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 September 30, 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
------------------------------
(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 November 14, 2008, 37,082,313 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. 1
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations. 25
Item 3. Quantitative and Qualitative Disclosures About Market Risk. 37
Item 4T. Controls and Procedures. 37
PART II - OTHER INFORMATION
Item 1. Legal Proceedings. 38
Item 1A Risk Factors. 39
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds. 39
Item 3. Defaults Upon Senior Securities. 39
Item 4. Submission of Matters to a Vote of Security Holders. 39
Item 5. Other Information. 39
Item 6. Exhibits. 39
SIGNATURES 40
CHINA BIOPHARMACEUTICALS HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
AS OF SEPTEMBER 30, 2008 AND DECEMBER 31, 2007
September 30, December 31,
2008 2007
------------- --------------
Unaudited
ASSETS
CURRENT ASSETS:
Cash $ 4,857,211 $ 669,699
Short term investment -- 1,096,800
Accounts receivable, trade, net of allowance for doubtful accounts of 4,228,598 3,551,483
$1,405,533 and $1,260,760 at September 30, 2008 and December 31, 2007,
respectively
Accounts receivable, related parties 141,446 41,932
Other receivables 21,592 863,627
Other receivables - related parties 1,444,902 819,621
Advances to suppliers 320,124 797,302
Prepaid expenses 165,339 363,819
Inventories 10,244,494 8,962,055
Loan to shareholders 48,279 45,243
------------- --------------
Total current assets 21,471,985 17,211,581
------------- --------------
PLANT AND EQUIPMENT, net 10,294,403 4,122,169
------------- --------------
OTHER ASSETS:
Intangible asset, net 7,606,319 7,398,189
Long term notes receivable 585,200 640,518
Long term other receivables - related parties 224,928 267,768
Restricted cash 1,566,832 518,589
Advance on patent and right purchase 1,024,100 959,700
Advance on equipment purchase 381,331 --
Other assets 52,611 81,484
------------- --------------
Other assets 11,441,321 9,866,248
------------- --------------
Total assets $ 43,207,709 $ 31,199,998
============= ==============
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 5,597,288 $ 5,988,289
Short-term loans 2,604,140 2,371,830
Other payables 616,362 1,381,462
Other payables - related parties 712,514 689,338
Customer deposits 2,848,834 2,129,318
Notes payable 5,214,132 1,727,460
Taxes payable 2,533,249 1,488,964
Redeemable series B preferred stock 13,521,209 12,585,641
Other accrued liabilities 449,953 281,390
------------- --------------
Total current liabilities 34,097,681 28,643,692
LONG TERM LIABILITIES: 55,545 65,114
------------- --------------
Total liabilities 34,153,226 28,708,806
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COMMITMENTS AND CONTINGENCIES -- --
------------- --------------
MINORITY INTEREST 8,941,658 5,508,061
------------- --------------
SHAREHOLDERS' EQUITY:
Preferred stock, $0.01 par value, 10,000,000 shares authorized; 50,000 500 500
shares issued and outstanding at September 30, 2008 and December 31,
2007, respectively
Common stock, $0.01 par value, 200,000,000 shares authorized; 36,490,312 364,903 364,903
shares issued and outstanding at September 30, 2008 and December 31,
2007, respectively
Paid-in capital 13,199,476 13,199,476
Capital receivable (252,471) (252,471)
Deferred compensation (2,625) (21,375)
Statutory reserves 1,668,259 976,439
Accumulated deficit (16,609,096) (18,059,232)
Accumulated other comprehensive income 1,743,879 774,891
------------- --------------
Total shareholders' equity 112,825 (3,016,869)
------------- --------------
Total liabilities and shareholders' equity $ 43,207,709 $ 31,199,998
============= ==============
The accompanying notes are an integral part of this statement.
- 1 -
CHINA BIOPHARMACEUTICALS HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2008 AND 2007
UNAUDITED
Three months ended Nine months ended
September 30, September 30,
-----------------------------------------------------------
2008 2007 2008 2007
------------ ------------- ------------ -------------
REVENUES $ 12,552,437 $ 8,586,051 $ 36,866,222 $ 22,502,081
COST OF GOODS SOLD 8,580,330 5,968,079 25,506,662 16,532,703
------------ ------------- ------------ -------------
GROSS PROFIT 3,972,107 2,617,972 11,359,560 5,969,378
------------ ------------- ------------ -------------
OPERATING EXPENSES
Research and development 102,701 315,335 362,048 329,603
Selling, general and administrative 1,203,592 2,167,721 3,502,753 4,217,023
------------ ------------- ------------ -------------
Total operating expenses 1,306,293 2,483,056 3,864,801 4,546,626
------------ ------------- ------------ -------------
INCOME FROM OPERATIONS 2,665,814 134,916 7,494,759 1,422,752
------------ ------------- ------------ -------------
OTHER INCOME (EXPENSE)
Interest expense, net (242,018) (410,518) (945,252) (1,042,904)
Other income (expense), net 15,693 (158,562) (14,034) 10,389
------------ ------------- ------------ -------------
Total other expense, net (226,325) (569,080) (959,286) (1,032,515)
------------ ------------- ------------ -------------
