSS | |
| | | | | | | |
| | | For the Years Ended June 30, | |
| | | 2011 | | | 2010 | |
| | | (Restated) | | | | |
| | | | | | | |
| SALES | | $ | 6,651,048 | | | $ | 6,115,774 | |
| COST OF SALES | | | 3,327,723 | | | | 2,341,195 | |
| GROSS PROFIT | | | 3,323,325 | | | | 3,774,579 | |
| | | | | | | | | |
| OPERATING EXPENSES: | | | | | | | | |
| Research and development expense | | | 929,598 | | | | 1,540,744 | |
| General and administrative expenses | | | 4,787,346 | | | | 3,804,972 | |
| Selling expenses | | | 1,603,114 | | | | 1,367,997 | |
| Depreciation and amortization | | | 594,720 | | | | 645,004 | |
| TOTAL OPERATING EXPENSES | | | 7,914,778 | | | | 7,358,717 | |
| | | | | | | | | |
| LOSS FROM OPERATIONS | | | (4,591,453 | ) | | | (3,584,138 | ) |
| | | | | | | | | |
| OTHER INCOME (EXPENSE): | | | | | | | | |
| Interest expense, net of interest income | | | (1,744,735 | ) | | | (2,427,675 | ) |
| Change in fair value of warrant and derivative liabilities | | | 1,912,373 | | | | 1,455,368 | |
| Forgiveness of debt | | | - | | | | 3,648,616 | |
| TOTAL OTHER INCOME (EXPENSE) | | | 167,638 | | | | 2,676,309 | |
| | | | | | | | | |
| LOSS BEFORE INCOME TAXES | | | (4,423,815 | ) | | | (907,829 | ) |
| | | | | | | | | |
| Income taxes (credit) | | | 3,394,103 | | | | (63,058 | ) |
| NET LOSS | | | (7,817,918 | ) | | | (844,771 | ) |
| | | | | | | | | |
| Net loss attributed to non-controlling interest in subsidiaries | | | (407,070 | ) | | | (12,612 | ) |
| LOSS ATTRIBUTABLE TO THE SHAREHOLDERS OF THE COMPANY | | | (7,410,848 | ) | | | (832,159 | ) |
| | | | | | | | | |
| OTHER COMPREHENSIVE INCOME: | | | | | | | | |
| Foreign currency translation adjustment | | | 1,429,145 | | | | 59,240 | |
| | | | | | | | | |
| COMPREHENSIVE LOSS | | | (5,981,703 | ) | | | (772,919 | ) |
| | | | | | | | | |
| Other comprehensive income attributable to non-controlling interest | | | 69,169 | | | | 2,696 | |
| | | | | | | | | |
| COMPREHENSIVE LOSS ATTRIBUTABLE TO THE COMPANY | | $ | (6,050,872 | ) | | $ | (775,615 | ) |
| | | | | | | | | |
| | | | | | | | | |
| BASIC AND DILUTED LOSSES PER COMMON SHARE | | $ | (0.16 | ) | | $ | (0.02 | ) |
| WEIGHTED AVERAGE NUMBER OF SHARES OUTSTANDING | | | 46,578,400 | | | | 45,581,724 | |
See notes to financial statements
| AOXING PHARMACEUTICAL CO., INC. AND SUBSIDIARIES | |
| CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | COMMON | | | PREFERRED | | | ADDITIONAL | | | | | | OTHER | | | TOTAL SHAREHOLDERS' | | | NON | | | | |
| | | STOCK | | | STOCK | | | PAID-IN | | | ACCUMULATED | | | COMPREHENSIVE | | | EQUITY | | | CONTROLLING | | | TOTAL | |
| | | SHARES | | | VALUE | | | SHARES | | | VALUE | | | CAPITAL | | | DEFICIT | | | INCOME | | | OF THE COMPANY | | | INTEREST | | | EQUITY | |
| BALANCE - JUNE 30, 2009 | | | 41,414,000 | | | $ | 41,414 | | | | - | | | $ | - | | | $ | 39,146,000 | | | $ | (14,766,441 | ) | | $ | 469,011 | | | $ | 24,889,984 | | | $ | (250,781 | ) | | $ | 24,639,203 | |
| Common stock issued for private placement | | | 2,631,579 | | | | 2,632 | | | | | | | | | | | | 4,997,368 | | | | | | | | | | | | 5,000,000 | | | | | | | | 5,000,000 | |
| Common stock issued for conversion of debt | | | 1,789,203 | | | | 1,789 | | | | | | | | | | | | 4,829,058 | | | | | | | | | | | | 4,830,847 | | | | | | | | 4,830,847 | |
| Common stock issued for services | | | 660,000 | | | | 660 | | | | | | | | | | | | 622,127 | | | | | | | | | | | | 622,787 | | | | | | | | 622,787 | |
| Translation adjustments | | | | | | | | | | | | | | | | | | | | | | | | | | | 56,544 | | | | 56,544 | | | | 2,696 | | | | 59,240 | |
| Net loss | | | | | | | | | | | | | | | | | | | | | | | (832,159 | ) | | | | | | | (832,159 | ) | | | (12,612 | ) | | | (844,771 | ) |
| Reverse split adjustments | | | 121 | | | | | | | | | | | | | | | | | | | | | | | | | | | | - | | | | | | | | - | |
| BALANCE - JUNE 30, 2010 | | | 46,494,903 | | | $ | 46,495 | | | | - | | | $ | - | | | $ | 49,594,553 | | | $ | (15,598,600 | ) | | $ | 525,555 | | | $ | 34,568,003 | | | $ | (260,697 | ) | | $ | 34,307,306 | |
| Common stock issued for conversion of debt | | | 2,432,296 | | | | 2,432 | | | | | | | | | | | | 6,564,767 | | | | | | | | | | | | 6,567,199 | | | | | | | | 6,567,199 | |
| Common stock issued for services | | | 231,756 | | | | 232 | | | | | | | | | | | | 1,222,789 | | | | | | | | | | | | 1,223,021 | | | | | | | | 1,223,021 | |
| Translation adjustments | | | | | | | | | | | | | | | | | | | | | | | | | | | 1,359,976 | | | | 1,359,976 | | | | 69,169 | | | | 1,429,145 | |
| Net loss | | | | | | | | | | | | | | | | | | | | | | | (7,410,848 | ) | | | | | | | (7,410,848 | ) | | | (407,070 | ) | | | (7,817,918 | ) |
| BALANCE - JUNE 30, 2011 (Restated) | | | 49,158,955 | | | $ | 49,159 | | | | - | | | $ | - | | | $ | 57,382,109 | | | $ | (23,009,448 | ) | | $ | 1,885,531 | | | $ | 36,307,351 | | | $ | (598,598 | ) | | $ | 35,708,753 | |
See notes to financial statements
| AOXING PHARMACEUTICAL CO., INC. AND SUBSIDIARIES | |
| CONSOLIDATED STATEMENTS OF CASH FLOWS | |
| | |
| | | For the Years Ended June 30, | |
| | | 2011 | | | 2010 | |
| | (Restated) | | | | |
| OPERATING ACTIVITIES: | | | | | | |
| Net income (loss) | | $ | (7,410,848 | ) | | $ | (832,159 | ) |
| Adjustments to reconcile net loss to net cash used in operating activities: | | | | | | | | |
| Depreciation and amortization | | | 1,151,833 | | | | 1,122,123 | |
| Deferred income tax | | | 3,394,103 | | | | (63,058 | ) |
| Loss on disposal of property and equipment | | | 41,837 | | | | 36,317 | |
