UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
x | Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 | |||
For the quarterly period ended September 30, 2013 | ||||
or
¨ | Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 |
For the transition period from ______ to ______. |
Commission File Number 001-34394
![](https://capedge.com/proxy/10-Q/0001144204-13-061871/ft0002img-1.jpg count=1)
SKYSTAR BIO-PHARMACEUTICAL COMPANY
(Exact name of small business issuer as specified in its charter)
Nevada | 33-0901534 |
(State or other jurisdiction of | (I.R.S. employer |
incorporation or organization) | identification number) |
4/F Building B, Chuangye Square, No. 48 Keji Road,
Gaoxin District, Xi’an, Shaanxi Province, P.R. China
(Address of principal executive offices and zip code)
(8629) 8819-3188
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
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 x No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. 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 ¨ | Smaller Reporting Company x |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ¨ No x
As of November 11, 2013, the Registrant had 7,604,800 shares of common stock outstanding.
SKYSTAR BIO-PHARMACEUTICAL COMPANY
FORM 10-Q
INDEX
Page No. | |||
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS | 3 | ||
PART I. FINANCIAL INFORMATION | |||
Item 1. | Condensed Consolidated Financial Statements | 4 | |
Condensed Consolidated Balance Sheets as of September 30, 2013 (unaudited) and December 31, 2012 | 4 | ||
Condensed Consolidated Statements of Comprehensive Income for the Three Months and Nine Months Ended September 30, 2013 and 2012 (unaudited) | 5 | ||
Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2013 and 2012 (unaudited) | 6 | ||
Condensed Consolidated Statement of Changes in Equity for the Nine Months Ended September 30, 2013 (unaudited) | 7 | ||
Notes to the Condensed Consolidated Financial Statements (unaudited) | 8 | ||
Item 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations | 31 | |
Item 4. | Controls and Procedures | 38 | |
PART II. OTHER INFORMATION | |||
Item 1. | Legal Proceedings | 39 | |
Item 6. | Exhibits | 40 | |
SIGNATURES |
2 | ||
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
This report contains forward-looking statements. All forward-looking statements are inherently uncertain as they are based on current expectations and assumptions concerning future events or future performance of the Company. Readers are cautioned not to place undue reliance on these forward-looking statements, which are only predictions and speak only as of the date hereof. Forward-looking statements usually contain the words “estimate,” “anticipate,” “believe,” “expect,” or similar expressions, and are subject to numerous known and unknown risks and uncertainties. In evaluating such statements, prospective investors should carefully review various risks and uncertainties identified in this Report, including the matters set forth under the captions “Risk Factors” and in our other SEC filings. These risks and uncertainties could cause our actual results to differ materially from those indicated in the forward-looking statements.
Although forward-looking statements in this Quarterly Report on Form 10-Q reflect the good faith judgment of our management, such statements can only be based on facts and factors currently known by us. Consequently, forward-looking statements are inherently subject to risks and uncertainties, and actual results and outcomes may differ materially from the results and outcomes discussed in or anticipated by the forward-looking statements. Factors that could cause or contribute to such differences in results and outcomes include, without limitation, those specifically addressed under the heading “Risks Relating to Our Business” contained in Form 10-K for the year ended December 31, 2012, as well as those discussed elsewhere in this Quarterly Report. Readers are urged not to place undue reliance on these forward-looking statements, which speak only as of the date of this Quarterly Report. We file reports with the SEC. You can read and copy any materials we file with the SEC at the SEC’s Public Reference Room, 100 F. Street, NE, Washington, D.C. 20549 on official business days during the hours of 10 a.m. to 3 p.m. You can obtain additional information about the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. In addition, the SEC maintains an Internet site (www.sec.gov) that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC, including the Company.
We undertake no obligation to revise or update any forward-looking statements in order to reflect any event or circumstance that may arise after the date of this Quarterly Report. Readers are urged to carefully review and consider the various disclosures made throughout the entirety of this Quarterly Report, which attempt to advise interested parties of the risks and factors that may affect our business, financial condition, results of operations and prospects.
3 | ||
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
SKYSTAR BIO-PHARMACEUTICAL COMPANY AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
September 30, | December 31, | ||||||
2013 | 2012 | ||||||
(Unaudited) | |||||||
ASSETS | |||||||
CURRENT ASSETS: | |||||||
Cash | $ | 4,456,619 | $ | 11,321,848 | |||
Restricted cash | 60,310 | - | |||||
Accounts receivable, net of allowance for doubtful accounts of $1,544,175 and $247,269 as of September 30, 2013 (Unaudited) and December 31, 2012, respectively | 26,901,414 | 10,010,796 | |||||
Inventories | 27,407,862 | 22,962,209 | |||||
Deposits, prepaid expenses and other receivables | 1,782,705 | 2,839,850 | |||||
Prepayments to suppliers | 27,671,219 | 23,438,735 | |||||
Loans receivable | - | 1,078,827 | |||||
Deferred tax assets | 343,922 | - | |||||
Total current assets | 88,624,051 | 71,652,265 | |||||
PROPERTY, PLANT AND EQUIPMENT, NET | 28,572,754 | 28,867,816 | |||||
CONSTRUCTION-IN-PROGRESS | 9,106,056 | 8,691,360 | |||||
OTHER ASSETS: | |||||||
Long-term prepayments | 4,622,340 | 1,050,327 | |||||
Long-term prepayments for acquisitions | 182,560 | 177,744 | |||||
Intangible assets, net | 5,277,138 | 5,319,831 | |||||
Total other assets | 10,082,038 | 6,547,902 | |||||
Total assets | $ | 136,384,899 | $ | 115,759,343 | |||
LIABILITIES AND SHAREHOLDERS’ EQUITY | |||||||
CURRENT LIABILITIES: | |||||||
Accounts payable | $ | 3,762,362 | $ | 4,017,530 | |||
Other payables and accrued expenses | 5,726,029 | 4,374,047 | |||||
Short-term loans | 10,595,000 | 4,443,600 | |||||
Deposits from customers | 1,589,449 | 1,621,061 | |||||
Taxes payable | 4,973,402 | 1,950,757 | |||||
Due to related parties | 1,741,820 | 798,925 | |||||
Total current liabilities | 28,388,062 | 17,205,920 | |||||
OTHER LIABILITIES: | |||||||
Long-term loan | - | 1,269,600 | |||||
Deferred government grant | 798,700 | 1,063,290 | |||||
Purchase option liability | 205,758 | 5,600 | |||||
Total other liabilities | 1,004,458 | 2,338,490 | |||||
Total liabilities | 29,392,520 | 19,544,410 | |||||
COMMITMENTS AND CONTINGENCIES | |||||||
SHAREHOLDERS’ EQUITY | |||||||
Preferred stock, $0.001 par value, 50,000,000 shares authorized, No Series “A” shares authorized. 48,000,000 Series “B” shares authorized. No Series “B” shares issued and outstanding | - | - | |||||
Common stock, $0.001 par value, 40,000,000 shares authorized, 7,604,800 shares issued and outstanding as of September 30, 2013 (Unaudited) and December 31, 2012 | 7,605 | 7,605 | |||||
Paid-in capital | 37,024,312 | 37,021,085 | |||||
Statutory reserves | 5,897,298 | 5,897,298 | |||||
Retained earnings | 52,713,107 | 44,515,296 | |||||
Accumulated other comprehensive income | 11,350,057 | 8,773,649 | |||||
Total shareholders’ equity | 106,992,379 | 96,214,933 | |||||
Total liabilities and shareholders’ equity | $ | 136,384,899 | $ | 115,759,343 |
The accompanying notes are an integral part of these condensed consolidated financial statements.
4 | ||
SKYSTAR BIO-PHARMACEUTICAL COMPANY AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
FOR THE THREE MONTHS AND NINE MONTHS ENDED SEPTEMBER 30, 2013 AND 2012
(Unaudited)
For Three Months Ended September 30, | For Nine Months Ended September 30, | ||||||||||||
2013 | 2012 | 2013 | 2012 | ||||||||||
REVENUE, NET | $ | 15,992,408 | $ | 8,933,005 | $ | 32,858,294 | $ | 25,730,190 | |||||
COST OF REVENUE | 7,778,691 | 3,670,230 | 16,087,401 | 11,060,826 | |||||||||
GROSS PROFIT | 8,213,717 | 5,262,775 | 16,770,893 | 14,669,364 | |||||||||
OPERATING EXPENSES: | |||||||||||||
Research and development | 324,353 | 198,838 | 417,740 | 533,024 | |||||||||
Selling expenses | 1,266,444 | 692,009 | 2,213,617 | 2,068,192 | |||||||||
General and administrative | 1,885,219 | 730,539 | 3,785,302 | 3,670,254 | |||||||||
Total operating expenses | 3,476,016 | 1,621,386 | 6,416,659 | 6,271,470 | |||||||||
INCOME FROM OPERATIONS | 4,737,701 | 3,641,389 | 10,354,234 | 8,397,894 | |||||||||
OTHER INCOME (EXPENSE): | |||||||||||||
Other income (expense), net | 32,757 | (734) | 28,908 | 55,264 | |||||||||
Interest (expense), net | (48,526) | (199,238) | (185,155) | (378,779) | |||||||||
Change in fair value of warrant/purchase option liability | (205,758) | 7,000 | (200,158) | 29,400 | |||||||||
Total other (expense), net | (221,527) | (192,972) | (356,405) | (294,115) | |||||||||
INCOME BEFORE PROVISION FOR INCOME TAXES | 4,516,174 | 3,448,417 | 9,997,829 | 8,103,779 | |||||||||
PROVISION FOR INCOME TAXES | 781,977 | 717,163 | 1,800,018 | 1,768,905 | |||||||||
NET INCOME | 3,734,197 | 2,731,254 | 8,197,811 | 6,334,874 | |||||||||
OTHER COMPREHENSIVE INCOME | |||||||||||||
Foreign currency translation adjustment | 513,281 | (198,269) | 2,576,408 | 484,203 | |||||||||
COMPREHENSIVE INCOME | $ | 4,247,478 | $ | 2,532,985 | $ | 10,774,219 | $ | 6,819,077 | |||||
EARNINGS PER SHARE: | |||||||||||||
Basic | $ | 0.49 | $ | 0.36 | $ | 1.08 | $ | 0.85 | |||||
Diluted | $ | 0.49 | $ | 0.36 | $ | 1.08 | $ | 0.85 | |||||
WEIGHTED AVERAGE NUMBER OF COMMON SHARES: | |||||||||||||
Basic | 7,617,726 | 7,604,800 | 7,615,733 | 7,426,082 | |||||||||
Diluted | 7,617,726 | 7,604,800 | 7,615,733 | 7,426,082 |
The accompanying notes are an integral part of these condensed consolidated financial statements.
5 | ||
SKYSTAR BIO-PHARMACEUTICAL COMPANY AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2013 AND 2012
(Unaudited)
Nine months ended September 30, | |||||||
2013 | 2012 | ||||||
CASH FLOWS FROM OPERATING ACTIVITIES: | |||||||
Net income | $ | 8,197,811 | $ | 6,334,874 | |||
Adjustments to reconcile net income to net cash provided by (used in) operating activities: | |||||||
Depreciation | 1,086,914 | 920,444 | |||||
Amortization | 184,496 | 300,589 | |||||
Provision for doubtful accounts | 1,274,058 | 31,340 | |||||
Change in fair value of warrant/purchase option liability | 200,158 | (29,400) | |||||
Loss on disposal of office equipment | 1,748 | - | |||||
Common stock to be issued to related parties for compensation | 3,227 | - | |||||
Common stock issued under 2010 stock incentive plan | - | 1,037,911 | |||||
Deferred tax assets | (339,618) | - | |||||
Change in operating assets and liabilities | |||||||
Accounts receivable | (17,685,435) | (12,094,949) | |||||
Inventories | (3,775,636) | (336,902) | |||||
Deposits, prepaid expenses and other receivables | 1,099,950 | 404,130 | |||||
Prepayments to suppliers | (3,552,385) | (5,426,601) | |||||
Accounts payable | (513,989) | 3,112,002 | |||||
Other payables and accrued expenses | 1,391,003 | (1,361,439) | |||||
Deposits from customers | (74,589) | (92,856) | |||||
Taxes payable | 2,932,621 | 1,078,604 | |||||
Deferred government grants | (450,688) | (317,040) | |||||
Net cash used in operating activities | (10,020,354) | (6,439,293) | |||||
CASH FLOWS FROM INVESTING ACTIVITIES: | |||||||
Payments of long-term prepayments | (3,510,666) | (343,960) | |||||
Refund of long-term prepayments | - | 475,560 | |||||
Loan to third parties | - | (1,941,248) | |||||
Repayment of loans from third parties | 1,094,190 | 802,270 | |||||
Placement of restricted cash | (59,555) | - | |||||
Purchases of property, plant and equipment | (9,290) | (157,782) | |||||
Proceeds from sale of plant and equipment | 161 | - | |||||
Payments on construction-in-progress | (10,977) | (182,774) | |||||
Net cash used in investing activities | (2,496,137) | (1,347,934) | |||||
CASH FLOWS FROM FINANCING ACTIVITIES: | |||||||
Proceeds from short-term loans | 10,462,400 | 4,503,728 | |||||
Repayment of short-term loans | (4,506,880) | (2,726,544) | |||||
Proceeds from long-term loan | - | 1,266,400 | |||||
Repayment of long-term loan | (1,287,680) | - | |||||
Due to related parties | 928,312 | 331,158 | |||||
Net cash provided by financing activities | 5,596,152 | 3,374,742 | |||||
EFFECT OF EXCHANGE RATE CHANGES ON CASH | 55,110 | 32,049 | |||||
DECREASE IN CASH | (6,865,229) | (4,380,436) | |||||
CASH, beginning of period | 11,321,848 | 7,048,968 | |||||
CASH, end of period | $ | 4,456,619 | $ | 2,668,532 | |||
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: | |||||||
Cash paid for interest | $ | 454,336 | $ | 508,667 | |||
Cash paid for income taxes | $ | 329,968 | $ | 971,784 | |||
Non-cash investing and financing activities | |||||||
Long-term prepayment transferred to construction-in-progress | $ | 22,438 | $ | 832,230 | |||
Construction-in-progress transferred to property, plant and equipment | $ | - | $ | 1,128,662 | |||
Shares issued to settle payables to related parties | $ | - | $ | 199,239 |
The accompanying notes are an integral part of these condensed consolidated financial statements.
6 | ||
SKYSTAR BIO-PHARMACEUTICAL COMPANY AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN EQUITY
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2013
(UNAUDITED)
Accumulated | ||||||||||||||||||||||
Retained earnings | other | |||||||||||||||||||||
Common stock | Paid-in | Statutory | comprehensive | |||||||||||||||||||
Shares | Amount | capital | reserves | Unrestricted | income | Total | ||||||||||||||||
BALANCE, January 1, 2013 | 7,604,800 | $ | 7,605 | $ | 37,021,085 | $ | 5,897,298 | $ | 44,515,296 | $ | 8,773,649 | $ | 96,214,933 | |||||||||
Net income | - | - | - | - | 8,197,811 | - | 8,197,811 | |||||||||||||||
Share-based compensation | - | - | 3,227 | - | - | - | 3,227 | |||||||||||||||
Foreign currency translation | - | - | - | - | - | 2,576,408 | 2,576,408 | |||||||||||||||
BALANCE, September 30, 2013 | 7,604,800 | $ | 7,605 | $ | 37,024,312 | $ | 5,897,298 | $ | 52,713,107 | $ | 11,350,057 | $ | 106,992,379 |
The accompanying notes are an integral part of these condensed consolidated financial statements.
7 | ||
SKYSTAR BIO-PHARMACEUTICAL COMPANY AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2013
(Unaudited)
Note 1 - ORGANIZATION
Organization and description of business
Skystar Bio-Pharmaceutical Company (“Skystar” or the “Company”) was incorporated in Nevada on September 24, 1998. Since its acquisition on November 7, 2005 of Skystar Bio-Pharmaceutical (Cayman) Holdings Co., Ltd. (“Skystar Cayman”), a Cayman Islands company, the Company has been engaged in the research, development, production, marketing, and sales of veterinary healthcare and medical care products. All current operations of the Company are in the People’s Republic of China (“China” or the “PRC”).