INCOME (LOSS) BEFORE INCOME TAXES AND MINORITY INTEREST 2,439,489 (434,164) 6,535,473 390,237
PROVISION FOR INCOME TAXES 377,583 -- 1,008,196 --
------------ ------------- ------------ -------------
INCOME (LOSS) BEFORE MINORITY INTEREST 2,061,906 (434,164) 5,527,277 390,237
MINORITY INTEREST 1,223,579 387,374 3,385,321 1,307,259
------------ ------------- ------------ -------------
INCOME (LOSS) FROM CONTINUING OPERATIONS 838,327 (821,538) 2,141,956 (917,022)
LOSS FROM DISCONTINUED OPERATIONS
Loss from discountinued operations, net of tax effect -- -- -- (22,074)
Loss from disposal of discountinued operations, net of tax effect -- (10,788,868) -- (10,788,868)
------------ ------------- ------------ -------------
Loss from discountinued operations -- (10,788,868) -- (10,810,942)
------------ ------------- ------------ -------------
NET INCOME (LOSS) 838,327 (11,610,406) 2,141,956 (11,727,964)
Foreign currency translation adjustment 68,492 (821,955) 968,988 (467,637)
------------ ------------- ------------ -------------
COMPREHENSIVE INCOME (LOSS) $ 906,819 $ (12,432,361) $ 3,110,944 $ (12,195,601)
============ ============= ============ =============
EARNINGS (LOSS) PER SHARE OF COMMON STOCK
Continuing operations
Basic $ 0.023 $ (0.023) $ 0.059 $ (0.025)
Diluted 0.023 (0.023) 0.059 (0.025)
============ ============= ============ =============
Discontinued operations
Basic -- (0.296) -- (0.298)
Diluted -- (0.296) -- (0.298)
============ ============= ============ =============
WEIGHTED AVERAGED NUMBER OF SHARES OUTSTANDING - BASIC 36,490,312 36,465,312 36,490,312 36,300,869
============ ============= ============ =============
WEIGHTED AVERAGED NUMBER OF SHARES OUTSTANDING - DILUTED 36,540,312 36,465,312 36,540,312 36,300,869
============ ============= ============ =============
The accompanying notes are an integral part of this statement.
- 2 -
CHINA BIOPHARMACEUTICALS HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Preferred stock (series A) Common stock
-------------------------- ---------------------- Paid-in Capital
Shares Par value Shares Par value capital receivable
----------- ------------ ---------- --------- ------------ ----------
BALANCE, December 31, 2006, Restated 930,000 $ 9,300 35,586,740 $ 355,868 $ 13,059,911 $ (252,471)
Common shares issued for service 125,000 1,250 36,250
Common shares issued for preferred stock
conversion (512,500) (5,125) 753,572 7,535 (2,410)
Net loss
Staturoty reserves
Foreign currency translation adjustments
----------- ------------ ---------- --------- ------------ ----------
BALANCE, September 30, 2007, (Unaudited) 417,500 4,175 36,465,312 364,653 13,093,751 (252,471)
Common shares issued for preferred stock
conversion (25,000) (250) 25,000 250 --
Cancellation of preferred shares (342,500) (3,425) 3,425
Amortization of deferred compensation
Disposal of Enshi
Change in value of warrants issued for Enshi
acquisition 102,300
Net loss
Statutory reserves
Foreign currency translation adjustments
----------- ------------ ---------- --------- ------------ ----------
BALANCE, December 31, 2007 50,000 $ 500 36,490,312 $ 364,903 $ 13,199,476 $ (252,471)
Amortization of deferred compensation
Net income
Statutory reserves
Foreign currency translation adjustments
----------- ------------ ---------- --------- ------------ ----------
BALANCE, September 30, 2008 (Unaudited) 50,000 $ 500 36,490,312 $ 364,903 $ 13,199,476 $ (252,471)
=========== ============ ========== ========= ============ ==========
Accumulated
Other
Deferred Accumulated Statutory comprehensive
compensation deficit reserves income (loss) Total
------------ ------------ ----------- ------------- -------------
BALANCE, December 31, 2006, Restated $ (18,000) $ (6,060,461) $ 2,524,655 $ 885,998 $ 10,504,800
Common shares issued for service (18,750) 18,750
Common shares issued for preferred stock
conversion --
Net loss (11,727,964) (11,727,964)
Staturoty reserves (268,747) 268,747 --
Foreign currency translation adjustments (467,637) (467,637)
------------ ------------ ----------- ------------- -------------
BALANCE, September 30, 2007, (Unaudited) (36,750) (18,057,172) 2,793,402 418,361 (1,672,051)
Common shares issued for preferred stock
conversion (18,750) (18,750)
Cancellation of preferred shares --
Amortization of deferred compensation 34,125 34,125
Disposal of Enshi 1,862,414 (1,862,414) (837,320) (837,320)
Change in value of warrants issued for
Enshi acquisition 102,300
Net loss (1,819,023) (1,819,023)
Statutory reserves (45,451) 45,451 --
Foreign currency translation adjustments 1,193,850 1,193,850
------------ ------------ ----------- ------------- -------------
BALANCE, December 31, 2007 $ (21,375) $(18,059,232) $ 976,439 $ 774,891 $ (3,016,869)
Amortization of deferred compensation 18,750 18,750
Net income 2,141,956 2,141,956
Statutory reserves (691,820) 691,820 --
Foreign currency translation adjustments 968,988 968,988
------------ ------------ ----------- ------------- -------------
BALANCE, September 30, 2008 (Unaudited) $ (2,625) $(16,609,096) $ 1,668,259 $ 1,743,879 $ 112,825
============ ============ =========== ============= =============
The accompanying notes are an integral part of this statement.