| Inventory markdown | | | 53,987 | | | | 177,987 | |
| Bad debts | | | 917,959 | | | | 216,879 | |
| Forgiveness of debt | | | - | | | | (3,648,616 | ) |
| Non-cash interest expense related to debentures and warrants | | | - | | | | 104,487 | |
| Common stock issued for services | | | 1,207,261 | | | | 622,127 | |
| Change in fair value of warrants and derivative liability | | | (1,912,373 | ) | | | (1,455,368 | ) |
| Net income attributable to non-controlling interests | | | (407,070 | ) | | | (12,612 | ) |
| Changes in operating assets and liabilities: | | | | | | | | |
| Accounts receivable | | | (1,105,898 | ) | | | (875,224 | ) |
| Inventories | | | 120,344 | | | | (1,026,653 | ) |
| Prepaid expenses and other current assets | | | (64,412 | ) | | | (325,038 | ) |
| Accounts payable | | | 67,885 | | | | 137,262 | |
| Accrued expenses and other current liabilities | | | 1,272,251 | | | | 1,842,828 | |
| NET CASH USED IN OPERATING ACTIVITIES | | | (2,673,141 | ) | | | (3,978,718 | ) |
| | | | | | | | | |
| INVESTING ACTIVITIES: | | | | | | | | |
| Acquisition of property and equipment | | | (1,373,156 | ) | | | (1,996,018 | ) |
| Repayment from (Loans to) unrelated parties | | | 651,525 | | | | (748,790 | ) |
| Cash proceeds from sale of assets | | | 6,122 | | | | 954,675 | |
| NET CASH USED IN INVESTING ACTIVITIES | | | (715,509 | ) | | | (1,790,133 | ) |
| | | | | | | | | |
| FINANCING ACTIVITIES: | | | | | | | | |
| Proceeds from bank loans | | | - | | | | 8,078,019 | |
| Payment of bank loans | | | - | | | | (4,288,782 | ) |
| Short-term borrowings | | | (75,339 | ) | | | - | |
| Other borrowings, net of repayments | | | 1,947,823 | | | | 376,340 | |
| Loans from related party | | | 111,502 | | | | 422,603 | |
| Repayment of convertible notes | | | - | | | | (1,173,000 | ) |
| Sale of common stock | | | - | | | | 5,000,000 | |
| NET CASH PROVIDED BY FINANCING ACTIVITIES | | | 1,983,986 | | | | 8,415,180 | |
| | | | | | | | | |
| EFFECT OF EXCHANGE RATE ON CASH | | | 189,698 | | | | 67,459 | |
| | | | | | | | | |
| INCREASE (DECREASE) IN CASH | | | (1,214,966 | ) | | | 2,713,788 | |
| CASH – BEGINNING OF YEAR | | | 3,985,710 | | | | 1,271,922 | |
| CASH – END OF YEAR | | $ | 2,770,744 | | | $ | 3,985,710 | |
| | | | | | | | | |
| | | | | | | | | |
| Supplemental disclosures of cash flow information: | | | | | | | | |
| Cash paid for interest | | $ | 1,285,864 | | | $ | 984,786 | |
| Cash paid for income taxes | | | - | | | | - | |
| | | | | | | | | |
| Non-cash financing activities: | | | | | | | | |
| Conversion of notes and accrued interest into common stock | | $ | 6,567,200 | | | $ | 4,830,847 | |
| Assets transferred to joint venture, classified as investment | | | 560,471 | | | | - | |
See notes to financial statements
AOXING PHARMACEUTICAL CO., INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2011
1 BUSINESS DESCRIPTION
Aoxing Pharmaceutical Co., Inc. (“the Company” or “Aoxing Pharma”) is a specialty pharmaceutical company specializing in research, development, manufacturing and distribution of a variety of narcotics and pain-management products. In March 2010, the Company changed to its current name from “China Aoxing Pharmaceutical Co., Inc.”
As of June 30, 2011, the Company had one operating subsidiary: Hebei Aoxing Pharmaceutical Co., Inc. (“Hebei”), which is organized under the laws of the People’s Republic of China (“PRC”). As of June 30, 2011, the Company owned 95% of the issued and outstanding common stock of Hebei.
Since 2002, Hebei has been engaged in developing narcotics and pain management products, building its facilities and obtaining the requisite licenses from the Chinese Government. Headquartered in Shijiazhuang City, the pharmaceutical capital of China, outside of Beijing, during the year ended June 30, 2009, Hebei integrated into itself the business operations of Shijazhuang Lerentang Pharmaceutical Company, Ltd. (“LRT”), which had been an operating subsidiary acquired by Hebei in May 2008.
Investment in Joint Venture (“JV”)
On April 26, 2010, Aoxing Pharma and Johnson Matthey Plc (‘JM”) entered into an agreement to establish a joint venture focused on research, development, manufacturing and marketing of active pharmaceutical ingredients for narcotics and neurological drugs for the China market. The joint venture represents a significant new opportunity for both companies to expand their business in the rapidly growing pharmaceutical market in China. Under the terms of the agreement, Macfarlan Smith Ltd, a wholly owned subsidiary of Johnson Matthey Plc, headquartered in the United Kingdom, will contribute technology expertise and capital to the joint venture. Hebei will contribute capital, fixed assets and related active pharmaceutical ingredients manufacturing licenses. The joint venture company is called Hebei Aoxing API Pharmaceutical Company, Ltd. (“API”). Hebei has a 51% stake in the Company, while Macfarlan Smith (Hong Kong) Ltd (a wholly owned subsidiary of JM) holds 49%. Each company has equal representation on the board of directors that will oversee a management team responsible for corporate strategies and operations. The new joint venture will be located on the Hebei campus in Xinle City, 200 kilometers southwest of Beijing. The total capital investment is projected to be approximately $15 million during the first five years, which will be shared between the equity shareholders of the joint venture. On December 10, 2010, the joint venture obtained business license from the City Industry & Commercial Administrative Bureau.