All of the Company’s operations are carried out by its subsidiaries in China and Xi’an Tianxing Bio-Pharmaceutical Co., Limited (“Xi’an Tianxing”), a PRC joint stock company that the Company controls through contractual arrangements originally between Skystar Cayman and Xi’an Tianxing. On March 10, 2008, the Company entered into a series of agreements transferring all of the rights and obligations of Skystar Cayman under the contractual arrangements to Sida Biotechnology (Xi’an) Co., Ltd. (“Sida”), a PRC company. Sida is the wholly owned subsidiary of Fortunate Time International Limited (“Fortunate Time”), a Hong Kong company and wholly owned subsidiary of Skystar Cayman. Xi’an Tianxing also has a wholly owned subsidiary, Shanghai Siqiang Biotechnological Co., Ltd. (“Shanghai Siqiang”), a PRC company.
On September 18, 2009, Skystar Bio-Pharmaceutical Inc. (“Skystar California”) was incorporated in California and became a wholly owned subsidiary of Skystar. On December 20, 2010, Skystar California was dissolved.
On April 21, 2010, Kunshan Sikeda Biotechnology Co., Ltd. (“Kunshan Sikeda”) was incorporated in Kunshan, Jiangsu Province, China with a registered capital of $ 81,500 (RMB 500,000), of which Xi’an Tianxing and Sida each contributed $ 40,750 (RMB 250,000). Kunshan Sikeda is jointly owned by Xi’an Tianxing and Sida. On July 31, 2013, Kunshan Sikeda was dissolved.
On May 7, 2010, Fortunate Time formed Skystar Biotechnology (Kunshan) Co., Limited (“Skystar Kunshan”) in Kunshan, Jiangsu Province, China with a registered capital of $ 15,000,000, of which $ 2,250,000 was paid by Fortunate Time in cash, and of which the remaining $ 12,750,000 is required to be invested in the future. Skystar Kunshan was formed in connection with an acquisition of assets to meet part of the registered capital requirements, and was intended to be a micro-organism manufacturing facility for the Company once the acquisition was complete. The asset acquisition was completed in September 2011.
On August 11, 2010, Sida became the parent company of Skystar Biotechnology (Jingzhou) Co., Limited (“Skystar Jingzhou”), a company established in Jingzhou, Hubei Province, China on February 5, 2010, with registered capital of approximately $ 4.2 million (RMB 26,000,000), of which approximately $ 3.8 million (RMB 23,480,000) was paid. On July 5, 2012, Sida paid up the remaining capital of $ 0.4 million (RMB 2,520,000).
On March 15, 2011, Xi’an Tianxing formed Xi’an Sikaida Bio-products Co., Ltd. (“Xi’an Sikaida”) with a registered capital of approximately $ 1,630,000 (RMB 10,000,000 ) paid by Xi’an Tianxing.
Hereinafter, Skystar, Skystar Cayman, Fortunate Time, Sida, Xi’an Tianxing, Skystar Kunshan, Kunshan Sikeda, Skystar Jingzhou, Shanghai Siqiang, and Xi’an Sikaida are sometimes collectively referred to as the “Company”.
Note 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The accompanying unaudited condensed consolidated financial statements have been prepared in conformity with United States generally accepted accounting principles (“U.S. GAAP”) applicable to interim financial information and the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. In the opinion of management, all adjustments (which include all significant normal and recurring adjustments) necessary to present fairly the financial position, results of operations and cash flows for all periods presented have been made. The accompanying results of operations are not necessarily indicative of the operating results that may be expected for the entire year ending December 31, 2013. These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and accompanying notes thereto of the Company, which are included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2012 filed with the Securities and Exchange Commission (“SEC”).
8 | ||
SKYSTAR BIO-PHARMACEUTICAL COMPANY AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2013
(Unaudited)
Note 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Principles of consolidation
The accompanying condensed consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America. The consolidated financial statements include the financial statements of the Company, its wholly-owned subsidiaries, and its variable interest entities (“VIEs”). All significant inter-company transactions and balances between the Company, its subsidiaries, and its VIEs have been eliminated in consolidation.
The Company has evaluated the relationship with Xi’an Tianxing and Xi’an Tianxing’s wholly owned subsidiaries, Xi’an Sikaida and Shanghai Siqiang. As a result of the contractual arrangements which obligate Sida to absorb all of the risk of loss from Xi’an Tianxing’s activities and enable Sida to receive all of its expected residual returns, the Company is the primary beneficiary of these VIEs and thus it accounts for Xi’an Tianxing, Xi’an Sikaida and Shanghai Siqiang as VIEs under the Financial Accounting Standards Board’s (“FASB”) interpretation on consolidation of variable interest entities. Accordingly, the Company consolidates the results, assets, and liabilities of Xi’an Tianxing, Xi’an Sikaida and Shanghai Siqiang.
Use of estimates
The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. The level of uncertainty in estimates and assumptions increases with the length of time to complete the underlying transactions. Actual results may differ from these estimates in amounts that may be material to the consolidated financial statements and accompanying notes. Significant estimates and assumptions made by the Company are used for, but not limited to the allowance for uncollectible receivables, obsolescence reserve against inventory, useful lives of property, plant and equipment and intangible assets, assumptions used in assessing impairment for long-lived assets and the fair value for derivative instruments.
Foreign currency translation
The Company uses the United States dollar (“U.S. dollar”) for financial reporting purposes and the Chinese Renminbi (“RMB”) as its functional currency. The Company’s subsidiaries and VIEs maintain their books and records in their functional currency, being the primary currency of the economic environment in which their operations are conducted.
The Company translates the subsidiaries’ and VIEs’ assets and liabilities into U.S. dollars using the applicable exchange rates prevailing at the balance sheet dates, and the statements of comprehensive income and cash flows are translated at average exchange rates during the reporting period. As a result, amounts related to assets and liabilities reported on the consolidated statements of cash flows will not necessarily agree with changes in the corresponding balances on the consolidated balance sheets. Equity accounts are translated at historical rates. Adjustments resulting from the translation of the subsidiaries’ and VIEs’ financial statements are recorded as accumulated other comprehensive income.
The quotation of the exchange rates does not imply free convertibility of RMB to other foreign currencies. All foreign exchange transactions continue to take place either through the People’s Bank of China or other banks authorized to buy and sell foreign currencies at the exchange rate quoted by the People’s Bank of China.
Approval of foreign currency payments by the People’s Bank of China or other institutions requires submitting a payment application form together with invoices, shipping documents, and signed contracts. Transaction gains and losses that arise from exchange rate fluctuations on transactions denominated in a currency other than the functional currency are included in the results of operations as incurred.
9 | ||
SKYSTAR BIO-PHARMACEUTICAL COMPANY AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2013
(Unaudited)
Note 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Fair values of financial instruments
ASC Topic 820, Fair Value Measurement and Disclosures, defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. This topic also establishes a fair value hierarchy, which requires classification based on observable and unobservable inputs when measuring fair value. Certain current assets and current liabilities are financial instruments. Management believes their carrying amounts are a reasonable estimate of fair value because of the short period of time between the origination of such instruments and their expected realization and, if applicable, their current interest rates are equivalent to interest rates currently available. The three levels of valuation hierarchy are defined as follows:
¨ | Level 1 inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets. |
¨ | Level 2 inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the assets or liability, either directly or indirectly, for substantially the full term of the financial instruments. |
¨ | Level 3 inputs to the valuation methodology are unobservable and significant to the fair value measurement. |
The following table sets forth by level within the fair value hierarchy our financial assets and liabilities that were accounted for at fair value on a recurring basis as of September 30, 2013 and December 31, 2012:
Carrying | |||||||||||||
Value at | Fair Value Measurement at | ||||||||||||
September 30, | September 30, 2013 | ||||||||||||
2013 | Level 1 | Level 2 | Level 3 | ||||||||||
Purchase option liability | $ | 205,758 | $ | — | $ | 205,758 | $ | — |
Carrying | |||||||||||||
Value at | Fair Value Measurement at | ||||||||||||
December 31, | December 31, 2012 | ||||||||||||
2012 | Level 1 | Level 2 | Level 3 | ||||||||||
Purchase option liability | $ | 5,600 | $ | — | $ | 5,600 | $ | — |
Below is the reconciliation for the purchase option liability changes from December 31, 2012 to September 30, 2013:
Balance, December 31, 2012 | $ | 5,600 | ||
Change in fair value | 200,158 | |||
Balance, September 30, 2013 | $ | 205,758 |
10 | ||
SKYSTAR BIO-PHARMACEUTICAL COMPANY AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2013
(Unaudited)
Note 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Revenue recognition
Revenue of the Company is primarily derived from the sales of veterinary healthcare and medical care products in China. Sales are recognized when the following four revenue criteria are met: persuasive evidence of an arrangement exists, delivery has occurred, the selling price is fixed or determinable, and collectability is reasonably assured. Sales are presented net of value added tax (“VAT”). No estimated allowance for sales returns is reflected in these consolidated financial statements as sales returns historically have been insignificant.
There are two types of sales upon which revenue is recognized:
a. | Credit sales: revenue is recognized when the products have been delivered to the customers. | |
b. | Full payment before delivery: Cash received is recorded as “deposits from customers” and revenue is recognized when the products have been delivered to the customers. |
The Company’s revenue and cost of revenue by product line were as follows:
Three months ended September 30, | Nine months ended September 30, | ||||||||||||
2013 | 2012 | 2013 | 2012 | ||||||||||
Revenue | |||||||||||||
Micro-organism | $ | 4,946,687 | $ | 4,922,168 | $ | 10,644,982 | $ | 12,059,414 | |||||
Veterinary Medications | 9,828,431 | 1,781,306 | 19,567,721 | 7,248,607 | |||||||||
Feed Additives | 610,082 | 1,189,563 | 1,410,531 | 3,491,396 | |||||||||
Vaccines | 607,208 | 1,039,968 | 1,235,060 | 2,930,773 | |||||||||
Total Revenue | 15,992,408 | 8,933,005 | 32,858,294 | 25,730,190 | |||||||||
Cost of Revenue | |||||||||||||
Micro-organism | 1,416,068 | 1,843,821 | 3,182,984 | 3,920,073 | |||||||||
Veterinary Medications | 5,826,896 | 848,105 | 11,672,910 | 4,039,759 | |||||||||
Feed Additives | 466,490 | 854,114 | 1,081,010 | 2,736,137 | |||||||||
Vaccines | 69,237 | 124,190 | 150,497 | 364,857 | |||||||||
Total Cost of Revenue | 7,778,691 | 3,670,230 | 16,087,401 | 11,060,826 | |||||||||
Gross Profit | $ | 8,213,717 | $ | 5,262,775 | $ | 16,770,893 | $ | 14,669,364 |
Cash
Cash includes currency on hand, demand deposits with banks, and liquid investments with an original maturity of three months or less.
Accounts receivable
Accounts receivable is stated at cost less an allowance for uncollectible accounts, as needed. The Company uses the aging method to estimate the allowance for anticipated uncollectible receivable balances. Under the aging method, a bad debt percentage is estimated by management based on historical experience and current economic climate. The resulting percentage is applied to customers’ balances categorized by the number of months the underlying invoices have remained outstanding. At each reporting period, the allowance balance is adjusted to reflect the amount computed as a result of the aging method. When facts subsequently become available to indicate that the allowance provided requires an adjustment, a corresponding adjustment is made to the allowance account as a change in estimate. The ultimate collection of the Company’s accounts receivable may take one year. Delinquent account balances are reserved after management determines that the likelihood of collection is not probable, and known bad debts are written-off against the allowance for doubtful accounts when identified.
Inventories
Inventories are stated at the lower of cost as determined on a weighted-average basis, or market. Inventories include purchases and related costs incurred in bringing the inventories to their present location and condition. Management reviews inventories for obsolescence and cost in excess of net realizable value and records a reserve against the inventory and additional cost of goods sold when the carrying value exceeds net realizable value.
11 | ||
SKYSTAR BIO-PHARMACEUTICAL COMPANY AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2013
(Unaudited)
Note 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Property, plant and equipment
Property, plant and equipment are stated at cost less accumulated depreciation and impairment losses, if any. Depreciation is computed using the straight-line method over the estimated useful lives of the assets. Expenditures for maintenance and repairs that do not improve or extend the useful lives of the assets are charged to operations as incurred, while renewals and betterments are capitalized. Gains and losses on disposals are included in the results of operations. Estimated useful lives of the assets are as follows:
Estimated useful life | |||
Buildings and improvements | 10-40 years | ||
Machinery and equipment | 5-10 years | ||
Office equipment and furniture | 5-10 years | ||
Vehicles | 5-10 years |
Management assesses the carrying value of property, plant and equipment annually or more often when factors indicating impairment are present, and reduce the carrying value of such assets by the amount of the impairment. The Company determines the existence of such impairment by measuring the expected future cash flows (undiscounted) and comparing such amount to the net asset carrying value. An impairment loss, if it exists, is measured as the amount by which the carrying amount of the asset exceeds the fair value of the asset. Based on its review, management believes that, as of September 30, 2013 and December 31, 2012, there was no impairment of its property, plant and equipment.
Construction-in-progress
Construction-in-progress includes direct costs of construction of a factory building. Interest incurred during the period of construction, if significant, is capitalized. All other interest is expensed as incurred. Construction-in-progress is not depreciated until such time as the asset is completed and put into service.
Intangible assets
Land use rights — Land use rights represent the amounts paid to acquire a long-term interest to utilize the land underlying the Company’s facilities. This type of arrangement is common for the use of land in the PRC. Land use rights are amortized on the straight-line method over the contractual lease terms. The land use right granted to the Company’s Huxian facility was for 50 years. The land use right granted to the Company’s Jingzhou facility was 30 years. The land use right granted to the Company’s Kunshan facility was for 41 years.
Technological know-how — Purchased technological know-how includes confidential formulas, manufacturing processes, and technical and procedural manuals, and is amortized using the straight-line method over an estimated useful life of between five to eleven years that reflects the period over which such confidential formulas, manufacturing processes, and technical and procedural manuals are kept confidential by the Company as agreed between the Company and the selling parties.
Impairment of intangible assets — the Company evaluates the carrying value of intangible assets at least annually when factors indicating impairment are present. The Company determines the existence of such impairment by measuring the estimated future cash flows (undiscounted) and comparing such amount to the net asset carrying value. If the undiscounted cash flow estimated to be generated by any such intangible asset is less than its carrying amount, a loss is recognized based on the amount by which the carrying amount exceeds the intangible asset’s fair market value. Loss on intangible assets to be disposed of is determined in a similar manner, except that fair market values are reduced by the cost of disposal. Based on its review, the Company believes that, as of September 30, 2013 and December 31, 2012, there was no impairment of its intangible assets.
Comprehensive income
Comprehensive income is defined as the change in equity of a business enterprise during a period from transactions and other events and circumstances from non-owner sources. Accumulated other comprehensive income is comprised of the foreign currency translation adjustments.
Shipping and handling costs
Shipping and handling costs related to costs of goods sold are included in selling expenses, which totaled $ 805,492 and $ 511,519 for the three months ended September 30, 2013 and 2012, respectively, and $ 1,452,981 and $ 1,358,852 for the nine months ended September 30, 2013 and 2012, respectively.
12 | ||
SKYSTAR BIO-PHARMACEUTICAL COMPANY AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2013
(Unaudited)
Note 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Advertising costs
Advertising costs are charged to selling expenses as incurred. Advertising costs were insignificant for both the three months and nine months ended September 30, 2013 and 2012, respectively.
Research and development costs
Research and development costs are charged to expenses as incurred and include salaries, professional fees, and technical support fees related to such efforts.
Income taxes
The Company accounts for income taxes using an asset and liability method. Under this method, deferred income taxes are recognized for the tax consequences of temporary differences by applying enacted statutory tax rates applicable to future years to differences between the financial statement carrying amounts and the tax bases of existing assets and liabilities. The effect on deferred income taxes of a change in tax rates is recognized in income in the period that includes the enactment date. A valuation allowance is recognized if it is more likely than not that some portion or all of a deferred tax asset will not be realized.
A tax position is recognized as a benefit only if it is “more likely than not” that the tax position would be sustained in a tax examination, with a tax examination being presumed to occur. The amount recognized is the largest amount of tax benefit that is greater than 50% likely of being realized on examination. For tax positions not meeting the “more likely than not” test, no tax benefit is recorded. As of September 30, 2013 and December 31, 2012, there are no unrecognized tax benefits, and the Company does not expect a significant change in tax benefits in the next 12 months. Penalties and interest levied by taxing authorities, if any, are classified as income tax expense in the year incurred. No significant penalties or interest relating to income taxes have been incurred during the three months and six months ended September 30, 2013 and 2012.
