UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 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 March 31, 2008
OR
|_| TRANSITIONAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ___________ to _____________
Commission File No. 814-00063
CHINA BIOPHARMACEUTICALS HOLDINGS, INC.
---------------------------------------
(Exact Name of registrant as specified in its charter)
Delaware 13-2949462
------------------------------ ---------------------------------
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
No. 859, Pan Xu Road, Suzhou,
Jiangsu Province, China 215000
55 Hakeshet Street, Reuth,
Israel 91708
--------------------------------------------------
(Address of principal executive offices)(Zip Code)
(86) 512 6855 0568
(Registrant's telephone number,
including area code)
----------------------------------------------------
(Former name, former address and former fiscal year,
of changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the past 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 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|
(Do not check if a smaller reporting company)
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). Yes |_| No |X|
As of March 31, 2008, 36,490,312 shares of Common Stock, par value $0.01 per
share, were outstanding.
Table of Contents
Item No. Description Page No.
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements. 2
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations. 24
Item 3. Quantitative and Qualitative Disclosures About Market Risk. 28
Item 4T. Controls and Procedures. 28
PART II - OTHER INFORMATION
Item 1. Legal Proceedings. 29
Item 1A Risk Factors. 29
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds. 29
Item 3. Defaults Upon Senior Securities. 29
Item 4. Submission of Matters to a Vote of Security Holders. 29
Item 5. Other Information. 29
Item 6. Exhibits. 29
SIGNATURES 30
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENT
CHINA BIOPHARMACEUTICALS HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
AS OF MARCH 31, 2008 AND DECEMBER 31, 2007
March 31, December 31,
2008 2007
------------ ------------
Unaudited
ASSETS
------
CURRENT ASSETS:
Cash $ 1,764,561 $ 669,699
Short term investment 714,000 1,096,800
Accounts receivable, trade, net of allowance
for doubtful accounts of $1,313,177 and
$1,260,760 at March 31, 2008 and
December 31, 2007, respectively 4,361,377 3,551,483
Accounts receivable, related parties 122,270 41,932
Notes receivables 71,400 --
Other receivables 148,259 863,627
Other receivables - related parties 924,326 819,621
Advances to suppliers 426,080 797,302
Advances to suppliers - related parties 237,139 --
Prepaid expenses 591,122 363,819
Inventories 9,581,567 8,962,055
Loan to shareholders 47,124 45,243
------------ ------------
Total current assets 18,989,225 17,211,581
PLANT AND EQUIPMENT, net 6,230,739 4,122,169
------------ ------------
OTHER ASSETS:
Intangible asset, net 7,548,052 7,398,189
Long term notes receivable 571,200 640,518
Long term other receivables - related parties 224,928 267,768
Restricted cash 755,421 518,589
Advance on patent and right purchase 999,600 959,700
Other assets 43,254 81,484
------------ ------------
Other assets 10,142,455 9,866,248
------------ ------------
Total assets $ 35,362,419 $ 31,199,998
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------
CURRENT LIABILITIES:
Accounts payable $ 6,292,705 $ 5,988,289
Short-term loans 2,184,840 2,371,830
Other payables 698,299 1,381,462
Other payables - related parties 672,208 689,338
Customer deposits 3,206,837 2,129,318
Notes payable 2,516,850 1,727,460
Taxes payable 1,743,818 1,488,964
Redeemable series B preferred stock 12,897,497 12,585,641
Other accrued liabilities 341,759 281,390
------------ ------------
Total current liabilities 30,554,813 28,643,692
LONG TERM LIABILITIES: 63,284 65,114
------------ ------------
Total liabilities 30,618,097 28,708,806
------------ ------------
COMMITMENTS AND CONTINGENCIES -- --
MINORITY INTEREST 6,577,603 5,508,061
------------ ------------
SHAREHOLDERS' EQUITY:
Preferred stock, $0.01 par value, 10,000,000
shares authorized; 50,000 and 50,000 shares
Issued and outstanding at March 31, 2008 and
December 31, 2007, respectively 500 500
Common stock, $0.01 par value, 200,000,000 shares
authorized; 36,490,312 shares issued and
outstanding at March 31, 2008 and
December 31, 2007, respectively 364,903 364,903
Paid-in capital 13,199,476 13,199,476
Capital receivable (252,471) (252,471)
Deferred compensation (12,000) (21,375)
Statutory reserves 1,186,025 976,439
Accumulated deficit (17,776,742) (18,059,232)
Accumulated other comprehensive income 1,457,028 774,891
------------ ------------
Total shareholders' equity (1,833,281) (3,016,869)
------------ ------------
Total liabilities and shareholders' equity $ 35,362,419 $ 31,199,998
============ ============
The accompanying notes are an integral part of this statement
2
CHINA BIOPHARMACEUTICALS HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME
FOR THE THREE MONTHS ENDED MARCH 31, 2008 AND 2007
UNAUDITED
2008 2007
------------ ------------
Restated
REVENUES $ 10,973,241 $ 6,155,560
COST OF GOODS SOLD 7,711,162 4,685,102
------------ ------------
GROSS PROFIT 3,262,079 1,470,458
------------ ------------
OPERATING EXPENSES
Research and development 17,947 43,163
Selling, general and administrative 1,074,797 903,500
------------ ------------
Total Operating Expenses 1,092,744 946,663
------------ ------------
INCOME FROM OPERATIONS 2,169,335 523,795
------------ ------------
OTHER INCOME (EXPENSE)
Interest income (expense), net (356,584) (347,485)
------------ ------------
Total other expense, net (356,584) (347,485)
------------ ------------
INCOME BEFORE INCOME TAXES AND MINORITY INTEREST 1,812,751 176,310
PROVISION FOR INCOME TAXES 299,409 1,108
------------ ------------
INCOME BEFORE MINORITY INTEREST 1,513,342 175,202
MINORITY INTEREST 1,021,266 352,995
------------ ------------
INCOME (LOSS) FROM CONTINUING OPERATIONS 492,076 (177,793)
INCOME ON DISCONTINUED OPERATIONS
Income from discontinued operations, net of tax effect -- 89,525
------------ ------------
NET INCOME (LOSS) 492,076 (88,268)
Foreign currency translation adjustment 682,137 34,954
------------ ------------
COMPREHENSIVE INCOME (LOSS) $ 1,174,213 $ (53,314)
============ ============
EARNING ( LOSS) PER SHARE OF COMMON STOCK
Continuing operations
Basic $ 0.013 $ (0.005)
Diluted 0.013 (0.005)
============ ============
Discontinued operations
Basic -- (0.002)
Diluted -- (0.002)
============ ============
WEIGHTED AVERAGED NUMBER OF SHARES OUTSTANDING - BASIC 36,490,312 36,027,615
============ ============
WEIGHTED AVERAGED NUMBER OF SHARES OUTSTANDING - DILUTED 36,540,312 36,027,615
============ ============
The accompanying notes are an integral part of this statement
3
CHINA BIOPHARMACEUTICALS HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
FOR THE THREE MONTHS ENDED MARCH 31, 2008 AND 2007
Preferred stock (series A) Common Stock
Shares Par value Shares Par Value
------------ ------------ ------------ ------------
BALANCE, December 31, 2006, Restated 930,000 $ 9,300 35,586,740 $ 355,868
Common shares issued for preferred
stock conversion (512,500) (5,125) 753,572 7,535
Net loss -- -- -- --
-- -- -- --
-- -- -- --
------------ ------------ ------------ ------------
BALANCE, March 31, 2007 (Unaudited) 417,500 4,175 36,340,312 363,403
Common shares issued for service -- -- 125,000 1,250
Common shares issued for preferred
stock conversion (25,000) (250) 25,000 250
Cancellation of preferred shares (342,500) (3,425) -- --
Amortization of deferred compensation -- -- -- --
Disposal of Enshi -- -- -- --
Change in value of warrants issued
for Enshi acquisition -- -- -- --
Net loss -- -- -- --
Statutory reserves -- -- -- --
Foreign currency translation adjustments -- -- -- --
------------ ------------ ------------ ------------
BALANCE, December 31, 2007 50,000 $ 500 36,490,312 $ 364,903
Amortization of deferred compensation -- -- -- --
Net income -- -- -- --
Statutory reserves -- -- -- --
Foreign currency translation adjustments -- -- -- --
------------ ------------ ------------ ------------
BALANCE, March 31, 2008 (Unaudited) 50,000 $ 500 36,490,312 $ 364,903
============ ============ ============ ============
Other
Paid-in Capital Deferred Accumulated
Capital Receivable Compensation Deficit
------------ ------------ ------------ ------------
BALANCE, December 31, 2006, Restated $ 13,059,911 $ (252,471) $ (18,000) $ (6,060,461)
Common shares issued for preferred
stock conversion (2,410) -- -- --
Net loss -- -- -- (88,268)
-- -- -- (81,785)
-- -- -- --
------------ ------------ ------------ ------------
BALANCE, March 31, 2007 (Unaudited) 13,057,501 (252,471) (18,000) (6,230,514)
Common shares issued for service 36,250 -- (37,500) --
Common shares issued for preferred
stock conversion -- -- -- --
Cancellation of preferred shares 3,425 -- -- --
Amortization of deferred compensation -- -- 34,125 --
Disposal of Enshi -- -- -- 1,862,414
Change in value of warrants issued
for Enshi acquisition 102,300 -- -- --
Net loss -- -- -- (13,458,719)
Statutory reserves -- -- -- (232,413)
Foreign currency translation adjustments -- -- -- --
------------ ------------ ------------ ------------
BALANCE, December 31, 2007 $ 13,199,476 $ (252,471) $ (21,375) $(18,059,232)
Amortization of deferred compensation -- -- 9,375 --
Net income -- -- -- 492,076
Statutory reserves -- -- -- (209,586)
Foreign currency translation adjustments -- -- -- --
------------ ------------ ------------ ------------
BALANCE, March 31, 2008 (Unaudited) $ 13,199,476 $ (252,471) $ (12,000) $(17,776,742)
============ ============ ============ ============
Statutory Comprehensive
Reserves Income (Loss) Totals
------------ ------------ ------------
BALANCE, December 31, 2006, Restated $ 2,524,655 $ 885,998 $ 10,504,800
Common shares issued for preferred
stock conversion -- -- --
Net loss -- -- (88,268)
81,785 -- --
-- 34,954 34,954
------------ ------------ ------------
BALANCE, March 31, 2007 (Unaudited) 2,606,440 920,952 10,451,486
Common shares issued for service -- -- --
Common shares issued for preferred
stock conversion -- -- --
Cancellation of preferred shares -- -- --
Amortization of deferred compensation -- -- 34,125
Disposal of Enshi (1,862,414) (837,320) (837,320)
Change in value of warrants issued
for Enshi acquisition -- -- 102,300
Net loss -- -- (13,458,719)
Statutory reserves 232,413 -- --
Foreign currency translation adjustments -- 691,259 691,259
------------ ------------ ------------
BALANCE, December 31, 2007 $ 976,439 $ 774,891 $ (3,016,869)