On April 19, 2011, in connection with establishment of the joint venture, Hebei contributed a parcel of land in the area of 14,766 square meters located at its Hebei campus to the JV. The land use rights’ book value is approximately $616,368 (RMB 3,984,203) with accumulated amortization of $65,112 (RMB 420,884). The land’s appraisal value is $520,830 (RMB 3,366,648) at the contribution. On June 10, 2011, Hebei Aoxing again contributed machinery and equipment with net book value of approximately $9,282 (RMB 60,000) to the JV. The appraisal value is $9,078 (RMB 58,680).
The Company accounts for its investment in the Joint Venture under the equity method of accounting.
AOXING PHARMACEUTICAL CO., INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2011
2 RESTATEMENT
The Company’s management has concluded that we should restate our financial statements as of and for the year ended June 30, 2011. The conclusion was reached by management because they determined that a deferred tax asset in the amount of $2,614,817 was improperly valued as an asset as of June 30, 2011 and that a valuation allowance for 100% of the balance of the deferred tax asset should be recorded. Upon review, management decided that the Company did not have sufficient competent evidence to support its conclusion that the Company would earn taxable income in the future against which it could realize the benefit of its net operating loss carryforwards.
The effect of the restatement on specific line items in our financial statements for the year ended June 30, 2011 is set forth in the table below:
| | | Consolidated Balance Sheet | |
| | | Previously | | | | | | | |
| | | Reported | | | Adjustments | | | As Restated | |
| | | | | | | | | | |
| Deferred income tax | | $ | 2,614,817 | | | $ | (2,614,817 | ) | | $ | - | |
| Total long-term assets | | $ | 51,110,346 | | | $ | (2,614,817 | ) | | $ | 48,495,529 | |
| Total assets | | $ | 58,488,541 | | | $ | (2,614,817 | ) | | $ | 55,873,724 | |
| Accumulated deficit | | $ | (20,525,372 | ) | | $ | (2,484,076 | ) | | $ | (23,009,448 | ) |
| Total shareholders' equity of the Company | | $ | 38,791,427 | | | $ | (2,484,076 | ) | | $ | 36,307,351 | |
| Noncontrolling interest in subsidiaries | | $ | (467,857 | ) | | $ | (130,741 | ) | | $ | (598,598 | ) |
| Total equity | | $ | 38,323,570 | | | $ | (2,614,817 | ) | | $ | 35,708,753 | |
| Total liabilities and shareholders' equity | | $ | 58,488,541 | | | $ | (2,614,817 | ) | | $ | 55,873,724 | |
| | | | | | | | | | | | | |
| | | Consolidated Statements of Operations | |
| | | | | | | | | | | | | |
| | | Previously | | | | | | | | | |
| | | Reported | | | Adjustments | | | As Restated | |
| | | | | | | | | | | | | |
| Income taxes | | $ | 779,286 | | | $ | 2,614,817 | | | $ | 3,394,103 | |
| Net loss | | $ | (5,203,101 | ) | | $ | (2,614,817 | ) | | $ | (7,817,918 | ) |
| Net loss attributed to non-controlling interest in subsidiaries | | $ | (276,329 | ) | | $ | (130,741 | ) | | $ | (407,070 | ) |
| Loss attributable to the shareholders of the Company | | $ | (4,926,772 | ) | | $ | (2,484,076 | ) | | $ | (7,410,848 | ) |
| Comprehensive loss | | $ | (3,497,627 | ) | | $ | (2,484,076 | ) | | $ | (5,981,703 | ) |
| Comprehensive loss attributable to the Company | | $ | (3,566,796 | ) | | $ | (2,484,076 | ) | | $ | (6,050,872 | ) |
| | | | | | | | | | | | | |
| | | | | | | | | | | | | |
| | | Consolidated Statement of Cash Flows | |
| | | | | | | | | | | | | |
| | | Previously | | | | | | | | | |
| | | Reported | | | Adjustments | | | As Restated | |
| | | | | | | | | | | | | |
| Net loss | | $ | (4,926,772 | ) | | $ | (2,484,076 | ) | | $ | (7,410,848 | ) |
| Deferred income tax | | $ | 779,286 | | | $ | 2,614,817 | | | $ | 3,394,103 | |
| Net loss attributed to non-controlling interest in subsidiaries | | $ | (276,329 | ) | | $ | (130,741 | ) | | $ | (407,070 | ) |
AOXING PHARMACEUTICAL CO., INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2011
3 SIGNIFICANT ACCOUNTING POLICIES
Basis of presentation
The consolidated financial statements include the accounts of the Company and its subsidiaries. All significant inter-company accounts and transactions have been eliminated. These financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America. The Company’s functional currency is the Chinese Renminbi (RMB); however, the accompanying consolidated financial statements have been translated and presented in United States Dollars (USD).
Certain amounts included in the 2010 financial statement have been reclassified to conform to the 2011 financial statement presentation.
Use of estimates in the preparation of financial statements
The preparation of the consolidated financial statements in conformity with generally accepted accounting principles in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements, and the reported amounts of revenue and expenses during the reporting period. Significant estimates reflected in the consolidated financial statements include, but are not limited to, the recoverability of the carrying amount and estimated useful lives of long-lived assets, allowance for accounts receivable, realizable values for inventories, valuation allowance of deferred tax assets, purchase price allocation of its acquisitions and share-based compensation expenses. Management makes these estimates using the best information available at the time the estimates are made; however, actual results when ultimately realized could differ from those estimates.
Cash and cash equivalents
The Company maintains cash and cash equivalents with financial institutions in the PRC which are not insured or otherwise protected. Should any of these institutions holding the Company’s cash become insolvent, or if the Company is unable to withdraw funds for any reason, the Company could lose the cash on deposit with that institution. Cash and cash equivalents include cash on hand and cash in time deposits, certificates of deposit and all highly liquid debt instruments with original maturities of three months or less.