According to the PRC Tax Administration and Collection Law, the statute of limitations is three years if the underpayment of taxes is due to computational or other errors made by the taxpayer or the withholding agent. The statute of limitations extends to five years under special circumstances. In the case of transfer pricing issues, the statute of limitations is ten years. There is no statute of limitations in the case of tax evasion. Accordingly, the income tax returns of the Company’s PRC operating subsidiaries for the years ended December 31, 2007 through 2012 are open to examination by the PRC state and local tax authorities.
Stock-based compensation
The Company records and reports stock-based compensation by measuring the cost of services received in exchange for an award of equity instruments based on the grant-date fair value of the award. That cost is recognized over the period during which services are received. Stock compensation for stock granted to non-employees is determined as the fair value of the consideration received or the fair value of equity instruments issued, whichever is more reliably measured.
Earnings per share
Basic earnings per share is based upon the weighted-average number of common shares outstanding. Diluted earnings per share is based on the assumption that all dilutive convertible shares, including convertible preferred shares, warrants and stock options were converted or exercised. Further, the method requires that stock dividends or stock splits be accounted for retroactively if the stock dividends or stock splits occur during the period or after the end of the period but before the release of the financial statements, by considering it outstanding for the entirety of each period presented. Diluted earnings per share is computed by applying the treasury stock method. Under this method, options and warrants are assumed to be exercised at the beginning of the period (or at the time of issuance, if later), and as if funds obtained thereby were used to purchase common stock at the average market price during the period.
Related parties
Parties are considered to be related to the Company if the parties, directly or indirectly, through one or more intermediaries, control, are controlled by, or are under common control with the Company. Related parties also include principal owners of the Company, its management, members of the immediate families of such principal owners and management, and other parties with which the Company may deal if one party controls or can significantly influence the management or operating policies of the other to an extent that one of the transacting parties might be prevented from fully pursuing its own separate interests.
13 | ||
SKYSTAR BIO-PHARMACEUTICAL COMPANY AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2013
(Unaudited)
Note 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Operating segments
While the chief operating decision-makers monitor the revenue streams of the various products lines, operations are managed and financial performance is evaluated on a Company-wide basis. Product lines are aggregated into one as operating results for all product lines are similar. Accordingly, all of the major product lines (micro-organism, veterinary medicine, feed additives and vaccines) are considered by management to be aggregated in one reportable operating segment.
As the Company primarily generates its revenues from customers in the PRC, no geographical segments are presented.
Recently issued accounting pronouncements
In February 2013, the FASB issued Accounting Standards Update No. 2013-02 Comprehensive Income (Topic 220): The objective of this update is to improve the reporting of reclassifications out of accumulated other comprehensive income. The amendments in this update seek to attain that objective by requiring an entity to report the effect of significant reclassifications out of accumulated other comprehensive income on the respective line items in net income if the amount being reclassified is required under U.S. generally accepted accounting principles (GAAP) to be reclassified in its entirety to net income. For other amounts that are not required under U.S. GAAP to be reclassified in their entirety to net income in the same reporting period, an entity is required to cross-reference other disclosures required under U.S. GAAP that provide additional detail about those amounts. This would be the case when a portion of the amount reclassified out of accumulated other comprehensive income is reclassified to a balance sheet account (for example, inventory) instead of directly to income or expense in the same reporting period. For public entities, the amendments are effective prospectively for reporting periods beginning after December 15, 2012. The adoption of the provisions in this update did not have a significant impact on the Company’s consolidated financial statements.
In March 2013, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update No. 2013-05, Foreign Currency Matters, (Topic 830): Parent's Accounting for the Cumulative Translation Adjustment upon Derecognition of Certain Subsidiaries or Groups of Assets within a Foreign Entity or of an Investment in a Foreign Entity (ASU 2013-05), to resolve a diversity in accounting for the cumulative translation adjustment of foreign currency upon derecognition of a foreign subsidiary or group of assets. ASU 2013-05 requires the parent to apply the guidance in Subtopic 830-30 to release any related cumulative translation adjustment into net income when a reporting entity (parent) ceases to have a controlling financial interest in a subsidiary or group of assets within a foreign entity. Accordingly, the cumulative translation adjustment should be released into net income only if the sale or transfer results in the complete or substantially complete liquidation of the foreign entity in which the subsidiary or group of assets had resided. Further, ASU 2013-05 clarified that the parent should apply the guidance in subtopic 810-10 if there is a sale of an investment in a foreign entity, including both (1) events that result in the loss of a controlling financial interest in a foreign entity and (2) events that result in an acquirer obtaining control of an acquiree in which it held an equity interest immediately before the acquisition date. Accordingly, the cumulative translation adjustment should be released into net income upon the occurrence of those events. ASU 2013-05 is effective prospectively for the Company in our first quarter of fiscal 2014, with early adoption permitted. The Company does not expect ASU 2013-05 to have a significant impact on its consolidated results of operations and financial condition.
In July 2013, the FASB issued Accounting Standards Update No. 2013-11, Income Taxes (Topic 740)(ASU 2013-11). The amendments in this update provide guidance on the financial statement presentation of an unrecognized tax benefit when a net operating loss carryforward, similar tax loss, or tax credit carryforward exists. These amendments provide that an unrecognized tax benefit, or a portion thereof, should be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward, except to the extent that a net operating loss carryforward, a similar tax loss, or a tax credit carryforward is not available at the reporting date to settle any additional income taxes that would result from disallowance of a tax position, or the tax law does not require the entity to use, and the entity does not intend to use, the deferred tax asset for such purpose, then the unrecognized tax benefit should be presented as a liability. The amendments in this update are effective for fiscal years, and interim periods within those years, beginning after December 15, 2013. Early adoption is permitted. The Company does not expect ASU 2013-11 to have a significant impact on its consolidated results of operations and financial condition.
Other accounting standards that have been issued or proposed by the FASB or other standards-setting bodies that do not require adoption until a future date are not expected to have a material impact on the Company’s consolidated financial statements upon adoption.
14 | ||
SKYSTAR BIO-PHARMACEUTICAL COMPANY AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2013
(Unaudited)
Note 3 - CONCENTRATIONS AND CREDIT RISK
The Company’s operations are all carried out in the PRC. Accordingly, the Company’s business, financial condition, and results of operations may be influenced by the political, economic, and legal environments in the PRC, and by the general state of the PRC’s economy. The Company’s operations in the PRC are subject to specific considerations and significant risks not typically associated with companies in North America and Western Europe. These include risks associated with, among others, the political, economic, and legal environments and foreign currency exchange. The Company’s results may be adversely affected by changes in governmental policies with respect to laws and regulations, anti-inflationary measures, currency conversion and remittance abroad, and rates and methods of taxation, among other things.
Financial instruments which subject the Company to concentration of credit risk consist of cash and accounts receivable. Balances at financial institutions or state-owned banks within the PRC are not covered by insurance. The Company has not experienced any losses in such accounts. The Company provides unsecured credit terms for sales to certain customers. As a result, there are credit risks with the accounts receivable balances. The Company constantly re-evaluates the credit worthiness of customers buying on credit and maintains an allowance for doubtful accounts.
For the three months and nine months ended September 30, 2013 and 2012, all of the Company’s sales occurred in the PRC. No major customers accounted for more than 10% of the Company’s total revenues. All accounts receivable at September 30, 2013 and December 31, 2012 are from customers located in the PRC.
The Company’s six largest vendors accounted for approximately 79% and 89% of the Company’s total purchases, respectively, for the three months ended September 30, 2013 and 2012. The Company’s six largest vendors accounted for approximately 75% and 88% of the Company’s total purchases, respectively, for the nine months ended September 30, 2013 and 2012. No other vendors accounted for more than 10% of the Company’s total purchases.
The Company had one product that accounted for 23% and 25% of the Company’s total revenues for the three months and nine months ended September 30, 2013, respectively. The Company had one product that accounted for 17% and 16% of the Company’s total revenues for the three months and nine months ended September 30, 2012, respectively. No other products accounted for more than 10% of the Company’s total sales.
Note 4 - ACCOUNTS RECEIVABLE, NET
Accounts receivable consisted of the following:
September 30, 2013 | December 31, 2012 | ||||||
Accounts receivable | $ | 28,445,589 | $ | 10,258,065 | |||
Allowance for doubtful accounts | (1,544,175) | (247,269) | |||||
Accounts receivable, net | $ | 26,901,414 | $ | 10,010,796 |
The following table presents the movement of the allowance for doubtful accounts:
Balance, January 1, 2013 | $ | 247,269 | ||
Addition | 1,274,058 | |||
Translation adjustment | 22,848 | |||
Balance, September 30, 2013 | $ | 1,544,175 |
15 | ||
SKYSTAR BIO-PHARMACEUTICAL COMPANY AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2013
(Unaudited)
Note 5 – INVENTORIES
Inventories consist of the following:
September 30, 2013 | December 31, 2012 | ||||||
Raw materials | $ | 24,144,924 | $ | 20,428,757 | |||
Packing materials | 366,703 | 220,078 | |||||
Work-in-process | 34,530 | 219 | |||||
Finished goods | 2,788,237 | 2,243,226 | |||||
Other | 73,468 | 69,929 | |||||
Total | $ | 27,407,862 | $ | 22,962,209 |
Note 6 - DEPOSITS, PREPAID EXPENSES AND OTHER RECEIVABLES
Deposits, prepaid expenses and other receivables are comprised of the following:
September 30, 2013 | December 31, 2012 | ||||||
Prepaid income taxes | $ | - | $ | 1,263,845 | |||
Other prepayments | 277,918 | 828,676 | |||||
Deposits placed with guarantors (note 14) | 489,000 | 198,375 | |||||
Interest receivable (note 7) | 336,691 | - | |||||
Other receivables | 679,096 | 548,954 | |||||
Total | $ | 1,782,705 | $ | 2,839,850 |
Note 7 – PREPAYMENTS TO SUPPLIERS
Prepayments to suppliers are comprised of the following:
September 30, 2013 | December 31, 2012 | ||||||
Prepayments for raw materials | $ | 26,937,935 | $ | 23,053,753 | |||
Prepayments for packaging materials | 733,284 | 384,982 | |||||
Total | $ | 27,671,219 | $ | 23,438,735 |
As part of the Company’s strategy to reduce inventory costs, the Company maintains a balance for prepayments to suppliers in order to secure favorable pricing for raw materials. As inventory is received throughout the period, this balance will fluctuate with the business operations.
Starting from January 1, 2013, the Company began to charge two major suppliers interest at an annual rate of 2.0% on these prepayments for raw materials. As of September 30, 2013, prepayments to these two suppliers were $20,789,359. For the three months ended September 30, 2013 and 2012, $104,324 and $Nil, respectively, of interest income was recognized on these prepayments. For the nine months ended September 30, 2013 and 2012, $332,472 and $Nil, respectively, of interest income was recognized on these prepayments. The unpaid interest balance of $336,691 as of September 30, 2013 was included in “Deposits, prepaid expenses and other receivables” (note 6).
16 | ||
SKYSTAR BIO-PHARMACEUTICAL COMPANY AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2013
(Unaudited)
Note 8 - PROPERTY, PLANT AND EQUIPMENT, NET
Property, plant and equipment consist of the following:
September 30, 2013 | December 31, 2012 | ||||||
Buildings and improvements | $ | 27,947,267 | $ | 27,210,008 | |||
Machinery and equipment | 6,056,881 | 5,876,467 | |||||
Office equipment and furniture | 336,244 | 332,653 | |||||
Vehicles | 609,372 | 593,296 | |||||
Total | 34,949,764 | 34,012,424 | |||||
Less: accumulated depreciation | (6,377,010) | (5,144,608) | |||||
Plant and equipment, net | $ | 28,572,754 | $ | 28,867,816 |
Depreciation expense was $456,392 and $284,588 for the three months ended September 30, 2013 and 2012, respectively. Depreciation expense was $1,086,914 and $920,444 for the nine months ended September 30, 2013 and 2012, respectively.
As of September 30, 2013 and December 31, 2012, property, plant and equipment with a carrying amount of $20,090,873 and $2,180,382, respectively, were pledged against the Company’s short-term and long-term loans.
Note 9 - CONSTRUCTION-IN-PROGRESS
Construction-in-progress (“CIP”) relates to facilities being built in Xi’an, Jingzhou and Kunshan.
Xi’an facility
Xi’an Tianxing has a vaccine facility and animal laboratory being built in Huxian, Xi’an.
In 2011, the Company started two projects at the vaccine facility to modify air filtration, water treatment, and other facility changes based on recommendations by outside experts hired by the Company to advise on the GMP qualification process for the vaccine facility. As of September 30, 2013, this vaccine facility had a total construction-in-progress of $2,473,589. On September 20 and 21, 2012, China’s Ministry of Agriculture (“MOA”) physically inspected this new facility and deemed the facility GMP compliant. Following physical inspection, the MOA’s inspection team recommended that the Office of the Working Committee proceed with Stage 2 of its GMP certification process. The Company expects the Stage 2 GMP inspection to be completed by the fourth quarter of 2013 and its GMP certification process to be completed thereafter.
In 2011, the Company started a facility improvement project in the amount of approximately $326,000 for the Huxian Animal Laboratory. The facility is a supporting project to the Huxian vaccine facility and is currently in Stage 2 of its GMP certification process. The Company expects the Stage 2 GMP inspection to be completed by the fourth quarter of 2013 and its GMP certification process to be completed thereafter.
Jingzhou facility
In 2011, the Company started a facility improvement project to expand veterinary medicine production capacity at the Jingzhou facility. The project includes plant construction and water supply and drainage and has an estimated total cost of $1,711,500, of which $1,208,319 had been incurred as of September 30, 2013. Due to the revision in the project blueprint to comply with GMP requirements, the project was temporarily halted. The Company expects the project will be resumed soon and completed by the end of the second quarter of 2014.
17 | ||
SKYSTAR BIO-PHARMACEUTICAL COMPANY AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2013
(Unaudited)
Note 9 - CONSTRUCTION-IN-PROGRESS (Continued)
Kunshan facility
In 2011, the Company started a supporting project at the Kunshan micro-organism facility that includes the construction and installation of plumbing, sewer, electrical, HVAC, fire protection and alarm system, drainage, office, lab, road construction, parking, and landscaping. As of September 30, 2013, the construction and installation of these facilities were completed, inspected and accepted. However, the construction-in-progress of $5,098,148 has not been transferred to property, plant and equipment as the Kunshan micro-organism facility was not operational at this point. During the third quarter of 2013, the Company contracted with an unrelated third party to purchase machinery and equipment at a total consideration of approximately $7,335,000, of which $3,497,980 was paid and was included in “Long-term prepayments” (note 11) as of September 30, 2013. The Company expects the purchase and installation of these equipment will be completed by the end of the second quarter of 2014.
No depreciation is provided for construction-in-progress until such time as the assets are completed and placed into service.
The construction projects the Company was in the progress of completing are as follows:
Total in CIP | ||||||||||||
as of | ||||||||||||
September 30, | Estimated Cost to | Estimated | Estimated | |||||||||
Project | 2013 | Complete | Total Cost | Completion Date | ||||||||
Xi'an vaccine facility | $ | 2,473,589 | $ | - | $ | 2,473,589 | Fourth quarter of 2013 | |||||
Xi'an animal laboratory | 326,000 | - | 326,000 | Fourth quarter of 2013 | ||||||||
Kunshan micro-organism facility | 5,098,148 | 7,335,000 | 12,433,148 | Construction - completed, Installation of machinery and equipment – Second quarter of 2014 | ||||||||
Jingzhou veterinary medication facility | 1,208,319 | 503,181 | 1,711,500 | Second quarter of 2014 | ||||||||
Total | $ | 9,106,056 | $ | 7,838,181 | $ | 16,944,237 |
As of September 30, 2013 and December 31, 2012, the Company had construction in progress amounting to $9,106,056 and $8,691,360, respectively. No interest expense had been capitalized for construction in progress for the three months and nine months ended September 30, 2013 and 2012 as management determined the amount of capitalized interest would be insignificant.
Note 10 – RESTRICTED CASH
On June 13, 2013, the Company obtained a one year loan of $815,000 (RMB 5,000,000) from Industrial and Commercial Bank of China (ICBC) Songzi Branch. The Company is required to keep 10 % of the loan or $81,500 (RMB 500,000) with the bank as collateral. During the third quarter of 2013, the collateral was reduced to $60,310 (RMB 370,000) (note 14).