Amortization of deferred compensation -- -- 9,375
Net income -- -- 492,076
Statutory reserves 209,586 -- --
Foreign currency translation adjustments -- 682,137 682,137
------------ ------------ ------------
BALANCE, March 31, 2008 (Unaudited) $ 1,186,025 $ 1,457,028 $ (1,833,281)
============ ============ ============
The accompanying notes are an integral part of this statement
4
CHINA BIOPHARMACEUTICALS HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE THREE MONTHS ENDED MARCH 31, 2008 AND 2007
UNAUDITED
2008 2007
----------- -----------
Restated
CASH FLOWS FROM CONTINUING OPERATING ACTIVITIES:
Net income (loss) $ 492,076 $ (88,268)
Net income from discontinued operations -- (89,525)
----------- -----------
Net loss from continuing operations 492,076 (177,793)
Adjustments to reconcile net loss from continuing
operations to cash provided by (used in) continuing
operating activities:
Amortization of shares issued for service 9,375 --
Depreciation 143,805 121,156
Amortization 61,597 25,360
Bad debt expense -- 78,444
Minority interest 1,021,266 516,243
Interest charge on redeemable stock 311,856 --
Change in operating assets and liabilities:
Accounts receivable, trade (648,188) (236,020)
Accounts receivable, related parties 110 (38,311)
Other receivables and prepayments 509,400 (348,909)
Notes receivables (69,885) (814,452)
Advances to suppliers 395,790 (147,610)
Advances to suppliers -related parties (232,107) --
Other assets 38,908 88,051
Inventories (241,671) (770,223)
Accounts payable 54,273 1,009,641
Accounts payable - related parties (77,037) 43,795
Other payables and accrued liabilities (647,743) (354,588)
Customer deposits 968,007 741,529
Taxes payable 188,855 (68,893)
----------- -----------
Net cash provided by (used in) continuing
operating activities 2,278,687 (332,580)
----------- -----------
CASH FLOWS FROM CONTINUING OPERATION INVESTING ACTIVITIES:
Repayment received from long term notes receivables -- 67,224
Purchase of equipment (43,066) (59,524)
Additions to construction in progress (2,000,563) --
Increase in other receivables - related parties (316,866) --
Decrease in short term investment 419,310 --
Repayment of loan to related party 134,958 --
----------- -----------
Net cash (used in) provided by continuing operation
investing activities (1,806,227) 7,700
----------- -----------
CASH FLOWS FROM CONTINUING OPERATION FINANCING ACTIVITIES:
Increase in restricted cash (210,704) (125,784)
Payments on bank loan (279,540) --
Proceeds (payments) on long term debts - related parties 202,275 (659)
Incease in notes payables 702,344 --
----------- -----------
Net cash provided by (used in) continuing operation
financing activities 414,375 (126,443)
----------- -----------
Net increase (decrease) in cash from continuing operations 886,835 (451,323)
----------- -----------
Cash provided by discontinued operating activities -- 11,945
----------- -----------
Net cash provided by discontinued operations -- 11,945
----------- -----------
Effect of exchange rate on cash 208,027 (35,119)
----------- -----------
INCREASE (DECREASE) IN CASH 1,094,862 (474,497)
Cash, beginning of period 669,699 2,958,556
----------- -----------
Cash, end of period $ 1,764,561 $ 2,484,059
=========== ===========
The accompanying notes are an integral part of this statement
5
CHINA BIOPHARMACEUTICALS HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2008
(Unaudited)
- --------------------------------------------------------------------------------
Note 1- ORGANIZATION AND OPERATIONS
China Biopharmaceuticals Holdings, Inc. (CBH), a Delaware corporation, was
originally organized as a corporation under the laws of the state of New York on
August 6, 1976 under the name of Globuscope, Inc. On August 7, 1984, its name
was changed to Globus Growth Group, Inc., which was its name until it was merged
into CBH, its wholly owned subsidiary in the state of Delaware on August 28,
2004 through an internal re-organizational merger. The principal activities of
the Company, through its subsidiaries located in Mainland China ("China" or
"PRC"), are research, manufacture, and sale of drug raw materials and
intermediates as well as prescription and non-prescription chemical drugs and
traditional Chinese medicines. Effective August 28, 2004, CBH completed the
acquisition of China Biopharmaceuticals Corp ("CBC"), a British Virgin Islands
corporation as the parent, the management company and holder of 90% of the
ownership interest in its then only operating subsidiary and asset, Nanjing
Keyuan Pharmaceutical R&D Co., Ltd., doing business in English a.k.a Nanjing
Chemsource Pharmaceutical R&D Co. Ltd, ("Keyuan" or "Chemsource"), a company
established in China and engaged in the discovery, development and
commercialization of innovative drugs and related bio-pharmaceutical products in
China. Nanjing keyuan Pharmaceutical R&D Co., Ltd. was established in March 2000
in Nanjing City of Jiangsu Province, China.
On June 11, 2005, the Company signed a purchase agreement, which was amended on
August 3, 2005 under which, the Company acquired approximately 51% of the
controlling ownership interest of Suzhou Erye Pharmaceutical Limited Company
("Erye"), a company established in Suzhou, China. Total consideration paid by
the Company to acquire 51% ownership interest in Erye is $3,000,000 cash to be
paid in installments, and 3,300,000 of common shares valued at $1.00 per share
or $3,300,000. During 2006, $3,000,000 was fully contributed to Erye for working
capital and/or expansion purposes.
On May 16, 2006, the Company entered into a purchase agreement which became
effective at June 5, 2006, under which the Company acquired 100% of the
controlling ownership interest of RACP Pharmaceutical Holdings LTD. ("RACP")
which owns 100% ownership interest of Shenyang Enshi Pharmaceutical Limited
Company ("Enshi"). Total consideration of $14,690,000 paid by the Company to
acquire the 100% interest in both RACP and Enshi is $550,000 paid in cash,
12,000,000 of CBH warrants valued at $0.22 per warrant or $2,640,000 and to
assume $11,500,000 debt of RACP. The detail information of accounting for this
transaction is disclosed in Note 16.
In March 2007, management determined that approximately $2.6 million of Enshi's
trade receivables purchased are likely non-existent and therefore had no fair
value on the date of acquisition. (See Note 15 for discussion of legal action
pursued against the former owner and manager of Enshi.) In addition, due to the
violation of certain covenants of the $11.5 million debt assumed in connection
with the Enshi Acquisition, the debtor, RimAsia has taken over Enshi as
collateral of the debt. The Company wrote off the entire amount of the
investment in Enshi as a loss on discontinued operations in the third quarter of
2007. See Note 16 for more detail.
Note 2 - RESTATEMENT OF FINANCIAL STATEMENTS
As discussed in Note 2, Enshi had been taken over by RimAisa as collateral of
the $11.5 million debt since the third quarter of 2007, financial statements as
of and for the three months ended March 31, 2007 have been restated to reflect
Enshi as a discontinued operation for comparison purpose.
6
CHINA BIOPHARMACEUTICALS HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2008
(Unaudited)
- --------------------------------------------------------------------------------
Note 3 - SIGNIFICANT ACCOUNTING POLICIES
Economic and Political Risks
The Company faces a number of risks and challenges since its assets are located
in China and its revenues are derived from its operations in China. China is a
developing country with a young market economic system overshadowed by the
state. Its political and economic systems are very different from the more
developed countries and are still in the stage of change. China also faces many
social, economic and political challenges that may produce major shocks and
instabilities and even crises, in both its domestic arena and its relationship
with other countries, including but not limited to the United States. Such
shocks, instabilities and crises may in turn significantly and negatively affect
the Company's performance.
Basis of Presentation
The consolidated financial statements include the accounts of the Company and
all its majority-owned subsidiaries that require consolidation. Material
inter-company transactions have been eliminated in the consolidation.
The consolidated financial statements of China Biopharmaceuticals Holdings, Inc.
and Subsidiaries reflect the activities of the following subsidiaries:
Entity Percentage of Ownership Location
------ ----------------------- ------------------------
CBH Parent Company United States of America
CBC 100% owned by CBH British Virgin Inland
Erye 51% owned by CBH P.R.C
Keyuan 90% owned by CBC P.R.C
Management has included all normal recurring adjustments considered necessary to
give a fair presentation of operating results for the periods presented. Interim
results are not necessarily indicative of results for a full year. The
information included in this Form 10-Q should be read in conjunction with
information included in the 2007 annual report filed on Form 10-KSB.
Land Use Rights
According to Chinese law, the government owns all the land in China. Companies
or individuals are authorized to possess and use the land only through land use
rights granted by the Chinese government. Land use rights are being amortized
using the straight-line method over the lease term of 40 to 50 years.
Plant and Equipment
Plant and equipment are stated at cost less accumulated depreciation.
Depreciation is provided on the straight-line basis over their respective
estimated useful lives. Estimated useful lives are as follows.
Equipment and machinery 5 years
Motor vehicles 5 years
Furniture and fixtures 5 years
Buildings 20 years
Land use right 40-50 years
7
CHINA BIOPHARMACEUTICALS HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2008
(Unaudited)
- --------------------------------------------------------------------------------
The cost and related accumulated depreciation of assets sold or otherwise
retired are eliminated from the accounts and any gain or loss is included in the
statement of operations. The cost of maintenance and repairs is charged to
income as incurred, whereas significant renewals and betterments are
capitalized.
Construction in progress represents the costs incurred in connection with the
construction of buildings or new additions to the Company's plant facilities. No
depreciation is provided for construction in progress until the assets are
completed and are placed into service.