AOXING PHARMACEUTICAL CO., INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2011
Accounts Receivable
Accounts receivables represent customer accounts receivables. The allowance for doubtful accounts is based on a combination of current sales, historical charge-offs and specific accounts identified as high risk. Uncollectible accounts receivable are charged against the allowance for doubtful accounts when all reasonable efforts to collect the amounts due have been exhausted. Such allowances, if any, would be recorded in the period the impairment is identified. The balances of allowance for doubtful accounts are $543,697 and $2,575,177 at June 30, 2011 and 2010 respectively. The Company recorded bad debt expense of $917,959 and $216,879 for the years ended June 30, 2011 and 2010, respectively.
Inventories
Inventories are stated at the lower of cost, determined using the weighted average cost method, and net realizable value. Net realizable value is the estimated selling price, in the ordinary course of business, less estimated costs to complete and dispose. The Company recorded $53,987 and $177,987 inventory markdown allowance for the year ended June 30, 2011 and 2010, respectively.
Advances to Suppliers
The Company makes advances to certain vendors for purchase of its material and equipment. The advances to suppliers are interest free.
Property and equipment
Property and equipment are recorded at cost. Depreciation is provided in amounts sufficient to amortize the cost of the related assets over their useful lives using the straight line method for financial reporting purposes.
Hebei Aoxing leases a parcel of land on which its offices and production facilities are situated pursuant to real estate contracts from the local government of the PRC expiring in 2053.
Maintenance, repairs and minor renewals are charged to expense when incurred. Replacements and major renewals are capitalized.
Other Intangible Assets
Other intangibles including product rights, which are recorded at fair value and assigned an estimated useful life, are amortized primarily on a straight-line basis over their estimated useful lives ranging from 10 to 15 years. When events or circumstances warrant a review, the Company will assess recoverability from future operations of acquired intangibles using pretax undiscounted cash flows derived from the lowest appropriate asset groupings. Impairments are recognized in operating results to the extent that carrying value of the intangible asset exceeds its fair value,
Goodwill
Goodwill represents the excess of the consideration transferred over the fair value of net assets of business acquired. Goodwill is not being amortized, but is evaluated for impairment on at least an annual basis.
AOXING PHARMACEUTICAL CO., INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2011
Revenue Recognition
Revenue is recognized at the date of shipment to customers when a formal arrangement exists, the price is fixed or determinable, the delivery is completed, and no other significant obligations of the Company exist and collectability is reasonably assured. Payments received before all of the relevant criteria for revenue recognition are satisfied are recorded as advances from customers. The agreements with customers do not contain any rights of return other than for goods that fail to meet the specifications provided by the customer or other quality problems. The Company has not experienced any significant returns from customers and accordingly, in management’s opinion, no reserve for returns is provided.
Research and Development
Research and development is charged to expense as incurred.
Share-Based Compensation
Share-based compensation cost is measured at the grant date based on the fair value of the award and is recognized as expense over the requisite service period. The Company’s policy is to recognize compensation cost for awards with only service conditions and a graded vesting schedule on a straight-line basis over the requisite service period for the entire award.
Impairment of long lived assets
Long-lived assets are reviewed for impairment when circumstances indicate the carrying value of an asset may not be recoverable. For assets that are to be held and used, impairment is recognized when the estimated undiscounted cash flows associated with the asset or group of assets is less than their carrying value. If impairment exists, an adjustment is made to write the asset down to its fair value, and a loss is recorded as the difference between the carrying value and fair value. Fair values are determined based on quoted market values, discounted cash flows or internal and external appraisals, as applicable. Assets to be disposed of are carried at the lower of carrying value or estimated net realizable value.
Income taxes
The Company uses the asset and liability method of accounting for income taxes in accordance with ASC Topic 740, “Income Taxes.” Under this method, income tax expense is recognized for the amount of: (i) taxes payable or refundable for the current year and (ii) deferred tax consequences of temporary differences resulting from matters that have been recognized in an entity’s financial statements or tax returns. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the results of operations in the period that includes the enactment date. A valuation allowance is provided to reduce the deferred tax assets reported if based on the weight of the available positive and negative evidence, it is more likely than not some portion or all of the deferred tax assets will not be realized.
ASC Topic 740.10.30 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements and prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. ASC Topic 740.10.40 provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. We have no material uncertain tax positions for any of the reporting periods presented.
AOXING PHARMACEUTICAL CO., INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2011
Currency translation
Since the Company operates primarily in the PRC, the Company’s functional currency is the Chinese Yuan (”RMB”). Revenue and expense accounts are translated at the average rates during the period, and balance sheet items are translated at year-end rates. Translation adjustments arising from the use of differing exchange rates from period to period are included as a separate component of shareholders’ equity. Gains and losses from foreign currency transactions are recognized in current operations.
The RMB is not freely convertible into foreign currency and all foreign exchange transactions must take place through authorized institutions. No representation is made that the RMB amounts could have been, or could be, converted into USD at the rates used in translation.
Fair value of financial instruments
The Company adopted the provisions of Accounting Standards Codification (“ASC”) 820, Fair Value Measurements and Disclosures. ASC 820 clarifies the definition of fair value, prescribes methods for measuring fair value, and establishes a fair value hierarchy to classify the inputs used in measuring fair value as follows:
Level 1-Inputs are unadjusted quoted prices in active markets for identical assets or liabilities available at the measurement date.
Level 2-Inputs are unadjusted quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets and liabilities in markets that are not active, inputs other then quoted prices that are observable, and inputs derived from or corroborated by observable market data.
Level 3-Inputs are unobservable inputs which reflect the reporting entity’s own assumptions on what assumptions the market participants would use in pricing the asset or liability based on the best available information.
The Company’s financial instruments primarily consist of cash, accounts receivable, prepaid expenses and other current assets, accounts payable, accrued expenses and other current liabilities, notes payables and related party advances and borrowings.
As of the balance sheet dates, the estimated fair values of financial instruments were not materially different from their carrying values as presented on the balance sheet. This is attributed to the short maturities of the instruments and that interest rates on the borrowings approximate those that would have been available for loans of similar remaining maturity and risk profile at the respective balance sheet dates.