Note 11 - LONG-TERM PREPAYMENTS
Long-term prepayments consist of the following:
September 30, 2013 | December 31, 2012 | ||||||
Deposits for equipment purchase and land use rights (note 9) | $ | 3,863,214 | $ | 311,227 | |||
Construction deposits | 387,890 | 377,657 | |||||
Prepayments for R&D project | 365,120 | 355,488 | |||||
Deposits for other | 6,116 | 5,955 | |||||
Long-term prepayments | $ | 4,622,340 | $ | 1,050,327 | |||
Long-term prepayments for acquisitions | $ | 182,560 | $ | 177,744 |
As of September 30, 2013 and December 31, 2012, deposits for potential acquisitions totaled $182,560 and $177,744, respectively, all of which was held by an unrelated third party engaged to facilitate potential acquisition projects.
18 | ||
SKYSTAR BIO-PHARMACEUTICAL COMPANY AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2013
(Unaudited)
Note 12 – INTANGIBLE ASSETS
Intangible assets consist of the following:
September 30, 2013 | December 31, 2012 | ||||||
Land use rights | $ | 4,930,752 | $ | 4,800,677 | |||
Technological know-how | 2,282,000 | 2,221,800 | |||||
Patents | 326,000 | 317,400 | |||||
Total | 7,538,752 | 7,339,877 | |||||
Less: accumulated amortization | (2,261,614) | (2,020,046) | |||||
Intangible assets, net | $ | 5,277,138 | $ | 5,319,831 |
For the three months ended September 30, 2013 and 2012, amortization expense for intangibles assets amounted to $62,018 and $100,019, respectively. For the nine months ended September 30, 2013 and 2012, amortization expense for intangibles assets amounted to $184,496 and $300,589, respectively.
Amortization expense expected for the next five years and thereafter is as follows:
Years ending December 31, | Amount | |||
2013 | $ | 62,278 | ||
2014 | 249,112 | |||
2015 | 249,112 | |||
2016 | 249,112 | |||
2017 | 249,112 | |||
Thereafter | 4,218,412 | |||
Total | $ | 5,277,138 |
As of September 30, 2013 and December 31, 2012, land use rights with a carrying amount of $1,536,847 and $1,199,456, respectively, were pledged against the Company’s short-term loans.
Note 13 – LOANS RECEIVABLE
In November 2010, the Company provided an unsecured non-interest bearing loan to Xi’an Tiantai Investment, Ltd., the Company’s acquisition advisor, in the amount of $190,400 (RMB 1,200,000) for two years from November 26, 2010 through November 25, 2012. On January 1, 2012, the Company changed this loan to an unsecured interest bearing loan at an annual interest rate of 12.0 % for eighteen months from January 1, 2012 to September 30, 2013. On June 28, 2013, the Company extended this loan for another six months from July 1, 2013 to December 31, 2013. On August 13, 2013, the entire loan was repaid.
On April 1, 2012, the Company provided a secured interest bearing loan to Shaanxi Jiali Pharmaceutical Co., Ltd., an unrelated third party, in the amount of $793,500 (RMB 5,000,000) at an annual interest rate of 12.0 % for eight months from April 1, 2012 through November 30, 2012. This loan receivable was secured by an irrecoverable corporate guarantee from Xi’an Lantech Pharmaceutical Co. Ltd., an unrelated third party. On December 1, 2012, the Company extended this loan for another five months from December 1, 2012 to April 30, 2013. On May 8, 2013, the entire loan was repaid.
As of September 30, 2013 and December 31, 2012, the Company had other unsecured non-interest bearing loans in the amount of $Nil and $94,887 respectively, due from the Company’s employees and unrelated third parties.
Interest income earned on these loans amounted to $1,932 and $54,083 for the three months ended September 30, 2013 and 2012, respectively. Interest income earned on these loans amounted to $45,713 and $65,672 for the nine months ended September 30, 2013 and 2012, respectively.
19 | ||
SKYSTAR BIO-PHARMACEUTICAL COMPANY AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2013
(Unaudited)
Note 14 – SHORT-TERM AND LONG-TERM LOANS
Short-term loan
On June 27, 2012, the Company entered into a line of credit agreement with Industrial and Commercial Bank of China (ICBC) Songzi Branch that allows the Company to borrow up to RMB 3,000,000. This line of credit agreement expired on June 18, 2013. The Company withdrew $478,800 (RMB 3,000,000) on July 3, 2012 at an annual interest rate determined by using the People's Bank of China floating benchmark lending rate over the same period plus 30% of that rate. This loan was secured by the Company’s buildings and land use rights in Jingzhou, Hubei Province. On June 18, 2013, the loan was fully repaid.
On August 13, 2012, the Company obtained fifteen six-month loans with Xi'an High-tech Zone Guoxin Microcredit Ltd. for a total amount of RMB 15,000,000 to meet short-term cash needs. Each loan was in the amount of $158,700 (RMB 1,000,000) at an annual interest rate of 22.4 %. These loans were guaranteed by Sida. On February 5, 2013, the loans were fully repaid.
On August 27, 2012, the Company obtained a one year loan with Chang’an Bank for RMB 10,000,000 at an annual interest rate determined by using the People's Bank of China floating benchmark lending rate over the same period plus 30% of that rate. This loan was guaranteed by Xi’an Taixin Investment Guarantee Co., Ltd. For this guarantee, the Company was required to pay RMB 200,000 of fees to Xi’an Taixin Investment Guarantee Co., Ltd. and 12.5 % of the loan or $198,375 (RMB 1,250,000) is required to be kept by Xi’an Taixin Investment Guarantee Co., Ltd. to serve as collateral until the loan is repaid. This loan is also personally guaranteed by the Company’s Chairman and CEO. On August 28, 2013, the loans were fully repaid.
On January 16, 2013, the Company obtained a one year loan with Industrial Bank Co. Ltd. Xi’an branch for $4,890,000 (RMB 30,000,000) at an annual interest rate of 6.6%. This loan is secured by the Company’s land use rights and manufacturing plant located in Huxian County. This loan is also personally guaranteed by the Company’s Chairman and CEO and his wife.
On April 16, 2013, the Company obtained a one year loan from May 27, 2013 to May 26, 2014 with Postal Savings Bank of China Xi’an Branch for $3,260,000 (RMB 20,000,000) at an annual interest rate determined by using the People's Bank of China floating benchmark lending rate over the same period plus 20% of that rate, which was 7.2% at September 30, 2013. This loan is guaranteed by Xi’an Investment and Financing Guarantee Co., Ltd. For this guarantee, the Company is required to pay RMB 360,000 of fees to Xi’an Investment and Financing Guarantee Co., Ltd. and 10% of the loan or $326,000 (RMB 2,000,000) is required to be kept by Xi’an Investment and Financing Guarantee Co., Ltd. to serve as collateral until the loan is repaid. This loan is secured by the Company’s office buildings located in Xi’an, Shaanxi Province and the manufacturing equipment in Huxian County. The Company’s Chairman and CEO, his wife, and two other company’s managers have provided personal guarantees to Xi’an Investment and Financing Guarantee Co., Ltd. for the repayment of the loan.
On June 13, 2013, the Company obtained a one year loan from June 20, 2013 to June 19, 2014 with Industrial and Commercial Bank of China (ICBC) Songzi Branch for $815,000 (RMB 5,000,000) at an annual interest rate determined by using the People's Bank of China floating benchmark lending rate over the same period plus 30% of that rate, which was 7.8% at September 30, 2013. The Company is required to keep 10% of the loan or $81,500 (RMB 500,000) with the bank as collateral (note 10). During the 3rd quarter of 2013, the collateral was reduced to $60,310 (RMB 370,000). This loan is secured by the Company’s buildings and land use rights in Jingzhou, Hubei Province.
On September 10, 2013, the Company entered into a loan agreement with its Chairman and CEO. Under the agreement, the Chairman and CEO obtained a one year personal bank loan from September 12, 2013 to September 11, 2014 with Bank of Beijing of $1,630,000 (RMB 10,000,000) and lent the entire loan proceeds to the Company. The interest and repayment terms of the loan from the Chairman and CEO are identical to those of the personal bank loan. The annual interest rate is determined by using the prime rate over the same period plus 30% of that rate, which was 7.8% at the date that the loan was issued. The Company agrees to bear all the costs and expenses associated with the personal bank loan. The personal bank loan is guaranteed by Xi’an Investment and Financing Guarantee Co., Ltd. For this guarantee, the CEO is required to (i) pay $29,340 (RMB 180,000) of fees to Xi’an Investment and Financing Guarantee Co., Ltd. This cost has been paid and recorded as an expense of the Company for the three and nine months ended September 30, 2013; and (ii) place 10% of the loan or $163,000 (RMB 1,000,000) at Xi’an Investment and Financing Guarantee Co., Ltd. to serve as collateral until the loan is repaid (note 10). The Company had placed such a deposit with Xi’an Investment and Financing Guarantee Co., Ltd. as at September 30, 2013. The personal bank loan is also secured by the Chairman and CEO’s real estate properties and the Company’s office buildings located in Xi’an.
20 | ||
SKYSTAR BIO-PHARMACEUTICAL COMPANY AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2013
(Unaudited)
Note 14 – SHORT-TERM AND LONG-TERM LOANS (Continued)
Outstanding short-term loans consisted of the following:
September 30, 2013 | December 31, 2012 | Interest | |||||||||||||||||
Bank | Amt RMB | Amt USD | Amt RMB | Amt USD | Due Date | Rate | |||||||||||||
ICBC Songzi Branch | - | $ | - | 3,000,000 | $ | 476,100 | 06/18/13 | (1) | |||||||||||
Xi'an High-tech Zone Guoxin Microcredit Ltd. | - | - | 15,000,000 | 2,380,500 | 02/12/13 | 22.40 | % | ||||||||||||
Chang’an Bank | - | - | 10,000,000 | 1,587,000 | 08/26/13 | (1) | |||||||||||||
Industrial Bank Co. Ltd. Xi’an branch | 30,000,000 | 4,890,000 | - | - | 01/15/14 | 6.60 | % | ||||||||||||
Postal Savings Bank of China Xi’an Branch | 20,000,000 | 3,260,000 | - | - | 05/26/14 | (2) | |||||||||||||
ICBC Songzi Branch | 5,000,000 | 815,000 | - | - | 06/19/14 | (1) | |||||||||||||
Related-party Individual – Chairman and CEO | 10,000,000 | 1,630,000 | - | - | 09/11/14 | 7.8 | % | ||||||||||||
Total | 65,000,000 | $ | 10,595,000 | 28,000,000 | $ | 4,443,600 |
(1) | People's Bank of China floating benchmark lending rate over the same period plus 30%, which was 7.8% at September 30, 2013. | |
(2) | People's Bank of China floating benchmark lending rate over the same period plus 20%, which was 7.2% at September 30, 2013. |
Long-term loan
On September 17, 2012, the Company entered into a two-year line of credit agreement with Shaanxi Agricultural Yanta Credit Union that allows the Company to borrow up to RMB 8,000,000. This line of credit agreement expires September 20, 2014. The Company withdrew RMB 8,000,000 on September 26, 2012 at an annual interest rate of 9.446%. The interest rate was determined annually by using the People's Bank of China floating benchmark lending rate over the same period plus the lender’s floating rate. This line of credit was secured by the Company’s office buildings located in Xi’an City. This line of credit was also personally guaranteed by the Company’s Chairman and CEO and his wife. On May 9, 2013, the loans were fully repaid.
Outstanding long-term loan consisted of the following:
September 30, 2013 | December 31, 2012 | Interest | ||||||||||||||||
Bank | Amt RMB | Amt USD | Amt RMB | Amt USD | Due Date | Rate | ||||||||||||
Shaanxi Agricultural Yanta Credit Union | - | - | 8,000,000 | $ | 1,269,600 | 09/20/14 | 9.446 | % |
Interest expense incurred and associated with the short-term and long-term loans amounted to $181,167 and $199,658 for the three months ended September 30, 2013 and 2012, respectively. Interest expense incurred and associated with the short-term and long-term loans amounted to $517,899 and $508,667 for the nine months ended September 30, 2013 and 2012, respectively, none of which has been capitalized as part of construction-in-progress in 2013 and 2012, respectively.
Note 15 - DEFERRED GOVERNMENT GRANT
The subsidies for Good Manufacturing Practice projects were granted by Shaanxi provincial government and Xi’an municipal government which may require the subsidies to be repaid. As of September 30, 2013 and December 31, 2012, the subsidies were RMB 2,500,000, equivalent to $407,500 and $396,750, respectively.
The subsidies granted by Xi’an City Science and Technology Bureau and Xi’an City High-Tech Industrial Development Zone are required to be used exclusively for the fish disease multi associated anti-idiotypic monoclonal antibody vaccine project during the development period from January 2012 through December 2014. As of September 30, 2013 and December 31, 2012, 70% of the subsidies or RMB 4,200,000, equivalent to $684,600 and $666,540 respectively had been received and $489,000 (RMB 3,000,000) and nil has been expensed on this project and were accounted for as an offset against deferred government grant as of September 30, 2013 and December 31, 2012, respectively.
21 | ||
SKYSTAR BIO-PHARMACEUTICAL COMPANY AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2013
(Unaudited)
The interest subsidies granted by Xi’an municipal government are required to be used exclusively for the chicken coccidia vaccine project in third quarter 2013. As of September 30, 2013, the subsidies or RMB 1,200,000, equivalent to $195,600 had been received and nil has been expensed on this project.
Note 16 - CAPITAL TRANSACTIONS
On March 30, 2010, the Company agreed to issue 2,500 shares of common stock to a non-executive director in exchange for services unrelated to his services as a director at the fair market value of $11.74 per share based on the closing price on March 30, 2010. On April 16, 2010, the Company entered into another agreement to grant 10,000 shares of common stock to that director for his one year service from April 1, 2010. The closing price per share on the grant date was $10.61. The common stock compensation vests in four equal quarterly installments of 2,500 shares. Shares owed were accrued at the end of each quarter at the fair market value on the grant date of $10.61 per share. On August 31, 2011, the Company entered into another agreement to grant 36,000 shares of common stock to that director for his one year service from April 1, 2011. The closing price per share on the grant date was $2.58. The common stock compensation vests in four equal quarterly installments of 9,000 shares. Shares owed were accrued at the end of each quarter at the fair market value on the grant date of $2.58 per share. Currently, the Company is working on completing the contract with this director for his service beginning April 1, 2012. As of September 30, 2013 and December 31, 2012, nil shares were to be issued to this non-executive director.
On May 26, 2009, the Company agreed to issue 5,556 shares of common stock to a director at the beginning of each term of his directorship. The trading value of the common stock on May 26, 2009 was $4.50 per share. In accordance with the agreement between the Company and this director, this director must continue to serve as a member of the Board until his successor is duly elected and qualified in order to receive the shares. As of September 30, 2013 and December 31, 2012, 5,556 shares to be issued to this non-executive director were included in the accrued expenses and amounted to $25,002.
On July 29, 2011, the Company entered into a one-year employment agreement with its CFO. Under the agreement, he is entitled to receive an aggregate 8,000 shares of common stock, 4,000 shares of which shall be issuable on the 6 month anniversary and the remaining 4,000 shares of which shall be issuable on the 12 month anniversary. The closing price per share on the grant date was $4.20. On July 29, 2012, the Company entered into another one-year employment agreement with the CFO. Under the agreement, he is entitled to receive an aggregate 8,000 shares of common stock, vested in four equal quarterly installments of 2,000 shares. The closing price per share of the stock on the next business day of the grant date was $2.17. On July 29, 2013, the Company entered into another one-year employment agreement with the CFO. Under the agreement, he is entitled to receive an aggregate 8,000 shares of common stock, vested in four equal quarterly installments of 2,000 shares. The closing price per share of the stock on the grant date was $1.37. The Board of Directors and its Compensation Committee are currently reviewing the terms and extending the CFO’s employment agreement with the Company. As of September 30, 2013 and December 31, 2012, 8,000 shares and 2,000 shares were vested to be issued to this executive amounted to $17,360 and $4,340, respectively.
Equity Compensation Plan
On December 8, 2009, the Company’s board of directors approved a stock incentive plan for officers, directors, employees and consultants entitled the “Skystar Bio-Pharmaceutical Company 2010 Stock Incentive Plan” (the “2010 Plan”). The maximum number of shares that may be issued under the 2010 Plan is 700,000 shares of common stock. The 2010 Plan was approved by the Company’s stockholders on December 31, 2009, and awards may be granted thereunder until December 7, 2019. On May 4, 2012, the Board approved common stock grants in the total amount of 442,881 shares to the Company’s employees and members of the Board of Directors, all of which grants were made pursuant to the terms and provisions of the Plan. As of September 30, 2013 and December 31, 2012, there are 247,119 shares of the Company’s common stock remaining available for future issuance under the Plan.