Long-term assets of the Company are reviewed annually, or more often if
necessary, to determine whether their carrying value has become impaired,
pursuant to the guidelines established in Statement of Financial Accounting
Standards (SFAS) No. 144, Accounting for the Impairment or Disposal of
Long-Lived Assets.
Cash and Cash Equivalents
For financial reporting purposes, the Company considers all highly liquid
investments purchased with original maturity of three months or less to be cash
equivalents.
Short term investment
In 2007, the Company opened an account with an investment broker to invest in
short term investments in initial public offering securities.
The Company classified the account balance as trading securities, which should
be carried at fair value with unrealized gains and losses reported as income
statement item, and realized gains and losses are included in other income
(expense). Total amount in this account was $714,000 as of March 31, 2008 and
$1,096,800 as of December 31, 2007. For the three months ended March 31, 2008,
the Company did not record any realized or unrealized gain or loss since the
whole account balance was cash as of March 31, 2008.
Inventories
Inventories are stated at the lower of cost or market using the first-in,
first-out basis.
Patent
The patents represent patented pharmaceutical formulas, on which the Company
have obtained official registration certificate or official approval for
clinical trials. No amortization is provided when the Company intends to and has
the ability to sell the patent or formulas within not more than two months,
otherwise the patent costs will be subject to amortization over its estimated
useful life period. Such costs comprise purchase costs of patented
pharmaceutical formulas and costs incurred for patent application. Patent costs
are accounted for on an individual basis. The carrying value of patent costs is
reviewed for impairment annually, or more often when events and changes in
circumstances indicate that the carrying value may not be recoverable.
8
CHINA BIOPHARMACEUTICALS HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2008
(Unaudited)
- --------------------------------------------------------------------------------
Research and Development Costs
Research and development (or "R&D") expenses include salaries, benefits, and
other headcount related costs, clinical trial and related clinical manufacturing
costs, contract and other outside service fees, and facilities and overhead
costs. R&D costs are expensed when incurred.
Under the guidance of paragraphs 8 to 11 of SFAS 2, the Company expenses the
costs associated with the research and development activities when incurred.
None of the intangible assets of the Company was recorded based on R&D costs.
Advertising costs
The Company expenses the cost of advertising as incurred or, as appropriate, the
first time the advertising takes place. Advertising costs for the three months
ended March 31, 2008 and 2007 were $17,616 and $ 43,163 respectively.
Shipping and handling costs
Shipping and handling costs related to costs of goods sold are included in
selling, general and administrative costs which were $104,547 and $64,161 for
the three months ended March 31, 2008 and 2007 respectively.
Concentration of risks
Cash includes cash on hand and demand deposits in accounts maintained with state
owned banks within the People's Republic of China and Hong Kong. Total cash in
these banks at March 31, 2008 and December 31, 2007 amounted to $1,985,852 and
$731,956 of which no deposits are covered by insurance. The Company has not
experienced any losses in such accounts and believes it is not exposed to any
risks on its cash in bank accounts.
The Company sells intermediary pharmaceutical products to general consumers.
Four major customers accounted for approximately 36% of the net revenue for the
three months ended March 31, 2008 with each customer individually accounting for
13%, 11%, 6%, and 6%, respectively. At March 31, 2008, the total receivable
balance due from these customers was $1,213,581, representing 21% of total
accounts receivable. For the three months ended March 31, 2007, two major
customers accounted for 10% of the net revenue with each customer individually
accounting for 5% and 5%, respectively.
For the three months ended March 31, 2008, two major suppliers provided
approximately 30% of the Company's purchases of raw materials with each supplier
individually accounting for 20% and 10%, respectively. Four suppliers provided
41% of the Company's purchase of raw materials for the three months ended March
31, 2007, with each suppliers individually accounting for 15%, 12%, 7%, and 7%,
respectively.
Financial Instruments
SFAS 107, "Disclosures about Fair Value of Financial Instruments" requires
disclosure of the fair value of financial instruments held by the Company. SFAS
107 defines the fair value of financial instruments as the amount at which the
instrument could be exchanged in a current transaction between willing parties.
The Company considers the carrying amount of cash, accounts receivable, other
receivables, accounts payable, accrued liabilities, and long term debts to
approximate their fair values because of the short period of time between the
origination of such instruments and their expected realization and their current
market rate of interest.
9
CHINA BIOPHARMACEUTICALS HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2008
(Unaudited)
- --------------------------------------------------------------------------------
The Company also analyzes all financial instruments with features of both
liabilities and equity under SFAS 150, "Accounting for Certain Financial
Instruments with Characteristics of Both Liabilities and Equity," The
convertible preferred shares issued in 2007 resulted in liability accounting.
Additionally, the Company analyzes registration rights agreements associated
with any equity instruments issued to determine if penalties triggered for late
filing should be accrued under FSP EITF 00-19-2, "Accounting for Registration
Payment Arrangements."
Fair value measurements
The Company adopted SFAS 157, "Fair Value Measurements" on January 1, 2008. SFAS
157 defines fair value, establishes a three-level valuation hierarchy for
disclosures of fair value measurement and enhances disclosures requirements for
fair value measures. The three levels are defined as follow:
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.
On November 16, 2007, the Company entered a conditional loan conversion
agreement (the "Agreement") with RimAsia, under which the principal amount of
the $11.5 million Loan owed to RimAsia in connection with the Enshi acquisition
plus unpaid interest of $1,008,534 (combined total of $12,508,534) was converted
in full into 6,185,607 shares of Series B redeemable convertible preferred
shares of the Company ("Series B Preferred Shares") at an effective conversion
price at $2.0222 per preferred share. This Agreement is conditioned on the
subsequent completion of at least one of sizeable acquisition by the end of June
2008 or will be reconverted to as a current liability.
Pursuant to SFAS 150, the 6,185,607 shares of Series B preferred stock was
recorded as liability due to the mandatory redemption feature. The shares were
recorded at the total face amount owed to RimAsia on the date of issuance plus
accrued but unpaid interest expense.
As of March 31, 2008, the carrying value of the redeemable convertible preferred
stock amounted to $12,897,497. Because this liability was short term in nature
and was treated as current liability. The Company evaluated the fair value of
the convertible notes using the level 2 inputs by comparing the market interest
rate of short term loans and determined that the fair value approximated the
carrying value.
The Company did not identify any assets or liabilities that are required to be
presented on the balance sheet at fair value in accordance with SFAS 157.
Revenue Recognition
The Company has three categories of revenue resources, sales of new drug
formulas, R&D services and revenue from sales of medical product.
The Company recognizes revenue from product and drug formula sales when title
has passed, the risks and rewards of ownership have been transferred to the
customer, the fee is fixed and determinable, and the collection of the related
receivable is probable which is generally at the time of shipment. Allowances
are established for estimated rebates, wholesaler charge backs, prompt pay sales
discounts, product returns, and bad debts.
For three months ended March 31, 2008 and 2007, revenue from sale of product was
$10,973,241 and $6,155,560, respectively, made up of the following product
categories.
2008 2007
----------- -----------
Unaudited Unaudited
----------- -----------
Restated
-----------
Revenue from continuing operations:
Intermediary pharmaceuticals products $ 3,966,283 $ 1,930,319
Prescription drugs 7,006,958 4,225,241
----------- -----------
Total revenue from continuing operations $10,973,241 $ 6,155,560
=========== ===========
10
CHINA BIOPHARMACEUTICALS HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2008
(Unaudited)
- --------------------------------------------------------------------------------
For revenue from R&D service, revenue is recognized based on fixed-price
refundable new drug contracts. The fixed-price refundable new drug contract is
also called as milestone contract, which establishes the phase goals of the R&D
service provided by the Company and the corresponding milestone payments by the
customers. Milestone payments become payable and are recognized as revenue when
milestone goals, as defined in the contract, are achieved. Milestones are
substantive and not derived solely from arriving at a specific date. Revenue is
recognized when milestone goals are achieved at the amount of the corresponding
milestone payment. To determine when milestones are achieved, typically, the
milestone goals require one or more of the following: (1) a certificate from a
licensed authoritative agency, (2) approval/acknowledgement by a governmental
agency, for example, the Food and Drug Administration of the United States, (3)
an authoritative professional appraisal report, or (4) an independent
technological feasibility report, testing analysis and other form of valuation
on the result and value of products and service. After receipt of the
certificate, and/or approval and/or report, continued service is not required
thus the respective milestone goals are achieved. Therefore, the milestone
payment is no longer refundable and revenue is recognized.
For the three months ended March 31, 2008, revenue from sales of product, sales
of new drug formulas, and R&D service amounted to $10,973,241, $0, and $0,
respectively. For the three months ended March 31, 2007, revenue from sales of
product, sales of new drug formulas, and R&D service was $6,155,560, $0, and $0,
respectively.
Income Taxes
Income taxes are provided on the liability method whereby deferred tax assets
and liabilities are recognized for the expected tax consequences of temporary
differences between the tax basis and reported amounts of assets and
liabilities. Deferred tax assets and liabilities are computed using enacted tax
rates expected to apply to taxable income in the periods in which temporary
differences are expected to be recovered or settled. The effect on deferred tax
assets and liabilities from a change in tax rates is recognized in income in the
period that includes the enactment date. The Company provides a valuation
allowance for certain deferred tax assets, if it is more likely than not that
the Company will not realize tax assets through future operations.
The Company adopted FASB Interpretation 48, "Accounting for Uncertainty in
Income Taxes" ("FIN 48"), as of January 1, 2007. 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. The adoption had no
effect on the Company's financial statements.
Use of Estimates
The preparation of the financial statements in conformity with generally
accepted accounting principles in the United States of America requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of revenues and
expenses during the reporting periods. For example, the Company estimates the
collectibility of its receivables which affects the carry value of the related
asset. Management makes these estimates using the best information available at
the time the estimate are made; however actual results could differ materially
from those estimates.
Comprehensive Income
SFAS No. 130, Reporting Comprehensive Income, establishes standards for the
reporting and display of comprehensive income, its components and accumulated
balances in a full set of general purpose financial statements. SFAS No. 130
defines comprehensive income to include all changes in equity except those
resulting from investments by owners and distributions to owners. Among other
disclosures, SFAS No. 130 requires that all items that are required to be
recognized under current accounting standards as components of comprehensive
income be reported in financial statement that is presented with the same
prominence as other financial statements.