Derivative financial instruments
The Company’s derivative financial instruments consist of embedded derivatives related to the convertible debentures and warrants (see Note 10). The accounting treatment of derivative financial instruments requires that the Company record the derivatives and related warrants at their fair values as of the inception date of the debt agreements and at fair value as of each subsequent balance sheet date. Any change in fair value is recorded as non-operating, non-cash income or expense at each balance sheet date. If the fair value of the derivatives was higher at the subsequent balance sheet date, the Company recorded a non-operating, non-cash charge. If the fair value of the derivatives was lower at the subsequent balance sheet date, the Company recorded non-operating, non-cash income.
AOXING PHARMACEUTICAL CO., INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2011
During the years ended June 30, 2011 and 2010, the Company recognized other income of $1,912,373 and $1,455,368, respectively, relating to recording the warrant and derivative liabilities at fair value. At June 30, 2011 and 2010 there were $1,161 and $1,913,534 of warrant and derivative liabilities.
The Company’s derivative instruments were valued using the black-scholes option pricing model, using the following assumptions during the year ended June 30, 2011:
| | | For the Year Ended | |
| | | June 30, | |
| | | 2011 | | | 2010 | |
| | | | | | | |
| Estimated dividends: | | None | | | None | |
| Expected volatility: | | | 70.97 | % | | | 55.5 | % |
| Risk-free interest rate: | | | 0.03 | % | | | 0.31 | % |
| Expected term (years): | | | 0.21 | | | | 1.21 | |
The expected volatility was determined based on the historic quoted market price of the common stock over the last 6 months. Risk free interest rate was determined based on the quoted US treasury rate under the same expected term with each corresponding financial instrument.
Comprehensive income
Comprehensive income is defined to include all changes in equity except those resulting from investments by shareholders and distributions to shareholders. Among other disclosures, all items that are required to be recognized under current accounting standards as components of comprehensive income are required to be reported in a financial statement that is presented with the same prominence as other financial statements. Comprehensive income includes net income and the foreign currency translation gain, net of tax.
Earnings per share
Basic earnings per common share are computed on the basis of the weighted average number of common shares outstanding during the period. Diluted earnings per share are computed on the basis of the weighted average number of common shares and dilutive securities (such as warrants and convertible preferred stock) outstanding. Dilutive securities having an anti-dilutive effect on diluted earnings per share are excluded from the calculation.
Statement of cash flows
In accordance with the provisions of Accounting Standards Codification on “Statement of Cash Flows,” cash flows from the Company’s operations are calculated based upon the local currencies. 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.
AOXING PHARMACEUTICAL CO., INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2011
Segment reporting
“Disclosure about Segments of an Enterprise and Related Information” requires use of the “management approach” model for segment reporting. The management approach model is based on the way a company’s management organized segments within the company for making operating decisions and assessing performance. Reportable segments are based on products and services, geography, legal structure, management structure, or any other manner in which management disaggregates a company. The related ASC provision has an immaterial effect on the Company’s financial statements, as the Company consists of one reportable business segment. All revenue is from customers in the PRC. The majority of the Company’s assets are located in the PRC.
New Accounting Pronouncements
In April 2010, the FASB issued ASU No. 2010-13, Compensation – Stock Compensation: Effect of Denominating the Exercise Price of a Share-Based Payment Award in the Currency of the Market in Which the Underlying Equity Security Trades. ASU 2010-13 clarifies that a share-based payment award with an exercise price denominated in the currency of a market in which a substantial portion of the entity’s equity securities trades should not be considered to contain a condition that is not a market, performance, or service condition. Therefore, such an award should not be classified as a liability if it otherwise qualifies as equity. ASU 2010-13 is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2010, with early adoption permitted. The adoption of this ASU did not have a material impact on the Company’s consolidated financial statements.
4 INVENTORIES
Inventories consist of the following:
| | | June 30, | |
| | | 2011 | | | 2010 | |
| Work in process | | $ | 159,388 | | | $ | 119,327 | |
| Raw materials | | | 1,017,658 | | | | 449,137 | |
| Finished goods | | | 292,371 | | | | 996,511 | |
| | | $ | 1,469,417 | | | $ | 1,564,975 | |
AOXING PHARMACEUTICAL CO., INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2011
5 PROPERTY AND EQUIPMENT
A summary of property and equipment and the estimated lives used in the computation of depreciation and amortization is as follows:
| | | June 30, | | |
| | | 2011 | | | 2010 | | LIFE |
| Right to use land | | $ | 7,737,592 | | | $ | 7,931,146 | | 50 years |
| Building and building improvements | | | 12,938,104 | | | | 12,283,275 | | 35 years |
| Machinery and equipment | | | 3,359,469 | | | | 3,061,075 | | 10 years |
| Furniture and office equipment | | | 513,023 | | | | 505,045 | | 5 years |
| Automobiles | | | 485,572 | | | | 460,996 | | 8 years |
| Construction in progress | | | 4,844,574 | | | | 3,616,378 | | |
| | | | 29,878,334 | | | | 27,857,915 | | |
| Accumulated depreciation and amortization | | | 3,209,178 | | | | 2,288,133 | | |
| | | $ | 26,669,156 | | | $ | 25,569,782 | | |
6 EQUITY-METHOD INVESTMENT IN JOINT VENTURE
The Company account for its investment in API (see Note 1), under the equity method of accounting.
Summarized financial information for our investment in API assuming a 100% ownership interest is as follows:
| | | June 30, | |
| | | 2011 | |
| | | | |
| Current assets | | $ | 126,458 | |
| Noncurrent assets | | | 627,660 | |
| Current liabilities | | $ | 150,379 | |
| Noncurrent liabilities | | | - | |
| Equity | | $ | 603,738 | |
Since the joint venture was formed in April 2011, there have been no activities other than the initial contribution of assets through June 30, 2011
7 SHORT-TERM BORROWING
Short-term borrowing is a non-interest bearing unsecured note payable to a local government, due on demand.