- 3 -
CHINA BIOPHARMACEUTICALS HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2008 AND 2007
UNAUDITED
2008 2007
-------------- --------------
CASH FLOWS FROM CONTINUING OPERATING ACTIVITIES:
Net income (loss) $ 2,141,956 $ (11,727,964)
Net loss from discontinued operations -- 10,810,942
--------------- --------------
Net income (loss) from continuing operations 2,141,956 (917,022)
Adjustments to reconcile net loss from continuing
operations to cash provided by (used in) continuing operating activities:
Common stock issued for services -- 18,750
Amortization of stock based compensation 18,750 --
Depreciation 408,253 363,647
Amortization 132,931 77,041
Bad debt expense 58,966 522,560
Minority interest 3,385,321 1,120,717
Change in operating assets and liabilities:
Accounts receivable, trade (488,973) (1,742,677)
Accounts receivable, related parties (15,743) (42,661)
Other receivables and prepayments 1,062,776 (766,004)
Advances to suppliers 520,052 (536,774)
Other assets 29,791 --
Inventories (667,407) (2,764,315)
Accounts payable (776,962) 2,337,325
Accounts payable - related parties (79,021) --
Other payables and accrued liabilities 296,152 1,367,241
Other payables - related parties (7,600) (1,217,880)
Customer deposits 565,081 2,603,385
Taxes payable 925,456 79,693
--------------- --------------
Net cash provided by continuing operating activities 7,509,779 503,026
--------------- --------------
CASH FLOWS FROM CONTINUING OPERATION INVESTING ACTIVITIES:
Purchase of intangible assets -- (515,767)
Payment received from long term notes receivables 92,118 169,067
Purchase of equipment (287,550) (209,265)
Additions to construction in progress (5,904,126) --
(Increase) in other receivables - related parties (572,263) --
Decrease in other receivables - related parties -- 198,787
Proceeds from sale of short term investment 1,146,960 --
Proceeds on loan from related party 42,840 65,656
--------------- --------------
Net cash used in continuing operation investing activities (5,482,021) (291,522)
--------------- --------------
CASH FLOWS FROM CONTINUING OPERATION FINANCING ACTIVITIES:
(Increase)decrease in restricted cash (993,147) 92,010
Payments on bank loan 2,365,605 --
Proceeds from bank loan (2,437,290)
Proceeds from notes payable 3,303,245 --
Payments on notes payable -- (378,856)
Payments on long term debt (13,659) (102,855)
--------------- --------------
Net cash provided by (used in) continuing operation financing activities 2,224,754 (389,701)
--------------- --------------
Net increase (decrease) in cash from continuing operations 4,252,512 (178,197)
--------------- --------------
Cash provided by discontinued operating activities -- 2,218,568
Cash provided by discontinued operations investing activities -- 17,036,316
Cash used in discontinued operations financing activities -- (20,382,480)
--------------- --------------
Net cash used in discontinued operations -- (1,127,596)
--------------- --------------
Effect of exchange rate on cash (65,000) (84,150)
--------------- --------------
INCREASE (DECREASE) IN CASH 4,187,512 (1,389,943)
Cash, beginning of period 669,699 2,958,556
--------------- --------------
Cash, end of period $ 4,857,211 $ 1,568,613
=============== ==============
The accompanying notes are an integral part of this statement.
- 4 -
CHINA BIOPHARMACEUTICALS HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 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. Since August 2004, the Company acquired various subsidiaries
located in mainland China (also referred to as "PRC"). The principal activities
of the Company, through its subsidiaries, are research, manufacture, and the
sale of drug raw materials and intermediates as well as prescription and
non-prescription drugs and traditional Chinese medicines. The Company is also
engaged in the discovery, development and commercialization of innovative drugs
and related bio-pharmaceutical products in China.
Note 2 - 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.
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 and estimates the fair value of share based compensation which affects the
amount of compensation recognized in earnings. 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.
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-K.
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:
- 5 -
CHINA BIOPHARMACEUTICALS HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2008
(Unaudited)
- --------------------------------------------------------------------------------
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
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
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 periodically 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. As of September 30, 2008,
management concluded long term assets are not impaired.
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.
- 6 -
CHINA BIOPHARMACEUTICALS HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2008
(Unaudited)
- --------------------------------------------------------------------------------
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 in income. Total amount in
this account was $0 as of September 30, 2008 and $1,096,800 as of December 31,
2007. For the nine months ended September 30, 2008, the Company did not record
any realized or unrealized gain or loss since the account didn't have activities
in 2008 and had no balance as of September 30, 2008.
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 ultimate collection of
the Company's accounts receivables may take over one year and accounts
receivables outstanding more than one year is considered to be written-off.
Inventories
Inventories are stated at the lower of cost or market using the first-in,
first-out basis. The Company reviews its inventory periodically for possible
obsolescence or to determine if any reserves are necessary.
Patents
The Company obtained various official registration certificates or official
approvals for clinical trials representing patented pharmaceutical formulas. 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,
generally fifteen years. 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 and more often when events and changes in
circumstances indicate that the carrying value may not be recoverable.
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.
- 7 -
CHINA BIOPHARMACEUTICALS HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2008
(Unaudited)
- --------------------------------------------------------------------------------
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 September 30, 2008 and 2007 amounted $10,202 and $37,587, and for the nine
months ended September 30, 2008 and 2007 amounted $83,320 and $61,918.
Shipping and Handling Costs
Shipping and handling costs related to costs of goods sold are included in
selling, general and administrative costs which were $90,620 and $288,691 for
the three months and nine months ended September 30, 2008; For the three months
and nine months ended September 30, 2007 amounted $79,582 and $218,867,
respectively.