11
CHINA BIOPHARMACEUTICALS HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2008
(Unaudited)
- --------------------------------------------------------------------------------
The Company's only current component of comprehensive income is the foreign
currency translation adjustment.
Foreign Currency Translation
The reporting currency of the Company is the US dollar. The Company's Chinese
subsidiaries' financial records are maintained and the statutory financial
statements are stated in its local currency, Renminbi (RMB), as their functional
currency. Results of operations are translated at average exchange rates during
the period, assets and liabilities are translated at the unified exchange rate
as quoted by the People's Bank of China at the end of each reporting period, and
equity are stated at their historical rates. Cash flows are also translated at
average translation rates for the period, therefore, amounts reported on the
statement of cash flows will not necessarily agree with changes in the
corresponding balances on the balance sheet.
This 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 Bank of China or other institutions
requires submitting a payment application form together with invoices, shipping
documents and signed contracts.
Translation adjustments resulting from this process are included in accumulated
other comprehensive income in the consolidated statement of shareholders' equity
and amounted to $1,457,028 and $774,891 at March 31, 2008 and December 31, 2007,
respectively. Assets and liabilities at March 31, 2008 and December 31, 2007
were translated at 7.00 and 7.29 RMB to $1.00. The average translation rates
applied to income statement accounts, statement of cash flows for the three
months ended March 31, 2008 and 2007 were 7.15 and 7.75 RMB to $1.00,
respectively. Cash flows are also translated at average translation rates for
the period, therefore, amounts reported on the statement of cash flows will not
necessarily agree with changes in the corresponding balances on the balance
sheet.
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. These amounts are immaterial
to the consolidated financial statements.
Earnings per Share
The Company adopted Statement of Financial Accounting Standards No. 128,
"Earnings per Share" (SFAS128). SFAS 128 requires the presentation of earnings
per share (EPS) as Basic and Diluted EPS. Basic earnings per share are
calculated by taking net income divided by the weighted average shares of common
stock outstanding during the period. Diluted earnings per share is calculated by
taking basic weighted average shares of common stock and increasing it for
dilutive common stock equivalents such as preferred stock, as well as warrants
and options that are in the money.
Under SFAS 150 "Accounting for Certain Financial Instruments with
Characteristics of both Liabilities and Equity", entities that have issued
mandatory redeemable shares of common stock or entered into forward contracts
that require physical settlement by repurchase of a fixed number of the issuer's
equity shares of common stock in exchange for cash shall exclude the common
shares that are to be redeemed or repurchased in calculating basic and diluted
earnings per share. Thus, the redeemable shares described in Note 14 have been
excluded from the March 31, 2008 earnings per share calculations.
12
CHINA BIOPHARMACEUTICALS HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2008
(Unaudited)
- --------------------------------------------------------------------------------
The Company determined that all the warrants were anti-dilutive because the
exercise prices were higher than average market price in the period presented.
The convertible preferred stock was anti-dilutive for the three months ended
March 31, 2007 because the Company recorded net loss for the period. For the
three months ended March 1, 2008, the convertible preferred stock of 50,000 was
considered to have diluted effect.
The following is a reconciliation of the basic and diluted earnings per share
computations for the three months ended March 31, 2008 and 2007:
2008 2007
------------ ------------
For the three months ended March 31, 2008 and 2007
Net income(loss) for basic and diluted earnings per share $ 492,076 $ (88,268)
============ ============
Weighted average shares used in basic computation 36,490,312 36,027,615
Diluted effect of Series A preferred stock 50,000 --
------------ ------------
Weighted average shares used in diluted computation 36,540,312 36,027,615
============ ============
Earnings (loss) per share:
Basic $ 0.013 $ (0.002)
============ ============
Diluted $ 0.013 $ (0.002)
============ ============
Shares Subject to Mandatory Redemption
The Company adopted SFAS 150, "Accounting for Certain Financial Instruments with
Characteristics of both Liabilities and Equity". SFAS 150 established
classification and measurement standards for three types of freestanding
financial instruments that have characteristics of both liabilities and equity.
Instruments within the scope of SFAS 150 must be classified as liabilities
within the Company's Consolidated Financial Statements and be reported at
settlement date value. The Company issued redeemable stock in November 2007
related to the settlement of notes payables owed to RimAisa. The amount of
redeemable stock was presented as a liability on the balance sheet at the fair
market value plus the accrued interest expense at the balance sheet date.
Recent Accounting Pronouncements
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for
Financial Assets and Financial Liabilities--including an amendment of FASB
Statement No. 115 ("FAS 159"). FAS 159 permits companies to choose to measure
many financial instruments and certain other items at fair value that are not
currently required to be measured at fair value. The objective of FAS 159 is to
provide opportunities to mitigate volatility in reported earnings caused by
measuring related assets and liabilities differently without having to apply
hedge accounting provisions. FAS 159 also establishes presentation and
disclosure requirements designed to facilitate comparisons between companies
that choose different measurement attributes for similar types of assets and
liabilities. The Company chose not to elect the option to measure the fair value
of eligible financial assets and liabilities.
13
CHINA BIOPHARMACEUTICALS HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2008
(Unaudited)
- --------------------------------------------------------------------------------
In June 2007, the FASB issued FASB Staff Position No. EITF 07-3, "Accounting for
Nonrefundable Advance Payments for Goods or Services Received for use in Future
Research and Development Activities" ("FSP EITF 07-3"), which addresses whether
nonrefundable advance payments for goods or services that used or rendered for
research and development activities should be expensed when the advance payment
is made or when the research and development activity has been performed. The
Company is currently evaluating the effect of this pronouncement on financial
statements.
In December 2007, the FASB issued SFAS No. 160,"Noncontrolling Interests in
Consolidated Financial Statements - an amendment of Accounting Research Bulletin
No. 51" ("SFAS 160"), which establishes accounting and reporting standards for
ownership interests in subsidiaries held by parties other than the parent, the
amount of consolidated net income attributable to the parent and to the
non-controlling interest, changes in a parent's ownership interest and the
valuation of retained non-controlling equity investments when a subsidiary is
deconsolidated. The Statement also establishes reporting requirements that
provide sufficient disclosures that clearly identify and distinguish between the
interests of the parent and the interests of the non-controlling owners. SFAS
160 is effective for fiscal years beginning after December 15, 2008. The Company
has not determined the effect that the application of SFAS 160 will have on its
consolidated financial statements.
In December 2007, Statement of Financial Accounting Standards No. 141(R),
Business Combinations, was issued. SFAS No. 141R replaces SFAS No. 141, Business
Combinations. SFAS 141R retains the fundamental requirements in SFAS 141 that
the acquisition method of accounting (which SFAS 141 called the purchase method)
be used for all business combinations and for an acquirer to be identified for
each business combination. SFAS 141R requires an acquirer to recognize the
assets acquired, the liabilities assumed, and any non-controlling interest in
the acquiree at the acquisition date, measured at their fair values as of that
date, with limited exceptions. This replaces SFAS 141's cost-allocation process,
which required the cost of an acquisition to be allocated to the individual
assets acquired and liabilities assumed based on their estimated fair values.
SFAS 141R also requires the acquirer in a business combination achieved in
stages (sometimes referred to as a step acquisition) to recognize the
identifiable assets and liabilities, as well as the non-controlling interest in
the acquiree, at the full amounts of their fair values (or other amounts
determined in accordance with SFAS 141R). SFAS 141R applies prospectively to
business combinations for which the acquisition date is on or after the
beginning of the first annual reporting period beginning on or after December
15, 2008. An entity may not apply it before that date. The Company is currently
evaluating the impact that adopting SFAS 141R will have on its financial
statements.
In March 2008, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 161, "Disclosures about
Derivative Instruments and Hedging Activities - An Amendment of SFAS No. 133"
("SFAS 161"). SFAS 161 seeks to improve financial reporting for derivative
instruments and hedging activities by requiring enhanced disclosures regarding
the impact on financial position, financial performance, and cash flows. To
achieve this increased transparency, SFAS 161 requires (1) the disclosure of the
fair value of derivative instruments and gains and losses in a tabular format;
(2) the disclosure of derivative features that are credit risk-related; and (3)
cross-referencing within the footnotes. SFAS 161 is effective on January 1,
2009. The Company is in the process of evaluating the new disclosure
requirements under SFAS 161.
14
CHINA BIOPHARMACEUTICALS HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2008
(Unaudited)
- --------------------------------------------------------------------------------
Reclassifications
Certain prior period amounts have been reclassified to conform to current
period's presentation. Those reclassifications had no material effect on
operations or cash flows. Further, the financial statements as of and for the
three months ended March 31, 2007 have been restated to reflect Enshi as a
discontinued operation for comparison purposes.
Note 4 - SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
o Interest expense paid amounted to $0 and $779,789 for the three months
ended March 31, 2008 and 2007, respectively.
o No income tax was paid for the three months ended March 31, 2008 and
2007.
Note 5 - ACCOUNTS RECEIVABLE
Accounts receivable are carried at original invoice amount less an estimate made
for doubtful receivables based on a review of all outstanding amounts on a
monthly basis. Management's judgment and estimates are made in connection with
establishing the allowance for doubtful accounts. Specifically, the Company
analyzes the aging of accounts receivables balances, historical bad debts,
customer concentrations, customer credit-worthiness, current economic trends and
changes in our customer payment terms. Significant changes in customer
concentrations or payment terms, deterioration of customer credit-worthiness or
weakening economic trends could have a significant impact on the collectibility
of the receivables and our operating results. If the financial condition of our
customers were to deteriorate, resulting in an impairment of their ability to
make payments, additional allowance may be required. The reserve for bad debts
was $1,313,177 and $1,260,760 at March 31, 2008 and December 31, 2007,
respectively.