AOXING PHARMACEUTICAL CO., INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2011
8 LOAN PAYABLE - BANK
Loan payable – bank consist of the following loans collateralized by assets of the company:
| | | June 30, | |
| | | 2011 | | | 2010 | |
| Bank Note in the amount of 30 million RMB with Bank of Communications of China bearing an annual floating rate of 7.572%, set to be 20% higher than the interest rate of the China People Bank rate, initially made on April 29, 2010 for one year and renewed on April 15, 2011 for one year maturing on April 15, 2012 | | $ | 4,641,089 | | | $ | 4,406,192 | |
| Bank Note in the amount of 25 million RMB with China Citic Bank bearing an annual floating rate of 6.941%, set to be 10% higher than the interest rate of the China People Bank rate, initially made on May 5, 2010 for one year and renewed on April 20, 2011 for one year maturing on April 20, 2012 | | | 3,867,574 | | | | 3,671,827 | |
| | | $ | 8,508,663 | | | $ | 8,078,019 | |
Bank Loan Restructuring
In October 2009, the Company reached a restructuring agreement with Eastern Asset Management Company “(“EAMC”), a nationwide investment company based in China, which acquired the ownership of the Company’s bank loan from Bank of China. Prior to the restructuring, the outstanding balance of the debt was $7,911,560 (or 54,092,916 RMB), including $6,101,203 (or 41,715,142 RMB) of principal and $1,748,724 (or 11,961,278 RMB) of accrued interest. Under the restructuring agreement, the Company received forgiveness from EAMC in the amount of $3,648,616 (or 24,892,316 RMB), including $1,830,361 (or 12,514,542 RMB) of principal and $1,748,724 (or 12,377,774 RMB) of accrued interest. The total outstanding balance of the debt was reduced to $4,270,842 (approximately 29,200,600 RMB) as of October 1, 2009. The Company completely retired this debt on October 1, 2009 with the proceeds of a RMB 32,000,000 bridge loan, most of which had been paid off as of June 30, 2011.
9 LOAN PAYABLE – OTHER
Loan payable – other consist of loans from unrelated third-parties, bearing interest at an average rate of 17.9% per annum. Loans will mature as following:
| Date | | Amount | |
| Within one year | | $ | 23,515 | |
| 1 - 2 years | | | - | |
| 2 - 3 years | | | - | |
| 3 - 4 years | | | 1,831,838 | |
| Total | | | 1,855,353 | |
| Less current portion | | | (23,515 | ) |
| | | $ | 1,831,838 | |
AOXING PHARMACEUTICAL CO., INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2011
10 LOAN PAYABLE – RELATED PARTIES
Loan payable – related parties consists of loans from shareholders, officers and other related parties, bearing interest at an average rate of 15.13% per annum. Loans will mature as follows:
| Date | | Amount | |
| Within one year | | $ | 5,793 | |
| 1 - 2 years | | | 1,286,219 | |
| 2 - 3 years | | | 2,180,142 | |
| 3 - 4 years | | | 229,849 | |
| Total | | | 3,702,003 | |
| Less current portion | | | (5,793 | ) |
| | | $ | 3,696,210 | |
11 ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES
Accrued expenses and taxes consist of the following:
| | | June 30, | |
| | | 2011 | | | 2010 | |
| Accrued salaries and benefits | | $ | 555,617 | | | $ | 308,694 | |
| Accrued interest | | | 745,866 | | | | 1,073,890 | |
| Accrued taxes | | | 316,229 | | | | 52,637 | |
| Deposit payable | | | 505,977 | | | | 358,839 | |
| Due to employee | | | 44,532 | | | | 57,213 | |
| Other accrued expenses and current liabilities | | | 1,037,788 | | | | 731,855 | |
| | | $ | 3,206,009 | | | $ | 2,583,128 | |
12 STOCK OPTION
During the year ended June 30, 2010, the Company issued a total of 300,000 options to an employee.
During the year ended June 30, 2011, the Company issued a total of 220,000 options to management and employees.
The Company uses the Black-Scholes option pricing model to calculate the fair value of stock options. The Company recognizes stock-based compensation expense on a straight-line basis over the requisite service period of the award.
The key assumptions for the Black-Scholes valuation method include the expected life of the option, stock price volatility, a risk-free interest rate, and dividend yield. Many of these assumptions are judgmental and highly sensitive. Following is a table of the key assumptions used in the valuation calculations for the options granted:
AOXING PHARMACEUTICAL CO., INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2011
| | | For the year ended | |
| | | June 30, 2010 | | | June 30, 2011 | |
| Estimated dividends | | None | | | None | |
| Expected volatility | | | 62.62 | % | | | 49.28%-53.05 | % |
| Risk-free interest rate | | | 1.54%-2.77 | % | | | 2.24%-2.38 | % |
| Expected term (years) | | | 3-5 | | | | 4-5 | |
The expected volatility was determined based on the historic quoted market price of the common stock over the last 6 months. Risk free interest rate was determined based on the quoted US treasury rate under the same expected term with each corresponding financial instrument.
A summary of option activity as of June 30, 2011 and 2010, and changes during the years then ended is as following:
| | | | | | | | | Weighted-avg. | | | Aggregate | |
| | | | | | Weighted-avg. | | | remaining | | | intrinsic | |
| | | Shares | | | Exercise Price | | | Term (yr.) | | | Value | |
| On June 30, 2009 | | | - | | | $ | - | | | | | | $ | - | |
| Granted: | | | 300,000 | | | $ | 1.96 | | | 3.50 | | | | 336,769 | |
| Exercised: | | | - | | | | | | | | | | | | |
| Forfeited: | | | - | | | | | | | | | | |
| On June 30, 2010 | | | 300,000 | | | $ | 1.96 | | | 3.50 | | | $ | 336,769 | |
| Granted: | | | 220,000 | | | $ | 2.05 | | | | 5 | | | 211,419 | |
| Exercised: | | | - | | | | | | | | | | |
| Forfeited: | | | (300,000 | ) | | | | | | | | (336,769 | ) |
| On June 30, 2011 | | | 220,000 | | | $ | 2.00 | | | | 3.11 | | | $ | 211,419 | |
Options issued during the year ended June 30, 2010 and 2011 were fully vested as of June 30, 2011.
13 WARRANTS
In 2006 the Company issued the Series A, B, C and D Warrants in connection with issuance of 10% convertible debentures. The terms of the Series A, B, C and D Warrants require that whenever the Company issues common stock for a price less than $4.00 per share, an equitable adjustment to the exercise price be made in order to prevent dilution of the equity interests of the warrant holders. As a result of the private placement and loan conversion transactions in August 2009, the exercise price of the Series A, B, C and D Warrants was reduced, and accordingly, the number of shares that a warrant-holder may purchase was increased based on the terms of the warrants, effective on August 27, 2009. These warrants were issued in September 2006, are exercisable for five years and may be redeemed by the Company if the market price of its common stock exceeds 200% of the exercise price of the warrants.