Concentration of Risks
Cash includes cash on hand and demand deposits in accounts maintained with banks
within the People's Republic of China, Hong Kong and the Untied States. Total
cash in these banks at September 30, 2008 and December 31, 2007 amounted to
$4,673,945 and $731,956 of which $100,000 deposits are covered by FDIC
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 pharmaceutical products to pharmacies and hospitals. Five
major customers accounted for approximately 12.0% and 11.1% of the net revenue
for the three months and nine months ended September 30, 2008, respectively. No
sales revenue from any single customer was above 5% of total sales revenue. At
September 30, 2008, the total receivable balance due from these customers was
$742,096, representing 17.5% of total accounts receivable. For the nine months
and three months ended September 30, 2007, five major customers accounted for
12.6% and 15% of the net revenue, respectively.
For the three months ended September 30 2008, five major suppliers provided
approximately 50.9% of the Company's purchases of raw materials with each
suuplier individually accounted for 15.7%, 12.8%, 8.8%, 8.1% and 5.5%,
respectively. For the nine months ended September 30, 2008, five major suppliers
provided approximately 53.7% of the Company's purchases of raw materials with
each supplier individually accounting for 18.4% 14.7%, 9.2%, 6.3% and 5.1%,
respectively. Five suppliers provided 54.0% of the Company's purchase of raw
materials for the three months ended September 30, 2007, with each suppliers
individually accounted for 19.9%, 16.0%, 6.4%, 6.3% and 5.4%, respectively. Five
suppliers provided 52.9% of the Company's purchase of raw materials for the nine
months ended September 30, 2007, with each suppliers individually accounting for
16.4%, 15.7%, 11.3%, 5.2% and 4.2%, respectively
Fair Value of Financial Instruments
On January 1, 2008, the Company adopted SFAS 157, Fair Value Measurements, which
defines fair value, establishes a three-level valuation hierarchy for
disclosures of fair value measurement and enhances disclosures requirements for
fair value measures. The carrying amounts reported in the balance sheets for
current assets and current liabilities qualify as financial instruments are a
reasonable estimate of fair value because of the short period of time between
the origination of such instruments and their expected realization and their
current market rate of interest. The three levels are defined as follow:
- 8 -
CHINA BIOPHARMACEUTICALS HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2008
(Unaudited)
- --------------------------------------------------------------------------------
o Level 1 inputs to the valuation methodology are quoted prices
(unadjusted) for identical assets or liabilities in active markets.
o 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.
o Level 3 inputs to the valuation methodology are unobservable and
significant to the fair value.
Revenue Recognition
The Company has various 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 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, such as agency like 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 September 30, 2008 and 2007, revenue was $12,552,437
and $8,586,051, respectively, made up of the following product categories.
2008 2007
------------- ------------
Unaudited Unaudited
------------
Revenue:
Intermediary pharmaceuticals products $ 2,744,041 $ 2,442,040
Prescription drugs 9,750,436 6,144,011
R&D service 57,960 --
------------- ------------
Total revenue $ 12,552,437 $ 8,586,051
============= ============
For the nine months ended September 30, 2008 and 2007, revenue was $36,866,222
and $22,502,081, respectively, made up of the following product categories.
- 9 -
CHINA BIOPHARMACEUTICALS HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2008
(Unaudited)
- --------------------------------------------------------------------------------
2008 2007
------------- -------------
Unaudited Unaudited
-------------
Revenue:
Intermediary pharmaceuticals products $ 10,261,372 $ 6,568,968
Prescription drugs 26,490,154 15,933,113
R&D service 114,696 --
------------- -------------
Total revenue $ 36,866,222 $ 22,502,081
============= =============
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.
Comprehensive Income
SFAS 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 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 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.
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.
- 10 -
CHINA BIOPHARMACEUTICALS HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2008
(Unaudited)
- --------------------------------------------------------------------------------
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 $1,743,879 and $774,891 at September 30, 2008 and December 31,
2007, respectively. Assets and liabilities at September 30, 2008 and December
31, 2007 were translated at 6.84 and 7.29 RMB to $1.00. The average translation
rates applied to income statement accounts, statement of cash flows for the
third quarter of 2008 and 2007 were 6.83 and 7.55 RMB to $1.00. For the, nine
months ended September 30, 2008 and 2007 were 6.97 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 SFAS 128, "Earnings per Share". 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 September 30, 2008 earnings per share calculations.
The Company determined that all the warrants were anti-dilutive because the
exercise prices were higher than average market price in the period presented.
For the three and nine months ended September 30, 2008, the convertible
preferred stock of 50,000 was considered to have diluted effect. The convertible
preferred stock was anti-dilutive for the three and nine months ended September
30, 2007 because the Company recorded net loss for the periods presented. The
number of shares used in computing basic earnings per share for the three months
and nine months ended September 30, 2008 was 36,490,312. The number of shares
used in computing diluted earnings per share for the three months and nine
months ended September 30, 2008 was 36,540,312. The number of shares used in
computing basic and diluted earnings per share for the three and nine months
ended September 30, 2007 were 36,465,312 and 36,300,869, respectively. Basic and
diluted earnings per share for the three months and nine months ended September
30, 2008 were $0.023 and $0.059. Basic and diluted losses per share for the
three and nine months ended September 30, 2007 was amount to $0.32 and 0.32.
- 11 -
CHINA BIOPHARMACEUTICALS HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2008
(Unaudited)
- --------------------------------------------------------------------------------
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 159, The Fair Value Option for Financial
Assets and Financial Liabilities--Including an amendment of FASB Statement No.
115. SFAS 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 SFAS 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.
SFAS 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.
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 adopted FSP EITF 07-3 on January 1, 2008 and there is no material effect
on financial statements.