Accounts receivable consisted of the following:
March 31, December 31,
2008 2007
(Unaudited)
----------- -----------
Accounts receivable $ 5,674,554 $ 4,812,243
Allowance for doubtful accounts (1,313,177) (1,260,760)
----------- -----------
Accounts receivable, net $ 4,361,377 $ 3,551,483
=========== ===========
15
CHINA BIOPHARMACEUTICALS HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2008
(Unaudited)
- --------------------------------------------------------------------------------
Note 6 - INVENTORIES
Inventories consisted of the following:
March 31, December 31,
2008 2007
(Unaudited)
---------- ----------
Raw materials $2,104,215 $1,858,866
Refinery materials 2,930,894 3,139,200
Packaging supplies 291,338 239,624
Sundry supplies 14,205 11,984
Work in process 520,708 351,611
Finished goods 3,720,207 3,360,770
---------- ----------
Total inventories $9,581,567 $8,962,055
========== ==========
Note 7 - PLANT AND EQUIPMENT
Plant and equipment consisted of the following:
March 31, December 31,
2008 2007
(Unaudited)
------------ ------------
Plant $ 2,381,094 $ 2,286,051
Office equipment 26,240 25,478
Machinery 6,728,998 6,368,927
Automobile 181,227 228,043
Construction in progress 2,237,627 185,963
------------ ------------
Total plant and equipment 11,555,186 9,094,462
Less: accumulated depreciation (5,324,447) (4,972,293)
------------ ------------
Plant and equipment, net $ 6,230,739 $ 4,122,169
============ ============
Depreciation expense for the three months ended March 31, 2008 and 2007 amounted
to $143,805 and $121,156, respectively. As of March 31, 2008 and 2007,
no interest was capitalized in construction in process.
The construction in progress includes amount spent on the construction of Erye's
new plant. According to the Section 7.3 of the Acquisition Agreement signed on
June 11, 2005 between CBH and Erye, Erye will relocate, and CBH or the investors
introduced by CBH promises to bear the removal fees and construction fees for
Erye's new plant, and all assets generated from this relocation belongs to Erye.
Due to the financial difficulties of CBH, the construction is funded by Erye's
cash flows from operations. CBH and Erye have been in discussions with respect
to the funding of this project and related obligations.
16
CHINA BIOPHARMACEUTICALS HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2008
(Unaudited)
- --------------------------------------------------------------------------------
Note 8- OTHER ASSETS
Intangible Assets
Intangible assets include land use rights and drug patents, and consist of the
following:
March 31, December 31,
2008 2007
(Unaudited)
----------- -----------
Land use rights:
Erye $ 5,501,781 $ 5,282,173
CBH 2,406,464 2,406,464
----------- -----------
Total land use rights 7,908,245 7,688,637
Less: accumulated amortization (531,458) (459,333)
----------- -----------
Land use rights, net 7,376,787 7,229,304
----------- -----------
Patent:
Approved drugs 336,008 322,596
Less: accumulated amortization (164,743) (153,711)
----------- -----------
Patents, net 171,265 168,885
----------- -----------
Total intangible assets, net $ 7,548,052 $ 7,398,189
=========== ===========
Land use rights are pledged as collateral for bank loans. Amortization expense
on intangible assets for the three months ended March 31, 2008 and 2007 were
$61,597 and $25,360, respectively.
Restricted Cash
Restricted cash represents cash required to be deposited with banks for the
balance of bank notes payable but are subject to withdrawal with restrictions
according to the agreement with the bank and saving accounts. The required
deposit rate is approximately 30-50% of the notes payable. Given the nature of
the restricted cash, it is reclassified as a financing activity in Statement of
Cash Flows. The following lists the depositors, the amount and names of the
banks as of March 31, 2008 and December 31, 2007:
March 31, December 31,
2008 2007
Name of Bank (Unaudited)
- -------------------------------------- -------- --------
Hua Xia Bank, Suzhou $ 366 $164,871
Industrial and commercial bank, Suzhou 188,496 353,718
China CITIC Bank 566,559
-------- --------
Total $755,421 $518,589
======== ========
Long Term Notes Receivable
Long term notes receivable represents loans made to third parties for cash flow
needs for R&D projects on new drugs. The Company has first priority to purchase
the new drug rights if the projects are successfully completed. If the Company
gives up the right, the debtors are required to repay the loans plus 3% interest
per annum within one month after the drug rights are sold to another party. If
on or before February 28, 2010, the R&D projects are not completed or failed,
the debtors are required to repay the loans plus 6% interest per annum within
ten days after such a conclusion was made. As of March 31, 2008 and December 31,
2007, the total amount of the long term notes receivable was $571,200 and
$640,518, respectively, where 51% of ownership equity of the debtor was pledged
for the loan. Management believes the likelihood of repayment to be collected is
high based on the above conditions and the well financial conditions of the
counter parties.
17
CHINA BIOPHARMACEUTICALS HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2008
(Unaudited)
- --------------------------------------------------------------------------------
Note 9- RELATED PARTIES TRANSACTIONS
Accounts Receivables - Related Parties
Accounts receivable - related parties consist of the following:
March 31, December 31, Manner of
2008 2007 Due From Term Settlement
- ---- ----------- ----------- ------------ --------- ----------
Erye $ 122,270 41,932 Hainan Kaiye Short Term Cash
Other Receivables - Related Parties
Other receivable - related parties consisted of the following balances where
Hainan Kaiye and Erye Trading are companies owned by minority shareholders of
Suzhou Erye Pharmaceutical Limited Company and Hengyi is the discontinued
subsidiary since August 28, 2006.
March 31, December 31, Manner of
2008 2007 Due From Term Settlement
- ---- ----------- ----------- ------------ --------- ----------
Erye $ 853,697 $ 819,621 Hainan Kaiye Short Term Cash
Erye -- -- Erye Trading Short Term Cash
CBH 70,629 -- Enshi Short Term Cash
- ----- ----------- -----------
Total $ 924,326 $ 819,621
=========== ===========
Loan to Shareholder and Officer
March 31, December 31, Manner of
2008 2007 Due From Term Settlement
- ------ ----------- ----------- ------------ --------- ----------
Keyuan $ 47,124 $ 45,243 Keyuan's Short Term Cash
shareholder
Other Payables - Related Parties
March 31, December 31, Manner of
2008 2007 Due From Term Settlement
- ---- ----------- ----------- ------------ ---------- ----------
Erye $ 671,555 $ 644,750 Erye Trading Short Term Cash
Other Payables- Related Parties, Shareholders
March 31, December 31, Manner of
2008 2007 Due From Term Settlement
- ------ ----------- ----------- ------------ --------- ----------
CBH $ -- $ 43,961 Chris Peng Mao Short Term Cash
Keyuan 653 627 Lufan An & Short Term Cash
- ------ ----------- ----------- Xiaohao Liu
Total $ 653 $ 44,588
=========== ===========
Long Term Other Receivables - Related Parties
March 31, December 31, Manner of
2008 2007 Due From Term Settlement
- ------ ----------- ----------- -------------- --------- ----------
CBH $ 224,928 $ 267,768 Suzhou Heng yi Long Term Cash
18
CHINA BIOPHARMACEUTICALS HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2008
(Unaudited)
- --------------------------------------------------------------------------------
Note 10 - NOTES PAYABLE
The Company's subsidiary, Erye, has $2,516,850 and $1,727,460 in notes payable
to Erye's vendors for the purchase of drug raw materials for the three months
ended March 31, 2008 and for the year ended December 31, 2007, respectively.
Notes payable are interest free and usually mature after a six month period.
Note 11 - STATUTORY RESERVES
According to Chinese corporation law, a company incorporated in China is
required to contribute an amount of no less than 10% of its yearly net income
for its employees to a reserve account in the company.
This statutory reserve fund is planned for future development of the company or
use for employee's benefits. These reserves represent restricted retained
earnings. The following table list the provision of statutory reserves
contributed as of March 31, 2008.
Year Amount Description
- -------- ------------- --------------------------------------------
2004 $ 60,750
2005 383,873 15% of China Subsidiaries' net income
2006 2,080,032 10% of China Subsidiaries' net income
2007 (1,548,216) 10% of Erye's net income, deducted Enshi's
Statutory reserve balance at December
12/31/2006
2008 209,586 10% of China Subsidiaries' net income
=============
Total $ 1,186,025
=============
Note 12 - INCOME TAXES
Corporation Income Tax (CIT)
The Company's subsidiaries operate in China. According to the Chinese Joint
Venture Business Law, these subsidiaries have been registered and incorporated
with the status of Sino-foreign joint venture companies and are subject to a two
year tax exemption and a three year 50% reduction in income tax rates preference
treatment, which generally commences from the first year of establishing a joint
venture or the approval date of the income tax preference application.
Erye was granted income tax exemption for two years commencing from January 1,
2006. Keyuan's total revenue is subject to 1.7% to 3.3% income tax rates depends
on the range of the taxable income. Provision for CIT amounted to $299,409 and
$1,108 for the three months ended March 31, 2008 and 2007, respectively.
Beginning January 1, 2008, the New Enterprise Income Tax ("EIT" law replaced the
existing laws for Domestic Enterprises ("DES") and Foreign Invested Enterprises
("FIEs"). The new standard EIT rate of 25% has replaced the past years of 33%
rate applicable to both DES and FIEs. Companies established before March 16,
2007 will continue to enjoy tax holiday treatment approved by local government
for a grace period of the next 5 years or until the tax holiday term is
completed, whichever is sooner.
The Company's subsidiaries, Suzhou Erye was established before March 16, 2007
and therefore is qualified to continue enjoying the reduced tax rate as
described above. The company is subject to 50% of the 25% EIT tax rate, or 12.5%
from January 1, 2008 through December 31, 2010.
19
CHINA BIOPHARMACEUTICALS HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2008
(Unaudited)
- --------------------------------------------------------------------------------
The following table reconciles the U.S. statutory rates to the Company's
effective tax rate:
March 31,
-----------------------
2008 2007
--------- ---------
U.S. Statutory rate 34.0% 34.0%
Foreign income not recognized in USA (34.0) (34.0)
China income taxes 25.0 33.0
Income tax exempted (12.5) (32.4)
--------- ----------
Total provision for income taxes 12.5% 0.6%
========= ==========
The estimated tax savings due to the reduced tax rate for the three months ended
March 31, 2008 and 2007 are $153,779 and $240,151, respectively. The net effect
on income per share if the income tax had been applied would decrease income per
share by $0.0042 for three months ended March 31, 2008. The net effect on loss
per share if the income tax had been applied would decrease net loss per share
for three months ended March 31, 2007 by $0.0067.
Business Tax
The Company is subject to business tax, which is charged on the selling price of
applicable product and service at a general rate of 5% in accordance with the
tax law applicable. Keyuan is exempt from business tax according to local
applicable favorable tax policy.