A summary of changes in the Company’s non-vested shares for the three months follows:
Non-vested Shares | ||||
Non-vested at January 1, 2013 | 6,000 | |||
Granted | 8,000 | |||
Vested | (6,000) | |||
Forfeited | - | |||
Non-vested at September 30, 2013 | 8,000 |
As of September 30, 2013, there was $9,053 of total unrecognized compensation cost related to non-vested shares granted. The total fair value of shares vested during the three months ended September 30, 2013 and 2012 was $4,340 and $Nil, respectively, based on the closing price of the Company’s common stock on the grant date. The total fair value of shares vested during the nine months ended September 30, 2013 and 2012 was $13,020 and $40,020, respectively, based on the closing price of the Company’s common stock on the grant date.
22 | ||
SKYSTAR BIO-PHARMACEUTICAL COMPANY AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2013
(Unaudited)
Note 16 - CAPITAL TRANSACTIONS (Continued)
Purchase Options
In connection with the 2009 equity offering, the Company granted 140,000 common stock purchase options to five designees of the Underwriters with a vesting date of June 30, 2010. The options are exercisable from June 30, 2010 to June 30, 2014, and each option is exercisable for one share of the Company’s common stock at an exercise price at $8.11 per share. All options were provided for services performed. As of September 30, 2013 and December 31, 2012, 140,000 common stock purchase options remained outstanding.
Outstanding purchase options do not trade in an active securities market, and as such, the Company estimates the fair value of these warrants and purchase options using the Black-Scholes Option Pricing Model (“Black-Scholes Model”) using the following assumptions:
Purchase Options – (1) | |||||||||
September 30, 2013 | December 31, 2012 | ||||||||
Stock price | $ | 5.85 | $ | 1.60 | |||||
Exercise price | $ | 8.11 | $ | 8.11 | |||||
Annual dividend yield | - | - | |||||||
Expected term (years) | 0.75 | 1.50 | |||||||
Risk-free interest rate | 0.10 | % | 0.16 | % | |||||
Expected volatility | 105 | % | 73 | % |
(1) | As of September 30, 2013 and December 31, 2012, 140,000 purchase options with an exercise price of $8.11 were outstanding. |
Expected volatility is based on historical volatility. Historical volatility was computed using daily pricing observations for recent periods that correspond to the term of the warrants. The Company believes this method produces an estimate that is representative of future volatility over the expected term of these warrants and purchase options. The Company has no reason to believe future volatility over the expected remaining life of these warrants and purchase options is likely to differ materially from historical volatility. The expected life is based on the remaining term of the warrants and purchase options. The risk-free interest rate is based on U.S. Treasury securities according to the remaining term of the warrants and purchase options.
As required by the FASB’s accounting standards, financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. Depending on the nature and the terms of the transaction, the fair values of the warrant/purchase option liability were modeled using a series of techniques, including closed-form analytic formula, such as the Black-Scholes Model, which does not entail material subjectivity because the methodology employed does not necessitate significant judgment, and the pricing inputs are observed from actively quoted markets.
The fair value of the 140,000 purchase options outstanding as of September 30, 2013 and December 31, 2012 was determined using the Black-Scholes Model, utilizing level 2 inputs, and the change was recorded in earnings. The Company recognized a loss of $205,758 and a gain of $7,000 from the change in fair value of derivative liability for the three months ended September 30, 2013 and 2012, respectively. The Company recognized a loss of $200,158 and a gain of $29,400 from the change in fair value of derivative liability for the nine months ended September 30, 2013 and 2012, respectively.
Following is an activity summary of the Company’s outstanding purchase options:
Weighted-average | ||||||||||
Number of | Weighted – | remaining | ||||||||
purchase | average | contractual term | ||||||||
options | exercise price | (Year) | ||||||||
Outstanding at January 1, 2013 | 140,000 | $ | 8.11 | 1.50 | ||||||
Granted | - | - | ||||||||
Forfeited | - | - | ||||||||
Exercised | - | - | ||||||||
Outstanding at September 30, 2013 | 140,000 | $ | 8.11 | 0.75 | ||||||
Exercisable at September 30, 2013 | 140,000 | $ | 8.11 | 0.75 |
23 | ||
SKYSTAR BIO-PHARMACEUTICAL COMPANY AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2013
(Unaudited)
Note 17 - STATUTORY RESERVES
Statutory reserves represent restricted retained earnings. Based on the legal formation of the entities, all PRC entities are required to set aside 10 % of net income as reported in their statutory accounts on an annual basis to the statutory surplus reserve fund. Once the total statutory surplus reserve reaches 50 % of the entity’s registered capital, further appropriations are discretionary. The statutory surplus reserve can be used to increase the entity’s registered capital (upon approval by relevant government authorities) and eliminate its future losses under PRC regulatory requirements (upon a resolution by the board of directors). The statutory surplus reserve is not distributable to shareholders except in the event of liquidation.
Appropriations to the above statutory reserves are accounted for as a transfer from unrestricted earnings to statutory reserves. There are no legal requirements in the PRC to fund these statutory reserves by the transfer of cash to any restricted accounts, and as such, the Company has not transferred any cash to these accounts. These reserves are not distributable as cash dividends.
Note 18 – TAXES
Skystar is subject to United States federal income tax. Skystar Cayman is a tax-exempt company incorporated in the Cayman Islands. Fortune Time did not have any assessable profits arising in or derived from Hong Kong for the three and nine months ended September 30, 2013 and 2012, and accordingly no provision for Hong Kong profits tax was made in these periods.
The Company’s subsidiaries and VIEs are subject to the PRC’s Enterprise Income Tax. Pursuant to the PRC Income Tax Laws, Enterprise Income Tax is generally imposed at a statutory rate of 25 %. Xi’an Tianxing has been approved as a new technology enterprise, and under PRC Income Tax Laws is entitled to a preferential tax rate of 15 %.
The following table reconciles the U.S. statutory rates to the Company’s effective tax rate for the three and nine months ended September 30, 2013 and 2012:
For the three months ended | For the nine months ended | ||||||||||||||||
September 30, | September 30, | ||||||||||||||||
2013 | 2012 | 2013 | 2012 | ||||||||||||||
U.S. Statutory rate | 34.0 | % | 34.0 | % | 34.0 | % | 34.0 | % | |||||||||
Foreign income not recognized in the U.S. | (34.0) | (34.0) | (34.0) | (34.0) | |||||||||||||
China income tax rate | 25.0 | 25.0 | 25.0 | 25.0 | |||||||||||||
China income tax exemption | (10.0) | (10.0) | (10.0) | (10.0) | |||||||||||||
Stock-based compensation | - | - | - | 1.9 | |||||||||||||
Other item (1) | 2.3 | 5.8 | 3.0 | 4.9 | |||||||||||||
Total provision for income taxes | 17.3 | % | 20.8 | % | 18.0 | % | 21.8 | % |
(1) | Other items are primarily for operating expenses (income) incurred by Skystar that are not deductible (taxable) in the PRC, expenses incurred by other subsidiaries that are not deductible on the consolidated level, the difference of taxable income under US GAAP rather than Chinese GAAP, and the difference of Enterprise Income Tax imposed at a statutory rate of 25% rather than preferential tax rate of 15% on the income from the subsidiaries other than Xi’an Tianxing, which resulted in an increase in the effective tax rate of 2.3% and 5.8% for the three months ended September 30, 2013 and 2012, respectively, and an increase in the effective tax rate of 3.0% and 4.9% for the nine months ended September 30, 2013 and 2012, respectively. |
Other items consisted of the following:
For the three months ended September 30, | For the nine months ended September 30, | ||||||||||||||||
2013 | 2012 | 2013 | 2012 | ||||||||||||||
Income taxed at Chinese statutory rate of 25% | (0.5) | % | 3.6 | % | (0.2) | % | 1.7 | % | |||||||||
Valuation allowance on tax loss | 1.4 | 0.9 | 1.6 | 1.4 | |||||||||||||
Non-deductible operating expenses | 1.4 | 1.3 | 1.6 | 1.8 | |||||||||||||
Total other items | 2.3 | % | 5.8 | % | 3.0 | % | 4.9 | % |
24 | ||
SKYSTAR BIO-PHARMACEUTICAL COMPANY AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2013
(Unaudited)
Note 18 – TAXES (Continued)
Taxes payable consisted of the following:
September 30, 2013 | December 31, 2012 | ||||||
Income taxes | $ | 821,772 | $ | 279,680 | |||
Value added taxes | 3,788,607 | 1,409,762 | |||||
Other taxes | 363,023 | 261,315 | |||||
Total | $ | 4,973,402 | $ | 1,950,757 |
As of September 30, 2013 and December 31, 2012, the estimated net operating loss carry forwards of Skystar for U.S. income tax purposes amounted to $5,011,754 and $4,711,862, which may be available to reduce future years’ taxable income. These carry forwards will expire, if not utilized, beginning in 2027 and through 2031. As of September 30, 2013 and December 31, 2012, the estimated net operating loss carry forwards of Skystar for PRC income tax purposes amounted to $4,557,142 and $3,467,227, which may be available to reduce future years’ taxable income. These carry forwards will expire, if not utilized, beginning in 2013 and through 2018. Management believes that the realization of the arising from this loss appears to be uncertain due to the Company’s limited operating history and continuing losses for U.S. income tax purposes. Accordingly, the Company has provided a 100% valuation allowance at September 30, 2013 and December 31, 2012. As of September 30, 2013 and December 31, 2012, the valuation allowance on tax loss of Skystar was $1,703,996 and $1,602,033, respectively, and that of PRC subsidiaries was $1,139,285 and $866,807. The Company’s management reviews this valuation allowance periodically and makes adjustments as necessary. As of September 30, 2013, the Company had deferred tax assets amounting to $343,922 in respect of accrued expenses of $87,740 and allowance on doubtful accounts of $256,182. As of December 31, 2012, the Company had no other deferred tax amounts.
The Company did not provide for deferred income taxes and foreign withholding taxes on the cumulative undistributed earnings of foreign subsidiaries as of September 30, 2013 and December 31, 2012 of approximately $46.1 million and $35.6 million, respectively. The cumulative undistributed earnings of foreign subsidiaries were included in consolidated retained earnings and will continue to be indefinitely reinvested in international operations. Accordingly, no provision has been made for U.S. deferred taxes or applicable withholding taxes, related to future repatriation of these earnings, nor is it practicable to estimate the amount of income taxes that would have to be provided if management concluded that such earnings will be remitted in the future.
Note 19 - EARNINGS PER SHARE
The following is the calculation of earnings per share:
For the three months ended September 30, | For the nine months ended September 30, | ||||||||||||
2013 | 2012 | 2013 | 2012 | ||||||||||
Net income | $ | 3,734,197 | $ | 2,731,254 | $ | 8,197,811 | $ | 6,334,874 | |||||
Weighted average shares used in basic and diluted computation | 7,617,726 | 7,604,800 | 7,615,733 | 7,426,082 | |||||||||
Earnings per share: | |||||||||||||
Basic | $ | 0.49 | $ | 0.36 | $ | 1.08 | $ | 0.85 | |||||
Diluted | $ | 0.49 | $ | 0.36 | $ | 1.08 | $ | 0.85 |
For the three and nine months ended September 30, 2013 and 2012, the outstanding 140,000 options were excluded from the diluted earnings per share calculation as they are anti-dilutive as the average stock price was less than the exercise prices of the options.
For the three and nine months ended September 30, 2013 and 2012, the outstanding 8,000 non-vested shares were excluded from the diluted earnings per share calculation as they were anti-dilutive.
25 | ||
SKYSTAR BIO-PHARMACEUTICAL COMPANY AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2013
(Unaudited)
Note 20 - RELATED PARTY TRANSACTIONS AND ARRANGEMENTS
Amounts payable to related parties are summarized as follows:
September 30, | December 31, | ||||||
2013 | 2012 | ||||||
Shares to be issued to related parties (Note 16) | |||||||
Mark D. Chen – non-executive director and shareholder | $ | 25,002 | $ | 25,002 | |||
Bing Mei – CFO | 13,020 | 4,340 | |||||
Total (included in other payables and accruals) | $ | 38,022 | $ | 29,342 | |||
Amounts due to related parties | |||||||
Weibing Lu – CEO (1) | $ | 1,260,672 | $ | 608,282 | |||
Scott Cramer – non-executive director and shareholder (2) | 285,780 | 138,169 | |||||
Officers, shareholders and other related parties (3) | 195,368 | 52,474 | |||||
Total | $ | 1,741,820 | $ | 798,925 |
(1) As of September 30, 2013 and December 31, 2012, the Company had unpaid reimbursement, compensation, and advances due to Mr. Weibing Lu, the Company’s Chairman and CEO, valued at $1,260,672 and $608,282, respectively.
(2) As of September 30, 2013 and December 31, 2012, the Company had unpaid reimbursement and compensation due to Mr. Scott Cramer valued at $285,780 and $138,169, respectively.
(3) The amounts due to officers, shareholders and other related parties at September 30, 2013 and December 31, 2012 include unpaid reimbursement and compensation and, advances to other related parties for business expenses.
Amounts due to related parties are unsecured and interest free.
Also refer to Notes 14, 16 and 21 for other related party transactions and arrangements.
26 | ||
SKYSTAR BIO-PHARMACEUTICAL COMPANY AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2013
(Unaudited)
Note 21 - COMMITMENTS AND CONTINGENCIES
(a) Lease commitments
The Company recognizes lease expense on the straight-line basis over the term of the lease.
The Company entered into a tenancy agreement for the lease of factory premises of Xi’an Tianxing in Sanqiao for a period of ten years from October 1, 2004 to December 31, 2014. The annual rent for the factory premises is subject to a 10% increase every two years starting October 1, 2009. As of September 30, 2013, the annual rent for the factory premises was approximately $20,799 (RMB 127,600).
The Company leased office space in Xi’an from Mr. Weibing Lu, the Company’s Chairman and CEO, for a period of five years from January 1, 2007 to December 31, 2011 , with an annual rent of approximately $26,993 (RMB 165,600). In January 2012, the Company renewed the lease with Mr. Lu for another 5 years from January 1, 2012 to December 31, 2016 at a rent of approximately $29,340 (RMB 180,000) per year.
The Company also entered into a tenancy agreement with Mr. Weibing Lu for the lease of Shanghai Siqiang’s office in Shanghai for a period of ten years from August 1, 2007 to August 1, 2017 with an annual rent of approximately $23,472 (RMB 144,000).
The Company entered into a one year tenancy agreement for an office lease in Kunshan, Jiangsu Province from April 15, 2011 to April 14, 2012 with an annual rent of approximately $3,130 (RMB 19,200). On April 15, 2012, the Company entered into a six-month tenancy agreement for this office from April 15, 2012 to October 14, 2012 with six-month rent of approximately $ 1,696 (RMB 10,405). On October 15, 2012, the Company entered into a another six-month tenancy agreement for this office from October 15, 2012 to April 14, 2013 with a six-month rent of approximately $1,696 (RMB 10,405 ). On April 15, 2013, the Company entered into a another one-year tenancy agreement for this office from April 15, 2013 to April 14, 2014 with a one-year rent of approximately $3,836 (RMB 23,536 ).
The Company entered into a tenancy agreement for the lease of warehouse premises in Xi’an for a period of three years from July 20, 2011 to July 19, 2014 with an annual rent of approximately $38,305 (RMB 235,000) subject to a 10% increase every two years starting July 20, 2013. As of September 30, 2013, the annual rent for the warehouse premises was approximately $42,136 (RMB 258,500).
The minimum future lease payments for the next five years and thereafter are as follows:
Unrelated third | ||||||||||
Period | parties | Related parties | Total | |||||||
Year ending December 31, 2013 | $ | 17,683 | $ | 13,203 | $ | 30,886 | ||||
Year ending December 31, 2014 | 43,331 | 52,812 | 96,143 | |||||||
Year ending December 31, 2015 | - | 52,812 | 52,812 | |||||||
Year ending December 31, 2016 | - | 52,812 | 52,812 | |||||||
Year ending December 31, 2017 and thereafter | - | 13,692 | 13,692 | |||||||
Total | $ | 61,014 | $ | 185,331 | $ | 246,345 |
Rental expense to unrelated third parties for the three months ended September 30, 2013 and 2012 amounted to $15,570 and $15,337, respectively. Rental expense to unrelated third parties for the nine months ended September 30, 2013 and 2012 amounted to $46,569 and $45,890, respectively.
Rental expense to related parties for the three months ended September 30, 2013 and 2012 amounted to $13,038 and $12,840, respectively. Rental expense to related parties for the nine months ended September 30, 2013 and 2012 amounted to $39,113 and $38,552, respectively.