In December 2007, the FASB issued SFAS 160, "Noncontrolling Interests in
Consolidated Financial Statements - an amendment of Accounting Research Bulletin
No. 51", 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.
- 12 -
CHINA BIOPHARMACEUTICALS HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2008
(Unaudited)
- --------------------------------------------------------------------------------
In December 2007, SFAS 141(R), Business Combinations, was issued. SFAS No. 141R
replaces SFAS 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 believes adopting SFAS No. 141R might materially impact the accounting
treatment for any future merger or acquisition consummated January 1, 2009.
In March 2008, the FASB) issued SFAS 161, Disclosures about Derivative
Instruments and Hedging Activities - An Amendment of SFAS No. 133. 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.
In June 2008, the FASB issued EITF 07-5 Determining whether an Instrument (or
Embedded Feature) is indexed to an Entity's Own Stock. This Issue is effective
for financial statements issued for fiscal years beginning after December 15,
2008, and interim periods within those fiscal years. Early application is not
permitted. Paragraph 11(a) of SFAS 133 "Accounting for Derivatives and Hedging
Activities" specifies that a contract that would otherwise meet the definition
of a derivative but is both (a) indexed to the Company's own stock and (b)
classified in stockholders' equity in the statement of financial position would
not be considered a derivative financial instrument. EITF 07-5 provides a new
two-step model to be applied in determining whether a financial instrument or an
embedded feature is indexed to an issuer's own stock and thus able to qualify
for the SFAS 133 paragraph 11(a) scope exception. The Company believes adopting
this statement will have a material impact on the financial statements because
among other things, any option or warrant previously issued and all new
issuances denominated is US dollars will be required to be carried as a
liability and marked to market each reporting period.
In June 2008, FASB issued EITF 08-4, Transition Guidance for Conforming Changes
to Issue No. 98-5. The objective of EITF 08-4 is to provide transition guidance
for conforming changes made to EITF 98-5, Accounting for Convertible Securities
with Beneficial Conversion Features or Contingently Adjustable Conversion
Ratios, that result from EITF 00-27 "Application of Issue No. 98-5 to Certain
Convertible Instruments", and SFAS 150, Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity. This Issue is
effective for financial statements issued for fiscal years ending after December
15, 2008. Early application is permitted. Management is currently evaluating the
impact the adoption of EITF 08-4 will have on its consolidated financial
statements.
- 13 -
CHINA BIOPHARMACEUTICALS HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2008
(Unaudited)
- --------------------------------------------------------------------------------
On October 10, 2008, the FASB issued FSP.157-3, Determining the Fair Value of a
Financial Asset When the Market for That Asset Is Not Active, which clarifies
the application of SFAS 157 in a market that is not active and provides an
example to illustrate key considerations in determining the fair value of a
financial asset when the market for that financial asset is not active. FSP
157-3 became effective on October 10, 2008, and its adoption did not have a
material impact on the Company's financial position or results for the quarter
ended September 30, 2008.
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.
Note 3 - SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Interest and Income Taxes Paid
o Interest expense paid amounted to $115,531 and $109,656 for the nine
months ended September 30, 2008 and 2007, respectively.
o Income tax was paid $246,001 and $0 for the nine months ended
September 30, 2008 and 2007, respectively.
Note 4 - ACCOUNTS RECEIVABLE
The reserve for bad debts was $1,405,533 and $1,260,760 at September 30, 2008
and December 31, 2007, respectively.
Accounts receivable consisted of the following:
September 30,
2008 December 31,
(Unaudited) 2007
-------------- ------------
Accounts receivable $ 5,634,131 $ 4,812,243
Allowance for doubtful accounts (1,405,533) (1,260,760)
-------------- ------------
Accounts receivable, net $ 4,228,598 $ 3,551,483
============== ============
Management regularly reviews aging of receivables and changes in payment trends
by its customers, and records a reserve when they believe collection of amounts
due are at risk. Accounts considered uncollectible are written off. As of
September 30, 2008 and December 31, 2007, management concluded its allowance for
bad debts were sufficient.
The following table consists of allowance for doubtful accounts.
- 14 -
CHINA BIOPHARMACEUTICALS HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2008
(Unaudited)
- --------------------------------------------------------------------------------
Allowance for bad debt, 12/31/2007 $ 1,260,760
Addition 58,966
Recovery --
Translation adjustment 85,807
-----------
Allowance for bad debt, 9/30/2008 (Unaudited) $ 1,405,533
===========
Note 5 - INVENTORIES
Inventories consisted of the following:
September 30,
2008 December 31,
(Unaudited) 2007
------------- ------------
Raw materials $ 2,386,866 $ 1,858,866
Refinery materials 3,082,366 3,139,200
Packaging supplies 310,502 239,624
Sundry supplies 10,032 11,984
Work in process 463,652 351,611
Finished goods 3,991,076 3,360,770
------------- ------------
Total inventories $ 10,244,494 $ 8,962,055
============= ============
Note 6 - PLANT AND EQUIPMENT
Plant and equipment consisted of the following:
September 30,
2008 December 31,
(Unaudited) 2007
------------- ------------
Plant $ 2,485,555 $ 2,286,051
Office equipment 104,879 25,478
Machinery 6,883,480 6,368,927
Automobile 317,233 228,043
Construction in progress 6,223,228 185,963
------------- ------------
Total plant and equipment 16,014,375 9,094,462
Less: accumulated depreciation (5,719,972) (4,972,293)
------------- ------------
Plant and equipment, net $ 10,294,403 $ 4,122,169
============= ============
Depreciation expense for the three months ended September 30, 2008 and 2007
amounted to $127,073 and $121,216, and for the nine months ended September 30,
2008 and 2007 amounted to $408,253 and $363,647, respectively. As of September
30, 2008 and 2007, capitalized interest amounted to $107,203 and $0,
respectively.