Value Added Tax ("VAT")
In accordance with the relevant taxation laws in China, the VAT rate for
domestic sales is 17% and 0% for export sales on the invoiced value of sales and
is payable by the purchaser. A credit is available whereby VAT paid on the
purchases of semi-finished products or raw materials used in the production of
the Company's finished products can be used to offset the VAT due on sales of
the finished product.
VAT on sales and VAT on purchases amounted to $1,863,365 and $1,574,092 for
three months ended March 31, 2008, and $1,079,162 and $837,647, respectively for
the same period in 2007. Sales and purchases are recorded net of VAT collected
and paid as the Company acts as an agent for the government. VAT taxes are not
impacted by the income tax holiday.
Note 13 - LOANS
Short Term Bank Loans
The Company has a total of $2,184,840 and $2,371,830 in short term loans from
different banks in China at March 31, 2008 and December 31, 2007, respectively.
These loans are mature in one year or less and renew automatically. The average
interest rates were approximately 7.95% and 7.33% respectively. Bank loans were
collateralized by the land use right and buildings of Erye.
Interest expense for the three months ended March 31, 2008 and 2007 were
$356,595 and 34,351, respectively.
20
CHINA BIOPHARMACEUTICALS HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2008
(Unaudited)
- --------------------------------------------------------------------------------
Note 14 - Redeemable Preferred Stock
On November 16, 2007, the Company entered a conditional loan conversion
agreement (the "Agreement") with RimAsia, under which the principal amount of
the $11.5 million Loan owed to RimAsia in connection with the Enshi acquisition
plus unpaid interest of $1,008,534 (combined total of $12,508,534) was converted
in full into 6,185,607 shares of Series B redeemable convertible preferred
shares of the Company ("Series B Preferred Shares") at an effective conversion
price at $2.0222 per preferred share. Each Series B Preferred Shares may be
converted into two shares of common stock. Additionally, the exercise price of
$1.375 for the 12 million existing warrants exercisable into the Company's
common stock previously issued to and currently held by RimAsia in connection
with the extension of the Loan financing ("Existing Warrants") was lowered to
$1.26 per share and the term of the Existing Warrants extended to 4.5 years from
the closing date. This Agreement is conditioned on the subsequent completion of
at least one of sizeable acquisition by the end of June 2008.
According to the Agreement, the Series B preferred stock are subject to optional
redemption at the Company's option before the 4th anniversary of issuance date
and mandatory redemption at the investors of the Company's option thereafter.
The Company maybe required to repurchase the remaining Series B preferred stock
four years after the closing date at a per share price of the sum of (1) the
original Series B issue price $2.0222 per share; (2) all accrued but unpaid
annual dividends; (3) 5% of the original Series B issue price per annum accrued
from the occurrence of certain triggering events, such as the Company's failure
to pay annual dividends, mandatory redemption price or any other amount due.
Pursuant to SFAS 150, the 6,185,607 shares of Series B preferred stock was
recorded as liability due to the mandatory redemption feature. The shares were
recorded at fair value on the date of issuance and any accrued interest expense
at the reporting dates. As of March 31, 2008, balance of redeemable preferred
stock amounted to $12,897,497, in which $388,963 was the accrued interest
expense for the period of November 16, 2007 through March 31, 2008.
The holders of the Series B Preferred Shares shall be entitled to receive an
annual dividend of 5% of the original issue price ($2.0222 per share) and
dividend is payable annually on January 1st in either cash or in kind determined
by the Board of directors. Accrued dividend payable at March 31, 2008 amounted
to $311,856. Further, since the Company did not make a dividend payment to the
shareholders on time pursuant to the Agreement, the Company has to accrue an
additional 5% of the original issue price of Series B Preferred Shares per
annum, effective January 1, 2008, as an addition to the redemption price. As of
March 31, 2008, $155,928 of penalty was included in the accrued dividend
payable.
Note 15 - COMMITMENTS AND CONTINGENCIES
Operating Leases
The Company leases office space from third parties. Accordingly, for the three
months ended March 31, 2008 and 2007, the Company recognized rent expense of
$33,443 and $30,868, respectively.
As of March 31, 2008, the Company has outstanding commitments in respect to
non-cancelable operating leases as follows:
Amount
-------
For the year ended December 31, 2008 $33,443
Thereafter --
-------
Total $33,443
=======
21
CHINA BIOPHARMACEUTICALS HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2008
(Unaudited)
- --------------------------------------------------------------------------------
Research and Development Contract
On November 5, 2007, the Company entered into a new drug development contract
with a third party ("the Developer"). Pursuant to the contract, the Developer
will transfer a drug patent to the Company, and also is responsible for
obtaining the New Drug Certificate and the Drug Manufacturing Approval from the
PRC Drug Administration Authority no later than July 1, 2009. In exchange, the
Company will pay up to RMB12 million (approximately $1.6 million) to the
Developer. Of the total $1.6 million, approximately $933,800 and $266,800 will
need to be paid before December 31, 2007 and February 25, 2008, respectively,
and the final payment ranging from $0 to $400,200 (depending on the date of the
Manufacturing Approval) needs to be paid no later than 10 days after the grant
date of the Manufacturing Approval. Further, the two parties agreed that the
Company will pay sales commission to the Developer based on the sales volume of
the contracted new drug during a 10 year period after this drug is put into
production. If the PRC Drug Administration Authority denies the application of
the Drug Manufacturing, all payments made by the Company would be fully returned
to the Company by the Developer. The Company had paid $999,600, or RMB 7,000,000
by March 31, 2008.
Legal Proceedings
In March 2007, the Company identified non-existent trade accounts receivable
acquired in the acquisition of Enshi. The Company has commenced legal proceeding
for damages of $10,000,000 against Mr. Li Xiaobo ("Mr. Li"), the previous owner
and controlling shareholder of Enshi, and his related parties ("Defendants") for
breach of representations and warranties and fraud. ("LXB Litigation") The Hong
Kong courts frozen approximately $10,000,000 worth of assets per the court order
in Hong Kong and the Defendants lost their opposition actions against the
seizure order. The company is has been waiting for the court hearing in HK
court. The Company reasonably expects to prevail in the lawsuit against the
Defendants. The Company reserves the right to take further actions if necessary
to seek additional damages and compensation for these serious breaches of
representations and warranties and fraud and will make appropriate disclosures
pending the legal proceedings. In April 2007, the Company lost an action in a
court in Shenyang, China to offset claims against Mr. Li and against Mr. Li's
working capital loan to Enshi. The court decided to view each action separately
on its own merit. The Company paid the amount of $560,735 due to Liao Ning Xie
He and $86,765 due to Mr. Li. The Company reserves the right to take additional
actions against Mr. Li and will continue its proceedings in other courts outside
as well as in China.
On November 16, 2007 and amended on January 22, 2008, the Company and RimAisa
entered into a litigation agreement ("Litigation Agreement"). Pursuant to this
Litigation Agreement, if RimAisa or RACP (as the plaintiff) prevail in the LXB
Litigation or the settlement is reached, any judgment awards, settlement amount
and salvage value realized from Enshi, would be firstly used to reimburse all
the legal and related expenses incurred by RimAsia in the LXB Litigation, up to
$4,000,000, and the remaining amounts of the judgment proceeds would be entitled
to the Company. If RimAisa and the Company do not prevail in the LXB Litigation,
RACP should be returned to CBH and all the proceeds of any sale of liquidation
of Enshi or any assets of or interest in Enshi shall be distributed as agreed by
both parties. In addition, all the costs and expenses (including attorneys'
fees) incurred by or on behalf of the plaintiffs shall be borne 55% by RimAsia
and 45% by the Company.
22
CHINA BIOPHARMACEUTICALS HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2008
(Unaudited)
- --------------------------------------------------------------------------------
Note 16 - BUSINESS COMBINATIONS
Discontinued Operation - Shenyang Enshi
We acquired Shenyang Enshi Pharmaceutical Limited Company ("Enshi") on June 6,
2006. Subsequent to the acquisition of Enshi, the Company identified fraud by
the previous owner and controlling shareholder of Enshi, Mr. Li Xiaobo and his
related parties ("Defendants") and breaches in the representations and
warranties provided by him to the Company and the Defendants' including their
refusal to honor their indemnification obligations to the Company. The Company's
subsidiary RACP filed a lawsuit against the Defendants alleging fraud and had
requested rescission of the agreement and damages. Enshi's operations have been
interfered with and as a result the Company decided to suspend its operations in
the third quarter of 2007. In addition, Enshi has been taken over by RimAsia in
July 2007 since Enshi was pledged as collateral for the $11.5 million loan owed
to RimAsia in connection with the Enshi Acquisition. As a result, Enshi is no
longer a subsidiary of the Company. Due to the uncertainty on the amount to be
recovered from the lawsuit, management has decided to write off the entire
carrying value of Enshi in third quarter of 2007 and has reported a loss on
discontinued operations in the consolidated financial statements. The recovered
value of Enshi after the completion of the litigation against Li Xiaobo, if any,
will be recognized as income.
23
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion and analysis should be read in conjunction with
the consolidated financial statements and related notes thereto. The following
discussion contains forward-looking statements. China Biopharmaceuticals
Holdings, Inc. is referred to herein as "we", "our,", "us", or "the Company".
The words or phrases "would be," "will allow," "expect to", "intends to," "will
likely result," "are expected to," "will continue," "is anticipated,"
"estimate," or similar expressions are intended to identify forward-looking
statements. Such statements include those concerning our expected financial
performance, our corporate strategy and operational plans. Actual results could
differ materially from those projected in the forward-looking statements as a
result of a number of risks and uncertainties, including: (a) those risks and
uncertainties related to general economic conditions in China, including
regulatory factors that may affect such economic conditions; (b) whether we are
able to manage our planned growth efficiently and operate profitable operations,
including whether our management will be able to identify, hire, train, retain,
motivate and manage required personnel or that management will be able to
successfully manage and exploit existing and potential market opportunities;(c)
whether we are able to generate sufficient revenues or obtain financing to
sustain and grow our operations; and (d) whether we are able to successfully
fulfill our primary requirements for cash which are explained below under
"Liquidity and Capital Resources". Statements made herein are as of the date of
the filing of this Form 10-Q with the Securities and Exchange Commission and
should not be relied upon as of any subsequent date. Unless otherwise required
by applicable law, we do not undertake, and we specifically disclaim any
obligation, to update any forward-looking statements to reflect occurrences,
developments, unanticipated events or circumstances after the date of such
statement.