FASB ASC 815-10 requires enhanced disclosures related to derivative and hedging activities and thereby seeks to improve the transparency of financial reporting. The fair value of embedded derivatives in connection with these warrants needs to be estimated. The accounting treatment of derivative financial instruments requires that the Company record the derivatives and related warrants at their fair values as of the inception date of the debt agreements and at fair value as of each subsequent balance sheet date. The change of exercise price along with number of shares issuable upon exercise of these warrants would cause a change in the fair value of the warrants. Any change in fair value will be recorded as non-operating, non-cash income or expense at each balance sheet date. If the fair value of the derivatives was higher at the subsequent balance sheet date, the Company recorded a non-operating, non-cash charge. If the fair value of the derivatives was lower at the subsequent balance sheet date, the Company recorded non-operating, non-cash income.
AOXING PHARMACEUTICAL CO., INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2011
The following table summarizes the information relating to the revised exercise price and the number of shares that a warrant-holder may purchase in connection with the sales of convertible debentures referred to above. The following table is illustrated based on the share account post 1:2 reverse split which took place in March 2010:
| | | Original Exercise Price | | | Revised Exercise Price | | | Original Number of Outstanding | | | Revised Number of Outstanding | | | Weighted Average Remaining Contractual Life (Years) | |
| | | | | | | | | | | | June 30, | | | | |
| | | | | | | | | | | | 2011 | | | | |
| Series A | | $ | 5.0000 | | | $ | 3.1442 | | | | 529,000 | | | | 841,231 | | | | 0.21 | |
| Series B | | | 7.0000 | | | | 4.0404 | | | | 529,000 | | | | 916,493 | | | | 0.21 | |
| Series C | | | 9.0000 | | | | 4.9366 | | | | 529,000 | | | | 964,429 | | | | 0.21 | |
| Series D | | | 11.000 | | | | 5.8328 | | | | 529,000 | | | | 997,634 | | | | 0.21 | |
| Placement Agent | | | 4.0000 | | | | 4.0000 | | | | 211,600 | | | | 211,600 | | | | 0.21 | |
| | | | | | | | | | | | | | | | 3,931,387 | | | | | |
14 STOCKHOLDERS’ EQUITY
Reverse Stock Split
Effective on March 19, 2010, the Company implemented a one-for-two reverse split of its outstanding common stock. All references in these financial statements to quantities of common stock or per share values have been adjusted to reflect the retroactive effect of the two-for-one reverse stock split.
Issuance of Common Stock
On August 6, 2009, the Company closed a private placement with a total of fifteen institutional and other accredited investors of 2,631,579 of shares of the Company’s common stock at a purchase price of $1.90 per share, for gross proceeds of $5 million.
On August 27, 2009, the Company issued 1,789,203 shares of common stock by exercising its option to pay the note from American Oriental Bioengineering, Inc. (“AOB”) and accrued interest in the total amount of 33 million RMB, or $4,830,847. As of June 30, 2011, AOB owns 16,789,203 shares, or 34.2% of the Company’s common stock.
On January 13, 2010, the Company issued 600,000 shares of restricted common stock, valued at 1.96 per share, to award the management and employees of the Company for their future services. The fair value of the shares is amortized over the next three years.
AOXING PHARMACEUTICAL CO., INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2011
On April 2, 2011, the Company issued 200,000 shares of restricted common stock, valued at $2.20 per share, to award eight employees working in our research and development department for services rendered by them during the year ended June 30, 2011.
On April 10, 2010, the Company issued 60,000 shares of restricted common stock to three of the Company’s independent directors for the services rendered by them from November 2009 to October 2010.
On June 26, 2011, the Company issued 2,432,296 shares of common stock for the conversion of long-term debt and accrued interest of $6,567,200 (RMB 42,449,723), held by a group of related and third-party holders, into common equity. The shares are valued at $2.70 per share.
During the year ended June 30, 2011, the Company issued 31,756 shares of common stock to an independent director John O’shea for services rendered. Those shares were valued using the stock price at granted date. Total value of the compensation is $62,667.
15 TAXES - Restated
The Company’s Chinese subsidiaries are governed by the Income Tax Law of the People’s Republic of China concerning private-run enterprises, which are generally subject to tax at a statutory rate of 25% on income reported in the statutory financial statements after appropriate tax adjustments.
The reconciliation of income tax at the U.S. statutory rate to the Company’s effective tax rate is as follows:
| | | Year Ended June 30, | |
| | | 2011 | | | 2010 | |
| | | (Restated) | | | | |
| Tax at U.S. Statutory rate | | $ | (1,548,335 | ) | | $ | (317,740 | ) |
| Tax rate difference between China and U.S. | | | 474,729 | | | | 25,224 | |
| Change in Valuation Allowance | | | 2,501,600 | | | | 229,458 | |
| Net operating loss expired | | | 1,819,209 | | | | - | |
| Stock and option compensation | | | 146,900 | | | | - | |
| Effective tax rate | | $ | 3,394,103 | | | $ | (63,058 | ) |
The provisions of income taxes (credit) are summarized as follows:
| | | Year Ended June 30, | |
| | | 2011 | | | 2010 | |
| | | (Restated) | | | | |
| Current | | $ | - | | | $ | - | |
| Deferred - U.S. | | | 113,217 | | | | (229,458 | ) |
| Deferred - China | | | 779,286 | | | | (63,058 | ) |
| Valuation allowance - U.S. | | | (113,217 | ) | | | 229,458 | |
| Valuation allowance - China | | | 2,614,817 | | | | - | |
| Total | | $ | 3,394,103 | | | $ | (63,058 | ) |
AOXING PHARMACEUTICAL CO., INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2011
The tax effects of temporary differences that give rise to the Company’s net deferred tax asset as of June 30, 2011 and 2010 are as follows:
| | | Year Ended June 30, | |
| | | 2011 | | | 2010 | |
| | | (Restated) | | | | |
| Net operating loss carryforward - China | | $ | 1,838,049 | | | $ | 2,786,398 | |
| Net operating loss carryforward - US | | | 1,043,874 | | | | 1,157,091 | |
| Allowance for doubtful accounts | | | 736,422 | | | | 506,932 | |
| Others | | | 40,346 | | | | 100,773 | |
| | | | 3,658,691 | | | | 4,551,194 | |
| Less: valuation allowance- U.S. | | | (1,043,874 | ) | | | (1,157,091 | ) |
| valuation allowance- China. | | | (2,614,817 | ) | | | - | |
| Deferred tax assets | | $ | - | | | $ | 3,394,103 | |
Subsequent to the filing of its initial Annual Report on Form 10-K, the Company restated its financial statements as of June 30, 2011 to record a full valuation allowance for its deferred tax asset balance related to China. The deferred tax assets are substantially related to loss carry forwards under Chinese tax law. The negative impact on selling prices of current products and the Company’s forecast of two new medicines that were imminent significantly impacted the Company’s forecasted future taxable income to support the deferred tax asset balance recorded. Because of the current situation in China, the Company provided a full valuation allowance of $2,614,817 for the deferred tax assets from China as of June 30, 2011.