Note 7 - OTHER ASSETS
Intangible Assets
Intangible assets consist of the following:
- 15 -
CHINA BIOPHARMACEUTICALS HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2008
(Unaudited)
- --------------------------------------------------------------------------------
September 30,
2008 December 31,
(Unaudited) 2007
------------- ------------
Land use rights:
Erye $ 5,636,629 $ 5,282,173
CBH 2,406,464 2,406,464
------------- ------------
Total land use rights 8,043,093 7,688,637
Less: accumulated amortization (602,728) (459,333)
------------- ------------
Land use rights, net 7,440,365 7,229,304
------------- ------------
Patent:
Approved drugs 190,190 322,596
Less: accumulated amortization (24,236) (153,711)
------------- ------------
Subtotal: 165,954 168,885
============= ============
Total intangible assets, net $ 7,606,319 $ 7,398,189
============= ============
Land use rights are pledged as collateral for bank loans. Amortization expenses
three months ended September 30, 2008 and 2007 amounted $25,747 and $49,247, for
the nine months ended September 30, 2008 and 2007 were $ 132,931 and $77,041,
respectively.
One of the Company's patent of approved drug was fully amortized during 2008,
$154,054 of costs and accumulated amortization were deducted from intangible
asset account.
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:
September 30,
2008 December 31,
Name of Bank (Unaudited) 2007
- ------------------------------------------------ ------------- ------------
Hua Xia Bank, Suzhou $ 374 $ 164,871
Industrial and commercial bank, Suzhou -- 353,718
China CITIC Bank 1,566,458 --
- ------------------------------------------------ ------------- ------------
Total $ 1,566,832 $ 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 September 30, 2008 and December
31, 2007, the total amount of the long term notes receivable was $585,200 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.
- 16 -
CHINA BIOPHARMACEUTICALS HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2008
(Unaudited)
- --------------------------------------------------------------------------------
Note 8 - RELATED PARTIES TRANSACTIONS
Accounts Receivables - Related Parties
Accounts receivable included the following:
September 30, December 31, Manner of
2008 2007 Due From Term Settlement
(unaudited)
- -------- ------------- -----------------------------------------------------
Erye $ 141,446 41,932 Hainan Kaiye Short Term Cash
Hainan Kaiye is company owned by minority shareholders of Suzhou Erye
Pharmaceutical Limited Company.
Other Receivables - Related Parties
Other receivable contained the following related party balances where Hainan
Kaiye is a company owned by minority shareholders of Suzhou Erye Pharmaceutical
Limited Company and Enshi is the discontinued subsidiary since July 2007.
September 30, December 31, Manner of
2008 2007 Due From Term Settlement
(unaudited)
- -------- ------------- -----------------------------------------------------
Erye $ 982,385 $ 819,621 Hainan Kaiye Short Term Cash
Erye 292,600 Enshi Short term Cash
CBH 169,917 -- Enshi Short Term Cash
- -------- ------------- ------------
Total $ 1,444,902 $ 819,621
============= ============
Loan to Shareholder and Officer
September 30, December 31, Manner of
2008 2007 Due From Term Settlement
(unaudited)
- -------- ------------- -------------------------------------------------------------
Keyuan $ 48,279 $ 45,243 Keyuan's shareholder Short Term Cash
Other Payables - Related Parties
September 30, December 31, Manner of
2008 2007 Due To Term Settlement
(unaudited)
- -------- ------------- -----------------------------------------------------
Erye $ 701,948 $ 644,750 Erye Trading Short Term Cash
Erye Trading is company owned by minority shareholders of Suzhou Erye
Pharmaceutical Limited Company.
Other Payables- Shareholders
September 30, December 31, Manner of
2008 2007 Due To Term Settlement
(unaudited)
- -------- ------------- ---------------------------------------------------------------
CBH $ -- $ 43,961 Chris Peng Mao Short Term Cash
Keyuan 10,566 627 Lufan An & Xiaohao Liu Short Term Cash
- -------- ------------- ------------
Total $ 10,566 $ 44,588
============= ============
Chris Peng Mao is the CEO of the Company. Lufan An & Xiaohao Liu are both
shareholder of the Company.
- 17 -
CHINA BIOPHARMACEUTICALS HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2008
(Unaudited)
- --------------------------------------------------------------------------------
Long Term Other Receivables - Related Parties
September 30, December 31, Manner of
2008 2007 Due From Term Settlement
(unaudited)
- ------- ------------- ------------------------------------------------------
CBH $ 224,928 $ 267,768 Suzhou Heng yi Long Term Cash
Suzhou Hengyi is the discontinued subsidiary since August 2006.
Note 9 - NOTES PAYABLE
The Company's subsidiary Erye has $5,214,132and $1,727,460 notes payable to
Erye's vendors for the purchase of drug raw materials as of September 30, 2008
and December 31, 2007. Notes payable are interest free and usually mature after
a six month period.
Note 10 - 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 September 30, 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 691,820 10% of China Subsidiaries' net income
- ---------- ==============
Total $ 1,668,259
==============
Note 11 - 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.
- 18 -
CHINA BIOPHARMACEUTICALS HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2008
(Unaudited)
- --------------------------------------------------------------------------------
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 $377,583 and $0
for three months ended September 30, 2008 and 2007, and amounted to $1,008,196
and $0 for the nine months ended September 30, 2008 and 2007,and respectively.
Effective 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 33% rate
previously 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.