27 | ||
SKYSTAR BIO-PHARMACEUTICAL COMPANY AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2013
(Unaudited)
Note 21 - COMMITMENTS AND CONTINGENCIES (Continued)
(b) Legal proceedings
From time to time, the Company is involved in legal matters arising in the ordinary course of business. Management currently is not aware of any legal matters or pending litigation that would have a significant effect on the Company’s consolidated financial statements as of September 30, 2013.
In May 2007, Andrew Chien filed suit against the Company, R. Scott Cramer, Steve Lowe, David Wassung and Weibing Lu in United States District Court for the District of Connecticut, alleging causes of action for violation of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934. On July 17, 2008, in a decision that is now published, the court granted defendants’ motion to dismiss and subsequently dismissed the lawsuit, entering judgment on behalf of the defendants. Chien appealed the dismissal. Defendants filed a post judgment motion for sanctions against Chien. On February 5, 2009, the court found the action filed by Chien to have been frivolous, and to have constituted a “substantial” violation of Rule 11, and imposed monetary sanctions on both Chien and his former attorney. Chien appealed the award of sanctions. All appeals, including the one referenced below concerning Chien’s second lawsuit, were subsequently consolidated. The Court of Appeals issued a Mandate upholding the decision granting defendant’s motion to dismiss and found that the District Court did not “abuse its discretion” in issuing sanctions against Chien in light of the circumstances and facts on record. This Mandate was entered on or about November 8, 2010.
Andrew Chien, proceeding pro se (i.e., he represented himself without an attorney), filed his second lawsuit against the Company, R. Scott Cramer, Steve Lowe, David Wassung and Weibing Lu in Connecticut Superior Court (which was removed to U.S. District Court) alleging causes of action similar to those alleged in his federal complaint described above as well as state law causes of action. The court held that all claims asserted against the defendants were barred and failed to state a claim on a multiplicity of grounds, including on the basis of res judicata. Defendants filed a second Motion for Sanctions under Rule 11 and the PSLRA, which was granted. Chien appealed the dismissal. The Court of Appeals for the Second Circuit consolidated all of Chien’s appeals from both of his lawsuits. On November 8, 2010, the Court of Appeals affirmed the dismissals and the awards of sanctions. On January 22, 2011, Chien filed a petition with the Supreme Court of the United States, appealing the lower court’s ruling. The Supreme Court denied review of the petition.
Andrew Chien, again proceeding pro se, commenced his third lawsuit against the Company, Scott Cramer, Steve Lowe, David Wassung, Weibing Lu (and also Weinberg & Company, P.A., Moore Stephens Wirth Frazer & Torbet, LLP, Frazer Frost, LLP, Crowe Horwath LLP, Richardson & Patel LLP, Kevin K. Leung, Harvey Kesner, and Jody M. Borrelli) alleging the same facts and circumstances as set forth in the above two matters, although adding the aforementioned accountants and lawyers as defendants to the claims. The matter commenced on August 8, 2011, and shortly thereafter was removed to U.S. District Court. On October 5, 2011, the court dismissed the entire action as to all defendants. As in the two previous lawsuits, sanctions were issued against Chien. Moreover, the District Court issued an order prohibiting Chien from filing any more lawsuits against the defedentants without prior approval from the court. Chien appealed the Court’s ruling to the United States Court of Appeals for the Second Circuit, where all defendants have filed motions to dismiss.
The United States Court of Appeals for the Second Circuit recently affirmed the judgments and orders of the United States District Court and dismissed all of Mr. Chien’s pending appeals.
Although the Second Circuit declined to issue sanctions against Chien, it expressly warned Chien “that the continued filing of duplicative, vexatious, or frivolous appeals regarding issues already resolved by this Court may result in the imposition of sanctions, including a leave-to-file sanction requiring Chien to obtain permission from this Court prior to filing further submissions in this Court.” Mr. Chien has filed a petition for writs of certiorari with the Supreme Court of the United States. The Supreme Court has not yet acted on Chien’s petitions.
(c) Ownership of leasehold property
In 2005, a shareholder contributed a leasehold office building as additional capital of Xi’an Tianxing. However, as of September 30, 2013, title of this leasehold property, with a carrying amount of $361,860 (RMB 2,220,000), has not passed to the Company. The Company does not believe there are any legal barriers for the shareholder to transfer the ownership to the Company. However, in the event that the Company fails to obtain the ownership certificate for the leasehold property, there is a risk that we may be required to vacate the building. Management believes that this possibility is remote, and, as such, no provision has been made in the consolidated financial statements for this potential occurrence.
28 | ||
SKYSTAR BIO-PHARMACEUTICAL COMPANY AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2013
(Unaudited)
Note 21 - COMMITMENTS AND CONTINGENCIES (Continued)
(d) R&D project
In 2008, Xi’an Tianxing contracted with Northwestern Agricultural Technology University to work jointly on an R&D project concerning the application of nano-technology in the prevention of major milk cow disease. The total projected budget for this project is approximately $652,000 (RMB 4,000,000), which is to be paid according to completed stages of the project. The project reached trial stage in September 2009. As of September 30, 2013, the Company incurred approximately $570,500 (RMB 3,500,000) of cumulative expenses relating to this project.
In 2009, Xi’an Tianxing contracted with the Fourth Military Medical University to jointly work on an R&D project on fish diseases linked immunosorbent detection kit and fish diseases multi-linked monoclonal antibody therapeutic agents. The contracted amount for this project is approximated $978,000 (RMB 6,000,000). As of September 30, 2013, the Company has incurred approximately $847,600 (RMB 5,200,000) of cumulative expenses relating to this project.
During the first quarter of 2011, Xi’an Tianxing contracted with the Fourth Military Medical University to jointly work on an R&D project to develop new treatment and diagnosis method for Mycoplasmal pneumonia of swine. The project term is from January 2011 through September 2013. The cost to the Company for the initial phase is approximately $326,000 (RMB 2,000,000). As of September 30, 2013, the Company has incurred approximately $244,500 (RMB 1,500,000).
During the second quarter of 2012, Xi’an Tianxing contracted with the Fourth Military Medical University to jointly work on an R&D project of ring disease and pseudo-rabies specific transfer factor and blue-ear disease and Mycoplasma pneumoniae disease specific transfer factor to enhance the livestock and poultry's own immuneforce and prevent the onset of conventional disease. The project term is from April 2012 through March 2013. As of September 30, 2013, the project was completed and the Company incurred expenses of $50,530 (RMB 310,000).
During the fourth quarter of 2012, Xi’an Tianxing launched eight in-house R&D projects as set forth in the following table. As of September 30, 2013, the Company incurred all the budget expenses and these projects were still under development.
During the second quarter of 2013, Xi’an Tianxing launched an R&D project to develop monoclonal antibody vaccine to prevent common fish skin disease. The cost to the Company for this project is approximately $570,500 (RMB 3,500,000). As of September 30, 2013, the Company has incurred $489,000 (RMB 3,000,000) and this project is still under development.
During the third quarter of 2013, Xi’an Tianxing launched an R&D project to develop livestock and avian disease multi-joint yolk antibody therapeutic agents and contracted with Lantian County Chicken Farm to test the effect of its developed agents. The project is expected to be completed by the end of 2014. The total projected budget for this project is approximately $717,200 (RMB 4,400,000). As of September 30, 2013, the Company has incurred $326,000 (RMB 2,000,000) and this project is still under development.
In addition, the Company also launched various R&D projects on veterinary products formula adjustment, pet drug development and fermentation engineering design and development, and lab tests. As of September 30, 2013, $1,127,359 (RMB 6,916,311) has been incurred related to these projects and lab tests.
29 | ||
SKYSTAR BIO-PHARMACEUTICAL COMPANY AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2013
(Unaudited)
Note 21 - COMMITMENTS AND CONTINGENCIES (Continued)
(d) R&D project (Continued)
R&D projects are summarized as follows:
Amount | Amount | Total amount | ||||||||
incurred as | expected to be | of | ||||||||
Project | of 09/30/2013 | incurred | project | |||||||
Project with Northwestern Agricultural Technology University | ||||||||||
Application of nano-technology in the prevention of major milk cow disease | $ | 570,500 | $ | 81,500 | $ | 652,000 | ||||
Project with the Fourth Military Medical University | ||||||||||
Fish diseases linked immunosorbent detection kit and fish diseases multi-linked monoclonal antibody therapeutic agents | 847,600 | 130,400 | 978,000 | |||||||
New treatment and diagnosis method for Mycoplasmal pneumonia of swine | 244,500 | 81,500 | 326,000 | |||||||
Transfer factor test | 50,530 | - | 50,530 | |||||||
In-house R&D projects in 2012 | ||||||||||
Oral liquid products R&D and field trials | 163,000 | - | 163,000 | |||||||
Powder for injection products R&D and field trials | 163,000 | - | 163,000 | |||||||
Vitamin E injection product development | 81,500 | - | 81,500 | |||||||
Anthelmintic product development | 81,500 | - | 81,500 | |||||||
Three disease grams product development | 81,500 | - | 81,500 | |||||||
Premixes class product development | 81,500 | - | 81,500 | |||||||
Bulk powder products development | 81,500 | - | 81,500 | |||||||
Livestock and fish diseases immunoassay kit development | 407,500 | - | 407,500 | |||||||
In-house R&D projects in 2013 | ||||||||||
Fish monoclonal antibody vaccine | 489,000 | 81,500 | 570,500 | |||||||
Livestock and avian disease multi-joint yolk antibody therapeutic agents | 326,000 | 391,200 | 717,200 | |||||||
Other projects for veterinary products formula adjustment, pet drug development and fermentation engineering design and development and lab tests | 1,127,359 | 16,300 | 1,143,659 | |||||||
Total | $ | 4,796,489 | $ | 782,400 | $ | 5,578,889 |
All payments made for R&D projects have been expensed as incurred.
(e) Registered capital commitment
Skystar Kunshan’s remaining registered capital of $12,750,000 was originally required to be invested by May 7, 2012. On July 25, 2012, the Company received the approval of extension for payment of the remaining registered capital but a new due date has not been specified by the government.
(f) Capital commitment
The Company’s commitments for capital expenditure as of September 30, 2013 are as follows:
Contracted but not accrued for: | ||||
Purchase of machinery and construction (Note 9) | $ | 4,340,201 |
30 | ||
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
Overview
We were incorporated in Nevada on September 24, 1998. We are a holding company that, through our wholly owned subsidiaries in China, including Skystar Bio Technology (Jingzhou) Co. (“Skystar Jingzhou”), and a variable interest entity (“VIE”), Xi’an Tianxing Bio-Pharmaceutical Co., Ltd. (“Xi’an Tianxing”), researches, develops, manufactures, and distributes veterinary health care and medical care products in the People’s Republic of China (“PRC”).
All of our operations are carried out by our subsidiaries in China and Xi’an Tianxing, which the Company controls through contractual arrangements between Xi’an Tianxing and Sida Biotechnology (Xi’an) Co., Ltd. (“Sida”), the wholly owned subsidiary of Fortunate Time International Limited, the wholly owned subsidiary of Skystar Bio-Pharmaceutical (Cayman) Holdings Co., Ltd. (“Skystar Cayman”), which became our wholly owned subsidiary in 2005. Such contractual arrangements are necessary to comply with PRC laws limiting foreign ownership of certain companies. Through these contractual arrangements, we have the ability to substantially influence Xi’an Tianxing’s daily operations and financial affairs, appoint its senior executives, and approve all matters requiring shareholder approval. As a result of these contractual arrangements, which enable us to control Xi’an Tianxing, we are considered the primary beneficiary of Xi’an Tianxing.
In addition to Xi’an Tianxing, Skystar Jingzhou also manufactures and distributes veterinary medicines, including aquaculture medicines in China. Skystar Jingzhou is a wholly owned subsidiary of the Company’s Sida entity. It was formed with the August 2010 acquisition of a veterinary medicine manufacturing facility in Hubei Province, China.
On August 21, 2007, Xi’an Tianxing invested $81,000 (RMB 500,000) to establish Shanghai Siqiang Biotechnological Company Limited (‘Shanghai Siqiang’). Xi’an Tianxing is the 100% shareholder. Shanghai Siqiang serves as a research and development center for Xi’an Tianxing to engage in research, development, production and sales of feed additives and veterinary disease diagnosis equipments.
Our financial statements are prepared in U.S. Dollars and in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”). See “Exchange Rates” below for information regarding the exchanges rates at which Renminbi (“RMB”) were translated into U.S. Dollars (“USD”) at various pertinent dates and for pertinent periods.
Critical Accounting Policies
In preparing the consolidated financial statements in accordance with U.S. GAAP, we make estimates and assumptions about the effect of matters that are inherently uncertain and may change in subsequent periods. The resulting accounting estimates will, by definition, vary from the related actual results. We consider the following to be the most critical accounting policies:
Principles of consolidation
The accompanying consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America. The consolidated financial statements include the financial statements of our company, our wholly-owned subsidiaries, and our VIEs. All significant inter-company transactions and balances between our company, its subsidiaries, and its VIEs have been eliminated in consolidation.
We have evaluated the relationship with Xi’an Tianxing and Xi’an Tianxing’s wholly owned subsidiaries, Xi’an Sikaida and Shanghai Siqiang. As a result of the contractual arrangements which obligate Sida to absorb all of the risk of loss from Xi’an Tianxing’s activities and enable Sida to receive all of its expected residual returns, the Company accounts for Xi’an Tianxing, Xi’an Sikaida and Shanghai Siqiang as VIEs under the Financial Accounting Standards Board’s (“FASB”) interpretation on consolidation of variable interest entities. Accordingly, the Company consolidates the results, assets, and liabilities of Xi’an Tianxing, Xi’an Sikaida and Shanghai Siqiang.
Revenue recognition
Our revenue is primarily from the sales of veterinary healthcare and medical care products in China. Sales are recognized when the following four revenue criteria are met: persuasive evidence of an arrangement exists, delivery has occurred, the selling price is fixed or determinable, and collectability is reasonably assured. Sales are presented net of value added tax (“VAT”). No estimated allowance for sales returns is reflected in these consolidated financial statements as sales returns are de minimus based on historical experience.
There are two types of sales upon which revenue is recognized:
a. | Credit sales: revenue is recognized when the products have been delivered to the customers. |
b. | Full payment before delivering: revenue is recognized when the products have been delivered to the customers. |
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Accounts receivable
Accounts receivable is stated at cost less an allowance for uncollectible accounts, as needed. We use the aging method to estimate the allowance for anticipated uncollectible receivable balances. Under the aging method, a bad debt percentage determined by management, based on historical experience and current economic climate, is applied to customers’ balances categorized by the number of months the underlying invoices have remained outstanding. At each reporting period, the allowance balance is adjusted to reflect the amount computed as a result of the aging method. When facts subsequently become available to indicate that the allowance provided requires an adjustment, a corresponding adjustment is made to the allowance account as a change in estimate. The ultimate collection of our accounts receivable may take one year. Delinquent account balances are reserved after management determines that the likelihood of collection is not probable, and known bad debts are written-off against the allowance for doubtful accounts when identified.
Stock based compensation
We record and report stock-based compensation by measuring the cost of services received in exchange for an award of equity instruments based on the grant-date fair value of the award. That cost is recognized over the period during which services are received. Stock compensation for stock granted to non-employees is determined as the fair value of the consideration received or the fair value of equity instruments issued, whichever is more reliably measured.
Recently Issued Accounting Pronouncements
See Item 1 of Part I, “Notes to the Condensed Consolidated Financial Statements — Note 2 – Summary of Significant Accounting Policies — Recently Issued Accounting Pronouncements.”
Results of Operations – Three Months ended September 30, 2013 and 2012
The following table summarizes our results of operations for the three months ended September 30, 2013 and 2012.