OUR BUSINESS
We are a vertically integrated bio-pharmaceutical company focused on
developing, manufacturing and distributing innovative drugs in the People's
Republic of China ("China" or PRC"). Our mission is to maximize investment
returns for our shareholders by integrating our strong drug discovery and
development strength with manufacturing and commercialization capabilities and
by actively participating in the consolidation and privatization of the
pharmaceutical industry in China to become a dominant player in the
bio-pharmaceutical industry in China.
CRITICAL ACCOUNTING POLICIES
We have identified the policies below as critical to understanding of our
financial statements. The application of these polices requires management to
make estimates and assumptions that affect the valuation of assets and expenses
during the reporting period. There can be no assurance that actual results will
not differ from these estimates. The impact and any associated risks related to
these policies on our business operations are discussed below.
REVENUE AND REVENUE RECOGNITION
For fixed-price refundable contracts, we recognize revenue on a milestone
basis. Progress payments received/receivables are recognized as revenue only if
the specified milestone is achieved and accepted by the customer. Confirmed
revenue is not refundable and continued performance of future research and
development services related to the milestone are not required. For sale of
patented pharmaceutical formulas, the Company recognizes revenue upon delivery
of the patented formulas. For sales of final medicines and processed materials,
we recognize revenue upon delivery of the goods. The company usually does not
offer sales returns or refunds on the products except for some specific
circumstances, such as quality problems, which is rare and is difficult to have
an accurate estimate.
24
ACCOUNTS RECEIVABLE
Accounts receivable are carried at original invoice amount less an estimate
made for doubtful receivables based on a review of all outstanding amounts on a
monthly basis. Management judgment and estimates are made in connection with
establishing the allowance for doubtful accounts. Specifically, we analyze the
aging of accounts receivable balances, historical bad debts, customer
concentrations, customer credit-worthiness, current economic trends and changes
in our customer payment terms. Significant changes in customer concentration or
payment terms, deterioration of customer credit-worthiness or weakening in
economic trends could have a significant impact on the collectibility of
receivables and our operating results. If the financial condition of our
customers were to deteriorate, resulting in an impairment of their ability to
make payments, additional allowances may be required. The reserve for bad debts
increased to $1,313,177 at March 31, 2008 from $1,260,760 at December 31, 2007.
This increase represents 0.42% of total revenues and is mainly resulted from
change in the exchange rate of RMB to USD. As of March 31, 2008, accounts
receivable, net of allowance for doubtful accounts, amounted to $4,361,377. The
days sales outstanding were 80 days for three months ended March 31, 2008,
compared to 78 days for the same period in 2007. The increase in the collection
period was mainly resulted from the slow collection of AR from Keyuan's
customers due to the enhanced government regulations on R&D activities. Also, in
2007, we approved to extend payment term for several major customers, which
slightly slowed down the collection of accounts receivable.
The following table provides the roll forward of the allowance of doubtful
accounts:
Allowance for doubtful accounts
As of December 31, 2007 $ 1,260,760
Foreign currency translation adjustment 52,417
-----------
As of March 31, 2008 $ 1,313,177
===========
The following list the aging of our accounts receivable as of March 31, 2008:
3 months 6 months 9 months Over 9 months Over 1 year
Total Amount % Amount % Amount % Amount % Amount %
5,674,554 4,077,730 71.9 192,197 3.4 80,237 1.4 74,299 1.3 1,250,091 22
We prepare the above consolidated aging based on the aging for each subsidiary
in above format. As each subsidiary of the Company conducts business with
different customers with different size and creditworthiness, and each
subsidiary has different impact on and different relationship with their
customers, we determine the allowance on an individual basis. Basically, we
assign various rates to each of the aging group of AR and add up the products
for respective aging group to the total allowance for doubtful accounts.
Different subsidiaries have different rates for even the same aging category. In
addition to that, we also consider the changes in specific financial condition
of their customers if situation or events indicate that some accounts may pose
unusual risk compared to others, additional allowance may be provided for those
accounts.
INCOME TAX
Significant judgment is required in determining our income tax provision.
In the ordinary course of business, there are many transactions and calculations
where the ultimate tax outcome is uncertain. Although we believe that our
estimates are reasonable, no assurance can be given that the final outcome of
these matters will not be different than that which is reflected in our
historical income tax provisions and accruals. Such differences could have a
material effect on our income tax provision and net income in the period in
which such determination is made. We apply an asset and liability approach to
accounting for income taxes. Deferred tax liabilities and assets are recognized
for the expected future tax consequences of temporary differences between the
financial statement and tax bases of assets and liabilities using enacted tax
rates in effect for the year in which the differences are expected to reverse.
The recoverability of deferred tax assets is dependent upon our assessment of
whether it is more likely than not that sufficient future taxable income will be
generated to utilize the deferred tax asset. In the event we determine that
future taxable income will not be sufficient to utilize the deferred tax asset,
a valuation allowance is recorded.
25
RESULTS OF OPERATIONS - THREE MONTHS ENDED MARCH 31, 2008 AS COMPARED TO THREE
MONTHS ENDED MARCH 31, 2007
We acquired Shenyang Enshi Pharmaceutical Limited Company ("Enshi) on June
6, 2006. Upon the acquisition of Enshi the Company identified major breaches and
fraud by the previous owner and controlling shareholders of Enshi, Mr. Li Xiaobo
and his related parties ("Defendants") in the representations and warranties
provided by him to the Company and the Defendants' refusal to honor their
indemnification obligations to the Company. The Company's subsidiary RACP filed
a lawsuit against the Defendants alleging fraud and for rescission and damages.
Enshi's operations have been interfered and as a result we decided to suspend
its operations. In addition, since Enshi was pledged as collateral for the $11.5
million debt owed to RimAsia Capital Partners, L.P. ("RimAsia") in connection
with the Enshi Acquisition, Enshi was taken over by RimAsia in July 2007. As a
result, Enshi is no longer a subsidiary of the Company. Due to the uncertainty
on the amount to be recovered from the lawsuit, our management decided to write
off the total carrying value of Enshi in the third quarter of 2007 and report it
as discontinued operations in the consolidated financial statements.
Accordingly, assets, liabilities and operating results that were attributed to
Enshi are presented as discontinued operations. The recovered value of Enshi, if
any, after the completion of the litigation against the Defendants will be
recognized as income. Under Statement of Financial Accounting Standards No. 144
("SFAS 144"), when a component of an entity, as defined in SFAS 144, has been
disposed of or is classified as held for sale, the results of its operations,
including the gain or loss on its disposal should be classified as discontinued
operations and the assets and liabilities of such component should be classified
as assets and liabilities attributed to discontinued operations, that is
provided that the operations, assets and liabilities and cash flows of the
component have been eliminated from the company's consolidated operations and
the Company will no longer have any significant continuing involvement in the
operations of the component.
Therefore, the results of Enshi's operations and cash flows for the three months
ended March 31, 2007 were reported as discontinued operations in our
consolidated financial statements.
REVENUE
Revenue for the three months ended March 31, 2008 was $10,973,241 while the
revenue for the three months ended March 31, 2007 was $6,155,560, representing
an approximately 77.7% increase. The increase is mainly attributed to three
reasons. First is the rise in selling price and sales of Erye's raw material
drugs. Second, the reform of medical insurance system in rural areas of China
promotes the sales of Erye's drugs. Third, the selling price of the freeze-dried
drugs has increased.
COST OF GOODS SOLD
Cost of goods sold for the three months ended March 31, 2008 was $7,711,162
as compared to $4,685,102 for the three months ended March 31, 2007. Cost of
goods sold as a percentage of sales revenues was approximately 70.3% for the
three months ended March 31, 2008 as compared to approximately 76.1% for the
three months ended March 31, 2007. The increase in cost of goods sold is mainly
attributed to the increase of sales.
GROSS PROFIT
Gross profit in the three months ended March 31, 2008 amounted at
$3,262,079, as compared to $1,470,458 for the three months ended March 31, 2007,
representing approximately 121.8% increase. The gross profit margin for the
three months ended March 31, 2008 was 29.7% as compared to approximately 23.9%
for the three months ended March 31, 2007. The increase is attributed primarily
to the increase of the gross profit of the freeze-dried drugs and raw material
drugs.
OPERATING EXPENSES
Operating expenses for the three months ended March 31, 2008 was $1,092,744
as compared to $946,663 for the three months ended March 31, 2007, representing
15% increase. The increase is attributed mainly to higher operational expenses
of Suzhou Erye due to advertising expenses.
RESEARCH AND DEVELOPMENT
Research and development costs for the three months ended March 31, 2008
were $17,947 as compared to $43,163 for the three months ended March 31,
2007,representing a 58% decrease. This decrease was primarily attributed to the
slowing down of drug approval of China FDA and new regulation policies.
INCOME FROM OPERATIONS
Income from operations in the three months ended March 31, 2008 amounted at
$2,169,335, as compared to $523,795 for the three months ended March 31, 2007,
representing approximately 314% increase. The increase is mainly attributable to
Erye's strong performance in sales and increased gross margin.
NET INCOME
Net income for the three months ended March 31, 2008 was $492,076 as
compared to net loss of $88,268 for the three months ended March 31, 2007,
representing 657% increase. The increase is attributed to Erye's strong
operating performance and increased profit margin.
26
LIQUIDITY AND CAPITAL RESOURCES
As of March 31, 2008, total current assets were $18,989,225 and total
current liabilities were $30,554,813. Cash and cash equivalents on March 31,
2008 was $1,764,561, an increase of $1,094,862 from the $669,699 reported on
December 31, 2007.
For the three months ended March 31, 2008, net cash provided by continuing
operating activities was $2,278,687 net cash used in continuing investing
activities was $1,806,227, net cash provided by continuing financing activities
was $414,375. For the three months ended March 31, 2007, net cash used in
continuing operating activities was $332, 580, net cash provided by continuing
investing activities was $7,700, net cash used in continuing financing
activities was $126,443 Net cash provided by operating activities in the three
months ended March 31, 2008 results primarily from the Company's strong
performance in sales and increase in its profit margin. Cash used for investing
activities during the three months ended March 31, 2008 results mainly from the
construction of the new plant and purchase of equipments.