The following table reconciles the U.S. statutory rates to the Company's
effective tax rate:
September 30,
---------------
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) (33.0)
------ ------
Total provision for income taxes 12.5% --%
====== ======
The estimated tax savings due to the reduced tax rate for the three months and
nine months ended September 30, 2008 are $360,279 and $990,800 for the three
months and nine months ended September 30, 2007 were $128,266 and $913,740,
respectively. The net effect on income per share if the income tax had been
applied would decrease income per share by $0.01 and $0.03 for the three months
and nine months ended September 30, 2008. The net effect on loss per share if
the income tax had been applied would increase net loss per share for the three
months and nine months ended September 30, 2007 by $0.03 and 0.004,
respectively.
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.
- 19 -
CHINA BIOPHARMACEUTICALS HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2008
(Unaudited)
- --------------------------------------------------------------------------------
VAT on sales and VAT on purchases amounted to $2,254,536 $1,347,136 for the
three months ended September 30, 2008, and $1,280,388 and $1,157,650 for the
same period in 2007, respectively. VAT on sales and VAT on purchases amounted to
$6,212,023 $4,575,536 for nine months ended September 30, 2008, and $3,591,543
and $2,949,533, for the same period in 2007, respectively. 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 12 - LOANS
Short Term Bank Loans
The Company has a total of $2,604,140 and $2,371,830 in short term loans from
different banks in China at September 30, 2008 and December 31, 2007,
respectively. These loans mature in one year or less and renew automatically.
The average interest rates were approximately 7.0% and 7.75%, respectively. Bank
loans were collateralized by the land use right and buildings of Erye.
Interest expense of the short term bank loans for the three months ended
September 30, 2008 and 2007 amounted $46,621 and $42,602, for the nine months
ended September 30, 2008 and 2007 were $115,531 and $96,513; respectively..
Note 13 - 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 acquisitions
plus unpaid interest of $1,008,534 (combined total of $12,508,534) was converted
into 6,185,607 shares of Series B redeemable convertible preferred shares of the
Company at an effective conversion price at $2.0222 per share. Each series B
share may be converted into two shares of common stock. Additionally, the
exercise price of $1.375 for the 12 million existing warrants exercisable into
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 extended to 4.5 years from the closing date.
According to the Agreement, the series B preferred stock is 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. The
Company adopted SFAS 150, Accounting for Certain Financial Instruments with
Characteristics of both Liabilities and Equity and the 6,185,607 shares of
series B preferred stock was counted 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
September 30, 2008, balance of redeemable preferred stock amounted to
$13,521,209, in which $1,012,675 was the accrued interest expense for the period
of November 16, 2007 through September 30, 2008.
- 20 -
CHINA BIOPHARMACEUTICALS HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2008
(Unaudited)
- --------------------------------------------------------------------------------
The holders of the series B 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 September 30, 2008 amounted to
$506,337. 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 shares per annum,
effective January 1, 2008, as an addition to the redemption price. As of
September 30, 2008, $506,337 of penalty was included in the accrued dividend
payable.
On November 2, 2008, the Company entered into an Agreement and Plan of Merger
(the "Merger Agreement") with Neostem, Inc., a Delaware corporation, and CBH
Acquisition LLC ("Merger Sub"), a Delaware "NBS" limited liability company and
wholly-owned subsidiary of Neostem. Pursuant to the Merger Agreement, CBH will
merge into Merger Sub, with Merger Sub as the surviving entity. All of the
shares of the Company's series B shares issued and outstanding immediately prior
to the effective time of the Merger will be converted into (i) 5,383,009 shares
of NeoStem Common Stock, (ii) 6,977,512 shares of Series C Convertible Preferred
Stock, without par value, of NeoStem, each with a liquidation preference of
$1.125 per share and convertible into shares of NeoStem Common Stock at a
conversion price of $0.90 per share, and (iii) warrants to purchase 2,400,000
shares of NeoStem Common Stock at an exercise price of $0.80 per share.
Note 14 - COMMITMENTS AND CONTINGENCIES
Operating Leases
The Company leases office space from third parties. Accordingly, for the three
months ended September 30, 2008 and 2007, the Company recognized rent expenses
of $3,865 and $4,621. For the nine months ended September 30, 2008 and 2007,
rent expense amounted to $11,595 and $42,124, respectively.
As of September 30, 2008, the Company has outstanding commitments in respect to
non-cancelable operating leases as follows:
Amount
-----------
For the year ended December 31, 2008 $ 3,283
Thereafter 6,566
-----------
Total $ 9,849
===========
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 approximately $1.6 million (RMB12 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 $1,459,000 (RMB
10,000,000) by September 30, 2008.
- 21 -
CHINA BIOPHARMACEUTICALS HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2008
(Unaudited)
- --------------------------------------------------------------------------------
Legal Proceedings
In March 2007, the Company's former subsidiary RACP identified non-existent
trade accounts receivable acquired in the acquisition of Enshi. RACP 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 has 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.
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.