Three Months Ended September 30, | |||||||||||||||
2013 | 2012 | ||||||||||||||
% of | % of | ||||||||||||||
Amount | total revenue | Amount | total revenue | ||||||||||||
Revenue | $ | 15,992,408 | 100.0 | % | $ | 8,933,005 | 100.0 | % | |||||||
Gross Profit | $ | 8,213,717 | 51.4 | % | $ | 5,262,775 | 58.9 | % | |||||||
Operating Expenses | $ | 3,476,016 | 21.7 | % | $ | 1,621,386 | 18.1 | % | |||||||
Income from Operations | $ | 4,737,701 | 29.6 | % | $ | 3,641,389 | 40.8 | % | |||||||
Other Income (Expense) | $ | (221,527) | (1.4) | % | $ | (192,972) | (2.2) | % | |||||||
Income Tax Expenses | $ | 781,977 | 4.9 | % | $ | 717,163 | 8.0 | % | |||||||
Net Income | $ | 3,734,197 | 23.3 | % | $ | 2,731,254 | 30.6 | % |
Revenues. All of our revenues are derived from the sale of veterinary healthcare and medical care products in the PRC. For the three months ended September 30, 2013, we had revenues of $15,992,408 as compared to revenues of $8,933,005 for the three months ended September 30, 2012, an increase of $7,059,403 or 79.0%. We generate revenue from sales of four product lines: veterinary medications, micro-organism, feed additives, and vaccines. The selling prices of our products decreased 1.8% on average in the three months ended September 30, 2013 compared to the same period of 2012. The increase in revenue was primarily due to the increase of sales volume.
Revenue — Veterinary Medications. Revenue from sales of our veterinary medications increased by $8,047,125 or 451.8%, from $1,781,306 for the three months ended September 30, 2012 to $9,828,431 for the three months ended September 30, 2013. This increase was primarily as a result of resumed veterinary medication production at the Huxian facility and third quarter is traditionally the high season for veterinary drug business in China. Following the renewal of our GMP certificate and the resumption of production at Huxian facility, we shifted our sales focus back to our veterinary medications product line and increased our marketing and sales efforts to strengthen customer relationships and recruit new customers. We have two veterinary medication plants located in Huxian and Jingzhou, with Huxian historically being our main facility. Of the total revenues from veterinary medications during the three months ended September 30, 2013, approximately 85.9% of total revenue resulted from the sale of products from the Huxian facility. The revenue from sales of veterinary medication products was the largest revenue contributor for the entire company and contributed 61.5% of total revenue during the three months ended September 30, 2013. The selling prices of our veterinary medication products for the three months ended September 30, 2013 decreased approximately 2.9% on average from last year due to the change in product mix. The increase in revenue was primarily due to the increase of sales volume.
Revenue — Micro-Organism. Revenue from sales of our micro-organism products increased slightly by $24,519 or 0.5% from $4,922,168 for the three months ended September 30, 2012 to $4,946,687 for the three months ended September 30, 2013..
32 | ||
Revenue — Feed Additives. Revenue from sales of our feed additives product line decreased by $579,481 or 48.7% from $1,189,563 for the three months ended September 30, 2012 to $610,082 for the three months ended September 30, 2013. The decrease was primarily the result of our limited sales resources for the feed additive products this year. Last year, due to the temporary suspension of veterinary medication production at Huxian facility for its GMP recertification, we were able to temporarily shift some veterinary medication sales forces to the feed additive product line resulting in significantly increased feed additive sales last year. Currently, we have a feed additive plant located in Sanqiao. The selling prices of our feed additives products for the three months ended September 30, 2013 have not materially changed on average from last year. The decrease in revenue was primarily due to the decrease of sales volume.
Revenue — Vaccines. Revenue from sales of our vaccines decreased by $432,760 or 41.6% from $1,039,968 for the three months ended September 30, 2012 to $607,208 for the three months ended September 30, 2013. The decrease was primarily the result of our limited sales resources for vaccine products this year. We completed the construction of a new vaccine facility at our Huxian plant in 2010. On September 20 and 21, 2012, MOA physically inspected this new facility and deemed the facility GMP compliant. Following physical inspection, the MOA’s inspection team recommended that the Office of the Working Committee proceed with Stage 2 of its GMP certification process. The Company expects the Stage 2 GMP inspection to be completed by the fourth quarter of 2013 and the facility is GMP certified and commences production shortly thereafter. The selling prices of our vaccine products for the three months ended September 30, 2013 have not materially changed on average from last year. The decrease in revenue was primarily due to the decrease of sales volume.
Cost of Sales. Cost of sales was $7,778,691 for the three months ended September 30, 2013, as compared to $3,670,230 for the three months ended September 30, 2012, an increase of $4,108,461 or 111.9%, as a result of significantly increased veterinary medication sales. For the three months ended September 30, 2013, raw material costs comprised the majority or approximately 80.1% of total cost of sales, packing material costs comprised approximately 16.6% of the total cost of sales, and labor costs and manufacturing overhead comprised approximately 3.3% of the total cost of sales. The decreased gross margins for the three months ended September 30, 2013 was mainly because the majority of our revenue during the three months came from the less profitable veterinary medications product line as we resumed the veterinary medication production at the Huxian facility.
Cost of Sales — Veterinary Medications. Cost of sales of our veterinary medications product line increased from $848,105 for the three months ended September 30, 2012 to $5,826,896 for the three months ended September 30, 2013, an increase of $4,978,791 or 587.0%. This increase was mainly due to the increase in corresponding sales as a result of resumed production at the Huxian veterinary medications facility during the third quarter of 2013. Cost of sales of veterinary medications product line comprised 74.9% of total cost of sales for the three months ended September 30, 2013.
Cost of Sales — Micro-Organism. Cost of sales of our micro-organism product line decreased from $1,843,821 for the three months ended September 30, 2012 to $1,416,068 for the three months ended September 30, 2013, a decrease of $427,753 or 23.2%. This decrease was mainly due to the improved control of raw material costs in micro-organism product line. In addition, less manufacturing overhead allocated to micro-organism product line this year than last year also contributed this decrease.
Cost of Sales — Feed Additives. Cost of sales of our feed additives product line decreased from $854,114 for the three months ended September 30, 2012 to $466,490 for the three months ended September 30, 2013, a decrease of $387,624 or 45.4%. This decrease in cost of sales was mainly due to the corresponding decrease in feed additive sales.
Cost of Sales — Vaccines. Cost of sales of our vaccines product line decreased from $124,190 for the three months ended September 30, 2012 to $69,237 for the three months ended September 30, 2013, a decrease of $54,953 or 44.2%. This decrease was the result of the corresponding decrease of vaccine product sales.
Operating Expenses
Three Months Ended September 30, | |||||||||||||||
2013 | 2012 | ||||||||||||||
Amount | % of total revenue | Amount | % of total revenue | ||||||||||||
Operating Expenses | |||||||||||||||
Research and Development Costs | $ | 324,353 | 2.0 | % | $ | 198,838 | 2.2 | % | |||||||
Selling Expenses | $ | 1,266,444 | 7.9 | % | $ | 692,009 | 7.7 | % | |||||||
General and Administrative Expenses | $ | 1,885,219 | 11.8 | % | $ | 730,539 | 8.2 | % | |||||||
Total Operating Expenses | $ | 3,476,016 | 21.7 | % | $ | 1,621,386 | 18.1 | % |
Research and Development Costs. Research and development costs totaled $324,353 for the three months ended September 30, 2013 as compared to $198,838 for the three months ended September 30, 2012, an increase of $125,515 or 63.1%. The increase was primarily due to newly launched R&D projects undertaken during the third quarter of 2013 to develop livestock and avian disease multi-joint yolk antibody therapeutic agents.
Selling Expenses. Selling expenses totaled $1,266,444 for the three months ended September 30, 2013 as compared to $692,009 for the three months ended September 30, 2012, an increase of $574,435 or 83.0%. This increase was mainly due to the increase of sales commission and shipping and handling costs as the result of significantly increased veterinary medication sales during the third quarter. Shipping and handling costs totaled $805,492 and $511,519 for the three months ended September 30, 2013 and 2012, respectively, an increase of $293,973 or 57.5%. Sales commission expenses totaled $374,570 and $144,860 for the three months ended September 30, 2013 and 2012, respectively, an increase of $229,710 or 158.6%.
33 | ||
General and Administrative Expenses. General and administrative expenses totaled $1,885,219 for the three months ended September 30, 2013 as compared to $730,539 for the three months ended September 30, 2012, an increase of $1,154,680 or 158.1%. The increased G&A expense was mainly due to the additional allowance for doubtful accounts of $976,894 booked during the third quarter for our increased accounts receivable balance partially because of our high sales season and tepid collection during the quarter.
Other Expenses. Other net expenses were $221,527 for the three months ended September 30, 2013 as compared to $192,972 for the three months ended September 30, 2012, an increase of $28,555 or 14.8%. The increase was primarily due to the loss on fair value change of derivative liability as a result of our significantly improved stock price during the third quarter. The loss was offset by an increase on interest income we charged on our prepayments to two vendors of $332,472. We started to charge them interest starting from January 1, 2013
Provision for Income Taxes. Income tax expenses were $781,977 for the three months ended September 30, 2013 as compared to $717,163 for the three months ended September 30, 2012, an increase of $64,814 or 9.0%, representing an effective tax rate of 17.3% and 20.8% for the three months ended September 30, 2013 and 2012, respectively. For the three months ended September 30, 2013 and 2012, Xi’an Tianxing was subject to a preferential income tax rate of 15% while other PRC subsidiaries were subject to statutory tax rate of 25%. For the three months ended September 30, 2013 and 2012, Xi’an Tianxing contributed the majority of consolidated profits in China.
Results of Operations – Nine Months ended September 30, 2013 and 2012
The following table summarizes our results of operations for the nine months ended September 30, 2013 and 2012.
Nine Months Ended September 30, | |||||||||||||||
2013 | 2012 | ||||||||||||||
% of total | % of | ||||||||||||||
Amount | revenue | Amount | total revenue | ||||||||||||
Revenue | $ | 32,858,294 | 100.0 | % | $ | 25,730,190 | 100.0 | % | |||||||
Gross Profit | $ | 16,770,893 | 51.0 | % | $ | 14,669,364 | 57.0 | % | |||||||
Operating Expenses | $ | 6,416,659 | 19.5 | % | $ | 6,271,470 | 24.4 | % | |||||||
Income from Operations | $ | 10,354,234 | 31.5 | % | $ | 8,397,894 | 32.6 | % | |||||||
Other Income (Expenses) | $ | (356,405) | (1.1) | % | $ | (294,115) | (1.1) | % | |||||||
Income Tax Expenses | $ | 1,800,018 | 5.5 | % | $ | 1,768,905 | 6.9 | % | |||||||
Net Income | $ | 8,197,811 | 24.9 | % | $ | 6,334,874 | 24.6 | % |
Revenues. All of our revenues are derived from the sale of veterinary healthcare and medical care products in the PRC. For the nine months ended September 30, 2013, we had revenues of $32,858,294 as compared to revenues of $25,730,190 for the nine months ended September 30, 2012, an increase of $7,128,104 or 27.7%. We generate revenue from sales of four product lines: veterinary medications, micro-organism, feed additives, and vaccines. The selling prices of our products decreased 2.5% on average in the nine months ended September 30, 2013 compared to the same period of 2012. The increase in revenue was primarily due to the increase of sales volume.
Revenue — Veterinary Medications. Revenue from sales of our veterinary medications increased by $12,319,114 or 170.0% from $7,248,607 for the nine months ended September 30, 2012 to $19,567,721 for the nine months ended September 30, 2013. The increase of revenue was primarily due to resumed production at the Huxian plant and our increased marketing and sales efforts for the nine months ended September 30, 2013. The revenue from sales of veterinary medication products was the largest revenue contributor for the entire company and contributed 59.6% of total revenue during the nine months ended September 30, 2013. The selling prices of our veterinary medication products for the nine months ended September 30, 2013 decreased approximately 4.3% on average from the same period of last year due to the change in product mix. The increase in revenue was primarily due to the increase of sales volume.
Revenue — Micro-Organism. Revenue from sales of our micro-organism products decreased by $1,414,432 or 11.7% from $12,059,414 for the nine months ended September 30, 2012 to $10,644,982 for the nine months ended September 30, 2013. The decrease was primarily due to weak market demand for micro-organism products in the first quarter. The selling prices of our micro-organism products for the nine months ended September 30, 2013 have not changed meaningfully on average from last year. The decrease in revenue was mainly due to the decrease of sales volume.
Revenue — Feed Additives. Revenue from sales of our feed additives product line decreased by $2,080,865 or 59.6% from $3,491,396 for the nine months ended September 30, 2012 to $1,410,531 for the nine months ended September 30, 2013. The decrease was primarily due to weak market demand for feed additive products in the first quarter and our limited sales resources for the feed additive product line this year. The selling prices of our feed additives products for the nine months ended September 30, 2013 have not changed meaningfully on average from last year. The decrease in revenue was primarily due to the decrease of sales volume.
Revenue — Vaccines. Revenue from sales of our vaccines decreased by $1,695,713 or 57.9% from $2,930,773 for the nine months ended September 30, 2012 to $1,235,060 for the nine months ended September 30, 2013. The decrease was primarily due to weak market demand for vaccine products in the first quarter and our limited sales resources for the vaccine product line this year. The selling prices of our vaccine products have not changed meaningfully on average for the nine months ended September 30, 2013 compared to those in the same period of 2012. The decrease in revenue was primarily due to the decrease of sales volume.
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Cost of Sales. Cost of sales was $16,087,401 for the nine months ended September 30, 2013, as compared to $11,060,826 for the nine months ended September 30, 2012, an increase of $5,026,575 or 45.4%, as a result of the increased sales of our veterinary medications product line after we resumed production at the Huxian facility. For the nine months ended September 30, 2013, raw material costs comprised the majority or approximately 77.9% of total cost of sales, packing material costs comprised approximately 17.4% of total cost of sales, and labor costs and manufacturing overhead comprised approximately 4.7% of the total cost of sales. The decreased gross margins was mainly because the majority of our revenue growth during the first nine months came from the less profitable veterinary medications product lines.
Cost of Sales — Veterinary Medications. Cost of sales of our veterinary medications product line increased from $4,039,759 for the nine months ended September 30, 2012 to $11,672,910 for the nine months ended September 30, 2013, an increase of $7,633,151 or 189.0%. This increase was mainly due to the increase in corresponding sales as a result of resumed production at the Huxian facility for the nine months ended September 30, 2013. Cost of sales of veterinary medications product line comprised 72.6% of the total cost of sales for the nine months ended September 30, 2013.
Cost of Sales — Micro-Organism. Cost of sales of our micro-organism product line decreased from $3,920,073 for the nine months ended September 30, 2012 to $3,182,984 for the nine months ended September 30, 2013, a decrease of $737,089 or 18.8%. This decrease was mainly due to the corresponding decreased sales. In addition, less manufacturing overhead allocated to micro-organism product line this year than last year also contributed this decrease.
Cost of Sales — Feed Additives. Cost of sales of our feed additives product line decreased from $2,736,137 for the nine months ended September 30, 2012 to $1,081,010 for the nine months ended September 30, 2013, a decrease of $1,655,127 or 60.5%. This decrease was mainly due to the corresponding decreased sales.
Cost of Sales — Vaccines. Cost of sales of our vaccines product line decreased from $364,857 for the nine months ended September 30, 2012 to $150,497 for the nine months ended September 30, 2013, a decrease of $214,360 or 58.8%. This decrease was mainly due to the corresponding decreased sales.
The following table summarizes our operating expense for the nine months ended September 30, 2013 and 2012.
Nine Months Ended September 30, | |||||||||||||||
2013 | 2012 | ||||||||||||||
Amount | % of total revenue | Amount | % of total revenue | ||||||||||||
Operating Expenses | |||||||||||||||
Research and Development Costs | $ | 417,740 | 1.3 | % | $ | 533,024 | 2.1 | % | |||||||
Selling Expenses | $ | 2,213,617 | 6.7 | % | $ | 2,068,192 | 8.0 | % | |||||||
General and Administrative Expenses | $ | 3,785,302 | 11.5 | % | $ | 3,670,254 | 14.3 | % | |||||||
Total Operating Expenses | $ | 6,416,659 | 19.5 | % | $ | 6,271,470 | 24.4 | % |
Research and Development Costs. Research and development costs totaled $417,740 for the nine months ended September 30, 2013 as compared to $533,024 for the nine months ended September 30, 2012, a decrease of $115,284 or 21.6%. We launched more R&D projects in this year, while the increased costs was offset against the related government grant, resulting a net decrease in R&D costs.
Selling Expenses. Selling expenses totaled $2,213,617 for the nine months ended September 30, 2013 as compared to $2,068,192 for the nine months ended September 30, 2012, an increase of $145,425 or 7.0%. This increase is mainly due to the increase of shipping and handling costs as well as sales commissions as the result of increased sales this year. Shipping and handling costs totaled $1,452,981 and $1,358,852 for the nine months ended September 30, 2013 and 2012, respectively, an increase of $94,129 or 6.9%. Sales commission expenses totaled $543,995 and $443,669 for the nine months ended September 30, 2013 and 2012, respectively, an increase of $100,326 or 22.6%.