On November 19, 2007, we entered into an agreement (the "Agreement")
RimAsia as a follow-up to letters of intent signed on July 14, 2007 and August
2, 2007, under which the principal amount of the $11.5 million Loan owed to
RimAsia in connection with the acquisition of Enshi plus unpaid interest of
$1,008,534 (total of $12,508,534) was converted in full into 6,185,607 shares of
senior redeemable convertible preferred shares of the Company ("Preferred
Shares") at a conversion price of $2.0222 per Preferred Share. Each Preferred
Share may be converted into two shares of common stock. Additionally, the
exercise price of US$1.375 for the 12 million existing warrants exercisable into
the Company's common stock previously issued to and currently held by RimAsia in
connection with the extension of the Loan financing ("Existing Warrants") was
lowered to $1.26 per share and the term of the Existing Warrants extended to 4.5
years from the closing date. This is conditioned on the registrant signing a
letter of intent for acquisition of a new company (or for the injection of the
remaining 49% equity stake of Erye not already owned by the registrant) before
January 15, 2008, having such acquisition closed before June 30, 2008. In
connection therewith, the parties also entered into a registration rights
agreement and certain other agreements, and the registrant issued additional
common stock purchase warrant and a modified common stock purchase warrant.
The Enshi acquisition has created a drag on the Company's overall
operational results and expansion plan due to Enshi below-expectation results
and the associated large acquisition financing loan. Upon the acquisition of
Enshi the Company has identified major breaches and fraud by the previous owner
and controlling shareholders of Enshi, Mr. Li Xiaobo and his related parties
("Defendants") in the representations and warranties provided by him to the
Company and the Defendants' refusal to honor their indemnification obligations
to the Company. The Company's subsidiary RACP filed a lawsuit against the
Defendants alleging fraud and for rescission and damages. Currently, RimAsia,
which provided the Company with the Enshi acquisition related financing loan has
taken ownership of RACP, the holding company of Enshi with expectation to return
Enshi to the Defendants. Enshi's operations have been interfered with and as a
result we have decided to suspend its operations. Enshi's operations have been
suspended and Enshi no longer a subsidiary of the Company. Due to the
uncertainty on the amount to be recovered from the lawsuit, our management
decided to write off the total carrying value of Enshi in the third quarter of
2007 and report it as discontinued operations in the consolidated financial
statements. Accordingly, assets, liabilities and operating results that were
attributed to Enshi were written off and presented as discontinued operations.
The recovered value of Enshi, if any, after the completion of the litigation
against the Defendants will be recognized as income.
Our main manufacturing unit, Erye, recorded a significant growth of 80% in
sales revenue for the three months ended March 31, 2008, along the line of our
expectation. The Enshi acquisition may slow down our original expansion plan in
terms of management resources devoted to its operations and integration but we
are still actively looking for growth and expansion opportunities and still
believe in the overall strategy of internal growth and acquisitions. We expect
that the recent changes in our management, whereas Erye's top management, Ms.
ZHANG Jian and Mr. SHI Mingsheng joined our board of directors and are now
playing an active role in our management, will improve our overall
operations,giving play to their industrial and manufacturing and marketing
expertise. Indeed, we returned to profitability during the 3 months period ended
March 31, 2008.
Going forward, our primary requirements for cash consist of: (1) Stabilize
and streamline the Erye operation;(2) acquire additional pharmaceutical
manufacturing companies with GMP standard facilities in order to commercialize
new drugs in our extensive new drug pipeline and further extend of product
pipeline and expand the our sales network (3) continue R&D for more selected new
drug projects (4) build up sales network for new drug distribution. We
anticipate that our internal source of liquid assets may enable us to continue
our operating activities other than acquisition activities for next twelve
months. However, we anticipate that our current operating activities may not
enable us to meet the anticipated cash requirements for future acquisition
activities. External source of capital may be needed for our expansion. We are
exploring bank loans and private equity financing to finance such expenditures
and intend to raise equity through the capital market to allow us to accomplish
our future acquisition goals.
MANAGEMENT ASSUMPTIONS
Management anticipates, based on internal forecasts and assumptions
relating to our current operations, that existing cash and funds generated from
operations may not be sufficient to meet capital requirements for future
acquisition activities. We could therefore be required to seek additional
financing. There can be no assurance that we will be able to obtain such
additional financing at acceptable terms to us, or at all.
EFFECT OF FLUCTUATION IN FOREIGN EXCHANGE RATES
Our operating subsidiaries are located in China. Their business activities
are mainly in China using Chinese Renminbi as the functional currency. The value
of the Renminbi against the U.S. dollar and other currencies may fluctuate and
is affected by, among other things, changes in China's political and economic
conditions. As we rely entirely on revenues earned in China, any significant
revaluation of the Renminbi may materially and adversely affect our cash flows,
revenues and financial condition. For example, to the extent that we need to
convert U.S. dollars we receive from an offering of our securities into Renminbi
for our operations, appreciation of the Renminbi against the U.S. dollar could
have a material adverse effect on our business, financial condition and results
of operations.
27
Conversely, if we decide to convert our Renminbi into U.S. dollars for the
purpose of making payments for dividends on our common shares or for other
business purposes and the U.S. dollar appreciates against the Renminbi, the U.S.
dollar equivalent of the Renminbi we convert would be reduced. To date, however,
we have not engaged in transactions of either type.
Since 1994 China has pegged the value of the Renminbi to the U.S. dollar.
We do not believe that this policy has had a material effect on our business.
However, there have been indications that the Chinese government may be
reconsidering its monetary policy in light of the overall devaluation of the
U.S. dollar against the Euro and other currencies during the last two years. In
July 2005, the Chinese government revalued the Renminbi by 2.1% against the U.S.
dollar, moving from Renminbi 8.28 to Renminbi 8.11 per dollar. As of March 31,
2008, the value of the Renminbi to the U.S. dollar was translated at 7.00 RMB to
$1.00 USD.
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
Not applicable.
Item 4T. Controls and Procedures
Disclosure Controls and Procedures. As of March 31, 2008, we carried out an
evaluation, under the supervision and with the participation of our management,
including our chief executive officer and our chief financial officer, of the
effectiveness of the design and operation of our disclosure controls and
procedures. Based on the foregoing, our chief executive officer and chief
financial officer concluded that our disclosure controls and procedures (as
defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of
1934) were not effective.
During our assessment of the effectiveness of internal control over financial
reporting as of December 31, 2007, our management identified significant
deficiencies related to the following:
1. Accounting and Finance Personnel Weaknesses - The current staff in the
accounting department is relatively inexperienced, and needs substantial
training so as to meet with the higher demands of being a U.S. public company.
The accounting skills and understanding necessary to fulfill the requirements of
U.S. GAAP-based reporting, including the skills of subsidiary financial
statement consolidation, are not at par, which resulted in a less than optimal
segregation of duties relative to key financial reporting functions.
2. Lack of Internal Audit Function - The Company lacks qualified resources to
perform the internal audit functions properly. In addition, the scope and
effectiveness of internal audit function are yet been fully developed.
3. Lack of Internal Audit System - The Company lacked internal audit department,
which was ineffective in preventing and detecting control lapses and errors in
the accounting of certain key areas like revenue recognition, purchase
approvals, inter-company transactions, cash receipt and cash disbursement
authorizations, inventory safeguard and proper accumulation for cost of
products, in accordance with the appropriate costing method used by the Company.
As disclosed in our Management's Annual Report on Internal Control over
Financial Reporting filed with the 2007 Form 10K, the Company's management has
identified the steps necessary to address the material weaknesses described
above and we are in the process to have the remediation procedures implemented.
Changes in Internal Control over Financial Reporting. During the fiscal quarter
ended March 31, 2008, there have been no changes in the Company's internal
control over financial reporting, identified in connection with our evaluation
thereof, that have materially affected, or are reasonably likely to materially
affect, its internal control over financial reporting.
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
None of our directors, officers or affiliates is involved in a proceeding
adverse to our business or has a material interest adverse to our business.
In March 2007, The Company has commenced legal proceeding for recession against
Mr. Li Xiaobo ("Mr. Li") the previous owner and controlling shareholder of Enshi
and his related parties ("Defendants") for breach of representations and
warranties and fraud and frozen approximately $10,000,000 worth of assets per
the court order in Hong Kong and the Defendants lost their opposition actions
against the seizure order. The Company has been waiting for the court hearing
date in HK court. The Company reasonably expects to prevail in the lawsuit
against the Defendants. The Company reserves the right to take further actions
if necessary to seek additional damages and compensation for such serious breach
of representations and warranties and fraud and will make appropriate
disclosures pending the legal proceedings. In April 2007, the Company lost an
action in a court in Shenyang, China to offset claims against Mr. Li against Mr.
Li's working capital loan to Enshi. The court decided to view each action
separately on its own merit. The Company paid the amount of $560,735 due to Liao
Ning Xie He and $86,765 due to Mr. Li. The Company reserves the right to take
additional actions against Mr. Li and will continue its proceedings in other
courts outside as well as in China.
28
Item 1A. RISK FACTORS.
Not applicable
Item 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.
None.
Item 3. DEFAULTS UPON SENIOR SECURITIES.
None.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
There was no matter submitted to a vote of security holders during the fiscal
quarter ended March 31, 2008.
Item 5. OTHER INFORMATION.
None.
ITEM 6. EXHIBITS
The following exhibits are filed as part of this quarterly report on Form 10-Q:
EXHIBIT
NUMBER DESCRIPTION
- ------ --------------------------------------------------------------
31.1 Certification of Chief Executive Officer Pursuant to Section 302
of the Sarbanes-Oxley Act of 2002.
31.2 Certification of Chief Financial Officer Pursuant to Section 302
of the Sarbanes-Oxley Act of 2002.
32.1 Certification of Chief Executive Officer pursuant to Section 906
of the Sarbanes-Oxley Act of 2002
32.2 Certification of Acting Chief Financial Officer pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002
29
SIGNATURES
In accordance with the requirements of the Securities Exchange Act of
1934, as amended, the Registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
CHINA BIOPHARMACEUTICALS HOLDINGS, INC.
By: /s/ Chris Peng Mao
-------------------------------------------
Name: Chris Peng Mao
Title: Chief Executive Officer
Date: May 15, 2008
By: /s/ ZHANG Jian
-------------------------------------------
Name: ZHANG Jian
Title: Chief Financial Officer
Date: May 15, 2008
30