16 CONCENTRATIONS
Sales to three major customers were 26%, 22% and 11% of total sales for the year ended June 30, 2011. Sales to two major customers were 31% and 11% for the year ended June 30, 2010.
Sales of one major product represented approximately 82% of total sales for the year ended June 30, 2011. Sales of three major products represented approximately 73%, 9% and 6% of total sales for the year ended June 30, 2010.
Three major customers accounted for 18%, 14% and 12% of outstanding accounts receivable as of June 30, 2011. Four major customers accounted for 14%, 12%, 11% and 11% of outstanding accounts receivable as of June 30, 2010.
17 VULNERABILITY DUE TO OPERATIONS IN PRC
The Company’s operations may be adversely affected by significant political, economic and social uncertainties in the PRC. Although the PRC government has been pursuing economic reform policies for more than twenty years, no assurance can be given that the PRC government will continue to pursue such policies or that such policies may not be significantly altered, especially in the event of a change in leadership, social or political disruption or unforeseen circumstances affecting the PRC’s political, economic and social conditions. There is also no guarantee that the PRC government’s pursuit of economic reforms will be consistent or effective.
AOXING PHARMACEUTICAL CO., INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2011
Substantially all of the Company’s businesses are transacted in RMB, which is not freely convertible. The Peoples Bank of China or other banks are authorized to buy and sell foreign currencies at the exchange rates quoted by the Peoples Bank of China. Approval of foreign currency payments by the Peoples Bank of China or other institutions requires submitting a payment application form together with suppliers’ invoices, shipping documents and signed contracts.
Since the Company has its primary operations in the PRC, the majority of its revenues will be settled in RMB, not U.S. Dollars. Due to certain restrictions on currency exchanges that exist in the PRC, the Company’s ability to use revenue generated in RMB to pay any dividend payments to its shareholders outside of China may be limited.
The Company’s business depends on maintaining licenses of its current products from the China State Food and Drug Administration. Obtaining licenses for additional products can be expensive and is usually time consuming. Failure to obtain the necessary licenses when needed can cause the Company’s business plan to be delayed. If the delays prevent the Company from generating positive cash flow or introducing a significant number of products, there will be a material adverse effect on the Company.
In September 2006, PRC changed the laws regarding transfer of equity in PRC companies in exchange for equity in non-PRC companies. Approvals and registrations for such transfers are required and penalties may be imposed if the requirements are not met.
Other Risks
The core business of the Company is the manufacture and sale of narcotic drugs, which is highly regulated by the PRC government. The Company depends on obtaining licenses of its products from the China State Food and Drug Administration (SFDA). Obtaining these licenses can be expensive and is usually time consuming. Failure to obtain the necessary licenses when needed can cause the Company’s business plan to be delayed. If the delays prevent the Company from generating positive cash flow or introducing a significant number of products, there will be a material adverse effect on the Company.
18 SUBSEQUENT EVENTS
In accordance with ASC 855, “Subsequent Events”, the Company has evaluated subsequent events that have occurred through the date of issuance of these financial statements and has determined that there was no material event that occurred after the date of the balance sheets included in this report.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
Not Applicable
Item 9A. Controls and Procedures
Evaluation of Disclosure Controls and Procedures.
We have established disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), to provide reasonable assurance that information required by Aoxing Pharma in the reports that it files with the Securities and Exchange Commission is recorded, processed, summarized and reported within the time limits specified in the Commission’s rules. “Disclosure controls and procedures” include, without limitation, controls and procedures designed to insure that information Aoxing Pharma is required to disclose in the reports it files with the Commission is accumulated and communicated to our Certifying Officers as appropriate to allow timely decisions regarding required disclosure.
The Company conducted self-assessments of our internal control procedures. Those self-assessment revealed the following material weakness in our internal control over financial reporting: the Company is relatively inexperienced with certain complexities within US GAAP and SEC reporting causing a material weakness in internal controls, Based on the results of these self-assessments, our principal executive officer and principal financial officer concluded that Aoxing Pharma’s system of disclosure controls and procedures was not effective as of June 30, 2011 for the purposes described in this paragraph.
Changes in Internal Controls.
There have been no changes in our internal control over financial reporting during the fourth quarter of 2011 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Management’s Report on Internal Control over Financial Reporting.
Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934. We have assessed the effectiveness of those internal controls as of June 30, 2011, using the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) Internal Control – Integrated Framework as a basis for our assessment.
Because of inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies and procedures may deteriorate. All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation.
A material weakness in internal controls is a deficiency in internal control, or combination of control deficiencies, that adversely affects the Company’s ability to initiate, authorize, record, process, or report external financial data reliably in accordance with accounting principles generally accepted in the United States of America such that there is more than a remote likelihood that a material misstatement of the Company’s annual or interim financial statements that is more than inconsequential will not be prevented or detected. In the course of making our assessment of the effectiveness of internal controls over financial reporting, we identified the following material weakness in our internal control over financial reporting: the Company is relatively inexperienced with certain complexities within US GAAP and SEC reporting causing a material weakness in internal controls, which resulted in not properly accounting for the deferred income tax related to loss carry forwards under Chinese tax law.
With regard to the material weakness, we have evaluated our internal resources related to income tax accounting and have taken steps to supplement these resources with external tax accounting and tax disclosure expertise.
Because we are a smaller reporting company, this Annual Report on Form 10-K does not include an attestation report of our independent registered public accounting firm regarding internal control over financial reporting.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned thereunto duly authorized.
| | AOXING PHARMACEUTICAL COMPANY, INC. |
| | |
| | |
| Date: September 28, 2012 | By: /s/ Zhenjiang Yue |
| | Zhenjiang Yue, Chief Executive Officer |
| | |
| | |
| Date: September 28, 2012 | By: /s/ Guoan Zhang |
| | Guoan Zhang, Chief Financial Officer |
29