General and Administrative Expenses. General and administrative expenses totaled $3,785,302 for the nine months ended September 30, 2013 as compared to $3,670,254 for the nine months ended September 30, 2012, an increase of $115,048 or 3.1%. We recorded a higher amount of doubtful accounts this year resulting from an increase in sales. Doubtful accounts were $1,274,058 and $31,340 for the nine months ended September 30, 2013 and 2012, respectively. The increase in doubtful accounts was offset by a decrease in stock based compensation expense in the nine months ended September 30, 2013 by $1,029,049 for the stock grants on May 4, 2012 pursuant to the 2010 Stock Incentive Plan when compared to the same period last year.
Other Expenses. Other net expenses were $356,405 for the nine months ended September 30, 2013 as compared to $294,115 for the nine months ended September 30, 2012, an increase of $62,290 or 21.2%. The increase was primarily due to the loss on fair value change of derivative liability as a result of our significantly improved stock price during the third quarter. The fair value loss was offset by a decreased net interest expenses resulting from the interest income of $332,472 that we charged on the long outstanding prepayments to our two major vendors from January 1, 2013.
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Provision for Income Taxes. Income tax expenses were $1,800,018 for the nine months ended September 30, 2013 as compared to $1,768,905 for the nine months ended September 30, 2012, an increase of $31,113 or 1.8%, representing an effective tax rate of 18.0% and 21.8% for the nine months ended September 30, 2013 and 2012, respectively. For the nine months ended September 30, 2013 and 2012, Xi’an Tianxing was subject to a preferential income tax rate of 15% while other PRC subsidiaries were subject to statutory tax rate of 25%. For the nine months ended September 30, 2013 and 2012, Xi’an Tianxing contributed the majority of consolidated profits in China.
Liquidity
For the nine months ended September 30, 2013, we used $10,020,354 of cash in operating activities, as compared to cash used in operating activities of $6,439,293 for the nine months ended September 30, 2012. The major operating activities that provided cash for the nine months ended September 30, 2013 were net income of $8,197,811 and an increase in taxes payable of $2,932,621. The major operating activities that used cash for the nine months ended September 30, 2013 were an increase in accounts receivable of $17,685,435, an increase in inventory of $3,775,636, and an increase in prepayments to suppliers of $3,552,385. The inflation rate in China accelerated more than expected to 3.1% in September 2013. We will monitor the market situation closely and continue the strategy of prepaying our suppliers to ensure the supply of raw materials at relatively lower cost levels. As of September 30, 2013, we had 75 suppliers as compared to 52 suppliers as of September 30, 2012 to which we made advances to secure our raw material needs and to obtain favorable pricing. We will continue to closely manage these advances to balance the need for lower materials cost and sufficient cash flow.
Cash used in investing activities for the nine months ended September 30, 2013 was $2,496,137, as compared to cash used in investing activities of $1,347,934 for the nine months ended September 30, 2012. Cash provided by investing activities for the nine months ended September 30, 2013 was primarily the result of collection of loans to third parties of $1,094,190. Cash used in investing activities for the nine months ended September 30, 2013 was primarily the result of payment of long-term prepayments of $3,510,666.
Cash provided by financing activities for the nine months ended September 30, 2013 was $5,596,152, as compared to cash provided by financing activities of $3,374,742 for the nine months ended September 30, 2012. Cash provided by financing activities for the nine months ended September 30, 2013 was primarily the result of proceeds from short-term loans of $10,462,400. Cash used in financing activities for the nine months ended September 30, 2013 was primarily the result of repayment of short-term and long-term loans totaled $5,794,560.
As of September 30, 2013, we had unrestricted cash of $4,456,619. Our total current assets were $88,624,051, and our total current liabilities were $28,388,062, which resulted in a net working capital of $60,235,989.
Capital Resources
We finance our ongoing operating activities by using funds from our operations and external credit or financing arrangements. We routinely monitor current and expected operational requirements and financial market conditions to evaluate the use of available financing sources. We secured $10,462,400 in short-term loans and repaid $5,794,560 of short-term and long-term loans during the nine months ended September 30, 2013. Considering our existing working capital position and our ability to access debt funding sources, we believe that our operations and borrowing resources are sufficient to provide for our current and foreseeable capital requirements to support our ongoing operations for at least next twelve months.
Contractual Obligations and Off-Balance Sheet Arrangements
Contractual Obligations
Payments Due by Period | ||||||||||||||||
Contractual Obligations | Total | Less than 1 year | 1 – 3 years | 3 – 5 years | More than 5 years | |||||||||||
R&D Project Obligations | $ | 782,400 | $ | 782,400 | $ | - | $ | - | $ | - | ||||||
Construction-in-progress Obligations | 4,340,201 | 4,340,201 | - | - | - | |||||||||||
Operating Lease Obligations | 246,345 | 108,154 | 111,296 | 26,895 | - | |||||||||||
Total | $ | 5,368,946 | $ | 5,230,755 | $ | 111,296 | $ | 26,895 | $ | - |
In addition to the contractual obligations listed above, we have a future registered capital commitment related to our subsidiary Skystar Kunshan. Skystar Kunshan has a registered capital of $15,000,000, of which we invested $2,250,000 in cash. The remaining $12,750,000 of capital was originally required to be invested prior to May 7, 2012. On July 25, 2012, the Company received the approval of extension for payment of the remaining registered capital but a new due date has not been specified by the government.
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Short-term loans:
September 30, 2013 | December 31, 2012 | Interest | |||||||||||||||||
Bank | Amt RMB | Amt USD | Amt RMB | Amt USD | Due Date | Rate | |||||||||||||
ICBC Songzi Branch | - | $ | - | 3,000,000 | $ | 476,100 | 06/18/13 | (1) | |||||||||||
Xi'an High-tech Zone Guoxin Microcredit Ltd. | - | - | 15,000,000 | 2,380,500 | 02/12/13 | 22.400 | % | ||||||||||||
Chang’an Bank | - | - | 10,000,000 | 1,587,000 | 08/26/13 | (1) | |||||||||||||
Industrial Bank Co. Ltd. Xi’an branch | 30,000,000 | 4,890,000 | - | - | 01/15/14 | 6.600 | % | ||||||||||||
Postal Savings Bank of China Xi’an Branch | 20,000,000 | 3,260,000 | - | - | 05/26/14 | (2) | |||||||||||||
ICBC Songzi Branch | 5,000,000 | 815,000 | - | - | 06/19/14 | (1) | |||||||||||||
Related-party Individual – Chairman and CEO | 10,000,000 | 1,630,000 | - | - | 09/11/14 | 7.800 | % | ||||||||||||
Total | 65,000,000 | $ | 10,595,000 | 28,000,000 | $ | 4,443,600 |
(1) | People's Bank of China floating benchmark lending rate over the same period plus 30%, which was 7.8% at September 30, 2013. | |
(2) | People's Bank of China floating benchmark lending rate over the same period plus 20%, which was 7.2% at September 30, 2013. |
Long-term loan:
September 30, 2013 | December 31, 2012 | Interest | |||||||||||||||||
Bank | Amt RMB | Amt USD | Amt RMB | Amt USD | Due Date | Rate | |||||||||||||
Shaanxi Agricultural Yanta Credit Union | - | - | 8,000,000 | $ | 1,269,600 | 09/20/14 | 9.446 | % |
We fully repaid the long-term loans on May 9, 2013.
Off-Balance Sheet Arrangements
We do not have any outstanding financial guarantees or commitments to guarantee the payment obligations of any third parties. We have not entered into any derivative contracts that are indexed to our shares and classified as stockholders’ equity or that are not reflected in our consolidated financial statements. Furthermore, we do not have any retained or contingent interest in assets transferred to an unconsolidated entity that serves as credit, liquidity, or market risk support to such entity. We do not have any variable interest in any unconsolidated entity that provides financing, liquidity, market risk, or credit support to us or engages in leasing, hedging, or research and development services with us.
Exchange Rate
Our operating subsidiaries in China maintain their books and records in Renminbi (“RMB”), the currency of China. In general, for consolidation purposes, we translate the subsidiaries’ assets and liabilities into US Dollars using the applicable exchange rates prevailing at the balance sheet date, and the statement of comprehensive income is translated at average exchange rates during the reporting period. Adjustments resulting from the translation of the financial statements of the Company’s Chinese subsidiaries are recorded as accumulated other comprehensive income.
The exchange rates used to translate amounts in RMB into US Dollars for the purposes of preparing the consolidated financial statements or otherwise stated in this MD&A were as follows:
September 30, 2013 | December 31, 2012 | ||||||
Assets and liabilities | 1 RMB = 0.1630 USD | 1 RMB = 0.1587 USD |
Nine Months Ended September 30, | |||||||
2013 | 2012 | ||||||
Statements of operations and cash flows | 1 RMB = 0.16096 USD | 1 RMB = 0.15865 USD |
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Inflation
Fuelled mainly by a surge in food prices, China's consumer prices rose more than forecast in September 2013 to 3.1% year-over-year, beating expectations for a 2.8% rise. This compares with a 2.7% rise in June. The rising prices had reduced the chance of any major monetary policy moves by the Chinese government. Some analysts said that prices were likely to rise further and that there was a risk the rate of inflation could even be above the government’s 3.5% target for some months in 2014. For the three and nine months ended September 30, 2013, we were able to secure favorable pricing by prepaying certain suppliers to lock in prices ahead of time. As a result, we did not experience as much cost pressure as evidenced in the spot market prices of raw materials. To take precautions to minimize the negative impact of cost increases that erode our profit margin, we will continue the practice of prepayments to suppliers.
ITEM 4. CONTROLS AND PROCEDURES
Evaluation of DisclosureControls and Procedures
As of the end of the period covered by this report, our management, under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer (the “Certifying Officers”), performed an evaluation of the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act), which are designed to ensure that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized, and reported within the time periods specified in the Commission’s rules and forms, and that such information is accumulated and communicated to our management, to allow timely decisions regarding required disclosure.
Based on the evaluation, the Certifying Officers concluded that, as of September 30, 2013, our disclosure controls and procedures were not effective due to an ongoing material weakness related to the lack of accounting personnel with an appropriate level of knowledge, experience, and training in the application of U.S. GAAP.
For the nine months ended September 30, 2013, aside from the remediation measures that we initiated in the previous year, we engaged a third party consulting firm to adequately address and to assist in remediation of the identified material weakness. This consulting firm is a global leading provider of consulting and internal audit services and the only consulting firm represented on the COSO advisory board guiding the development of a conceptual framework on Enterprise Risk Management. With such additional external assistance, we are in the process of improving our accounting policies and procedures manual in accordance to US GAAP, and are going to provide proper training on the manual for our accounting team and continue to standardize our accounting treatments in compliance with US GAAP, especially non-routine transactions, and improve our accounting team’s US GAAP competence.
In September 2013, this third party consulting firm completed its initial field work at our main administrative offices in China and helped us to develop a draft of new accounting policies and procedures manual in accordance to US GAAP. We intend to complete the project on or before the end of 2013 and to conduct quarterly assessments of the state of the Company’s financial reporting measures and systems.
Changes in Internal Control over Financial Reporting
There was no change in our internal control over financial reporting during our most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
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PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
From time to time, the Company is involved in legal matters arising in the ordinary course of business. Management currently is not aware of any legal matters or pending material litigation that would have a significant effect on the Company’s consolidated financial statements as of September 30, 2013.
In May 2007, Andrew Chien filed suit against the Company, R. Scott Cramer, Steve Lowe, David Wassung and Weibing Lu in United States District Court for the District of Connecticut, alleging causes of action for violation of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934. On July 17, 2008, in a decision that is now published, the court granted defendants’ motion to dismiss and subsequently dismissed the lawsuit, entering judgment on behalf of the defendants. Chien appealed the dismissal. Defendants filed a post judgment motion for sanctions against Chien. On February 5, 2009, the court found the action filed by Chien to have been frivolous, and to have constituted a “substantial” violation of Rule 11, and imposed monetary sanctions on both Chien and his former attorney. Chien appealed the award of sanctions. All appeals, including the one referenced below concerning Chien’s second lawsuit, were subsequently consolidated. The Court of Appeals issued a Mandate upholding the decision granting defendant’s motion to dismiss and found that the District Court did not “abuse its discretion” in issuing sanctions against Chien in light of the circumstances and facts on record. This Mandate was entered on or about November 8, 2010.
Andrew Chien, proceeding pro se (i.e., he represented himself without an attorney), filed his second lawsuit against the Company, R. Scott Cramer, Steve Lowe, David Wassung and Weibing Lu in Connecticut Superior Court (which was removed to U.S. District Court) alleging causes of action similar to those alleged in his federal complaint described above as well as state law causes of action. The court held that all claims asserted against the defendants were barred and failed to state a claim on a multiplicity of grounds, including on the basis of res judicata. Defendants filed a second Motion for Sanctions under Rule 11 and the PSLRA, which was granted. Chien appealed the dismissal. The Court of Appeals for the Second Circuit consolidated all of Chien’s appeals from both of his lawsuits. On November 8, 2010, the Court of Appeals affirmed the dismissals and the awards of sanctions. On January 22, 2011, Chien filed a petition with the Supreme Court of the United States, appealing the lower court’s ruling. The Supreme Court denied review of the petition.
Andrew Chien, again proceeding pro se, commenced his third lawsuit against the Company, Scott Cramer, Steve Lowe, David Wassung, Weibing Lu (and also Weinberg & Company, P.A., Moore Stephens Wirth Frazer & Torbet, LLP, Frazer Frost, LLP, Crowe Horwath LLP, Richardson & Patel LLP, Kevin K. Leung, Harvey Kesner, and Jody M. Borrelli) alleging the same facts and circumstances as set forth in the above two matters, although adding the aforementioned accountants and lawyers as defendants to the claims. The matter commenced on August 8, 2011, and shortly thereafter was removed to U.S. District Court. On October 5, 2011, the court dismissed the entire action as to all defendants. As in the two previous lawsuits, sanctions were issued against Chien. Moreover, the District Court issued an order prohibiting Chien from filing any more lawsuits against the defedentants without prior approval from the court. Chien appealed the Court’s ruling to the United States Court of Appeals for the Second Circuit, where all defendants have filed motions to dismiss.
The United States Court of Appeals for the Second Circuit recently affirmed the judgments and orders of the United States District Court and dismissed all of Mr. Chien’s pending appeals.
Although the Second Circuit declined to issue sanctions against Chien, it expressly warned Chien “that the continued filing of duplicative, vexatious, or frivolous appeals regarding issues already resolved by this Court may result in the imposition of sanctions, including a leave-to-file sanction requiring Chien to obtain permission from this Court prior to filing further submissions in this Court.” Mr. Chien has filed a petition for writs of certiorari with the Supreme Court of the United States. The Supreme Court has not yet acted on Chien’s petitions.
Other than the above described legal proceedings, the Company is not aware of any other legal matters or pending material litigation in which any director, officer, or any owner of record or beneficial owner of more than five percent of any class of voting securities of the Company, or any affiliate of any such director, officer, affiliate of the Company, or security holder, is a party adverse to the Company or has a material adverse interest to the Company. No provision has been made in the consolidated financial statements for the above contingencies.
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ITEM 6. EXHIBITS
Exh. No. | Description | |
3.1 | Articles of Incorporation, as amended (2) | |
3.2 | Bylaws, as amended (1) | |
31.1 | Certifications of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 * | |
31.2 | Certifications of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 * | |
32.1 | Certifications of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 * | |
32.2 | Certifications of Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 * | |
101.INS* | XBRL Instance Document | |
101.SCH* | XBRL Taxonomy Extension Schema | |
101.CAL* | XBRL Taxonomy Extension Calculation Linkbase | |
101.DEF* | XBRL Taxonomy Extension Definition Linkbase | |
101.LAB* | XBRL Taxonomy Extension Label Linkbase | |
101.PRE* | XBRL Taxonomy Extension Presentation Linkbase |
_________________________________________________
* | Filed herewith. |
(1) | Incorporated by reference from the Registrant’s Current Report on Form 8-K filed on July 15, 2008. |
(2) | Incorporated by reference from Registrant’s Quarter Report on Form 10-Q filed on November 15, 2010. |
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SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
SKYSTAR BIO-PHARMACEUTICAL COMPANY | ||
November 14, 2013 | By: | /s/ Weibing Lu |
Weibing Lu | ||
Chief Executive Officer | ||
(Principal Executive Officer) |
November 14, 2013 | By: | /s/ Bing Mei |
Bing Mei | ||
Chief Financial Officer | ||
(Principal Financial and Accounting Officer) |
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