On September 1, 2008, the Company and RimAisa entered into an Understanding on
Litigation Residual Payment (the "Understanding"). Pursuant to this
Understanding, if there is no consummation of the Merger, the gross residual
(the "Gross Residual") from the LXB Litigation receivable by CBH (being the
gross settlement proceeds of the LXB litigation paid by Li Xiao Bo less the
litigation and related expenses incurred by and reimbursed to RACP pursuant to
the Litigation Agreement shall be paid to CBH in cash or shares of common stock
and warrants to purchase common stock of NBS (collectively, "NBS Securities"),
such NBS Securities being valued at their original purchase price but in no case
to be more than (a) US$1,250,000 or (b) the value of the Gross Residual,
whichever is less, and only to the extent there is any such residual from the
LXB litigation. Any amount of the Gross Residual remaining after deducting the
value of NBS Securities under the immediately preceding sentence shall be
immediately paid to CBH in cash. In case of a closing of the Merger, RACP may no
longer deliver such NBS Securities to CBH, but shall be able to deliver to Erye
Economy & Trade Ltd ("EET") NBS Securities, valued at their purchase price and
up to an amount equal to 50% of the "Net Residual" (to be defined below), in
exchange for the withholding of an equal amount of cash from the Gross Residual,
pursuant to the terms of an agreement with EET that will be documented and
signed prior to or at the closing of the Merger. The "Net Residual" means the
Gross Residual minus the sum of (a) US$1.3 million representing the legal fees
and costs and the un-reimbursed advances and expenses made by Erye to Shenyang
Enshi Pharmaceutical Ltd. and CBH, and (b) US$300,000 for operating expenses of
CBH over the next 12 months.
In October 17, 2008, RACP has entered into a settlement with Mr. Li and the
Defendants (the "Settlement"). Pursuant to the Settlement RACP was to receive an
amount of $8,125,000 to be paid by Mr. Li Xiaobo (the "Consideration"). Of the
Consideration, $7,310,815 was paid by November 12, 2008. An amount of $5,725,000
was used to pay for legal expenses in connection with the above described
litigation.
- 22 -
CHINA BIOPHARMACEUTICALS HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2008
(Unaudited)
- --------------------------------------------------------------------------------
Note 15 - 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
former 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.
Note 16 - SUBSEQUENT EVENTS
As previously mentioned in Note 13, on November 2, 2008, CBH entered into an
Agreement and Plan of Merger (the "Merger agreement") with CBC, NeoStem, Inc.,
and CBH Acquisition LLC ("Merger Sub"). The Merger Agreement contemplates the
merger of CBH with and into Merger Sub, with Merger Sub as the surviving entity
(the "Merger"). Prior to the consummation of the Merger, CBH will spin off all
of its shares of capital stock of CBC to CBH's stockholders in a liquidating
distribution so that the only material assets of CBH following such spin-off
will be CBH's 51% ownership interest in Erye, plus net cash which shall not be
less than $550,000.
Pursuant to the terms and subject to the conditions set forth in the Merger
Agreement, all of CBH's common stock, par value $.01 per share, issued and
outstanding immediately prior to the effective time of the Merger (the
"Effective Time") will be converted into the right to receive, in the aggregate,
7,500,000 shares of NeoStem's common stock at par value of $.001 per share (of
which 150,000 shares will be held in escrow pursuant to the terms of an escrow
agreement to be entered into between CBH and NeoStem).
Subject to the cancellation of outstanding warrants to purchase shares of CBH
Common Stock held by RimAsia, all of the shares of CBH Series B Preferred Stock
solely held by RimAsia, issued and outstanding immediately prior to the
Effective Time will be converted into NeoStem's common stock, Series C
Convertible Preferred Stock and warrants to purchase NeoStem's common stock. See
details in Note 13.
- 23 -
CHINA BIOPHARMACEUTICALS HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2008
(Unaudited)
- --------------------------------------------------------------------------------
At the Effective Time, in exchange for cancellation of all of the outstanding
shares of CBH Series A Convertible Preferred Stock which is held by Stephen
Globus, a director of CBH, and/or related persons, NeoStem will issue to Mr.
Globus and/or related persons 50,000 shares of NeoStem Common Stock. NeoStem
also will issue 60,000 shares of NeoStem Common Stock to Mr. Globus and 40,000
shares of NeoStem Common Stock to Chris Peng Mao, the Chief Executive Officer of
CBH, in exchange for the cancellation and the satisfaction in full of
indebtedness in the aggregate principal amount of $90,000, plus any and all
accrued but unpaid interest thereon, and other obligations of CBH to Globus and
Mao. NeoStem will bear 50% of up to $450,000 of CBH's expenses post-merger, and
satisfaction of the liabilities of Messrs. Globus and Mao will count toward that
obligation. NeoStem also will issue 200,000 shares to CBC to be held in escrow,
payable if NeoStem successfully consummates its previously announced acquisition
of control of Shandong New Medicine Research Institute of Integrated Traditional
and Western Medicine Limited Liability Company.
Also at the Effective Time, subject to acceptance by the holders of all of the
outstanding warrants to purchase shares of CBH Common Stock (other than warrants
held by RimAsia), such warrants shall be canceled and the holders thereof shall
receive warrants to purchase up to an aggregate of up to 2,012,097 shares of
NeoStem Common Stock at an exercise price of $2.50 per share.
Upon consummation of the transactions contemplated by the Merger, Merger Sub
will own 51% of the ownership interests in Erye, and Suzhou Erye Economy and
Trading Co. Ltd., a company incorporated in the PRC ("EET"), will own the
remaining 49% ownership interest. In connection with the execution of the Merger
Agreement, NeoStem, Merger Sub and EET have negotiated a revised joint venture
agreement (the "Joint Venture Agreement"), which, subject to finalization and
approval by the requisite PRC governmental authorities, will become effective
and will govern the rights and obligations with respect to their respective
ownership interests in Erye. Pursuant to the terms and conditions of the Joint
Venture Agreement, dividend distributions to EET and Merger Sub will be made in
proportion to their respective ownership interests in Erye; provided, however,
that for the three-year period commencing on the first day of the first fiscal
quarter after the Joint Venture Agreement becomes effective, (i) 49% of
undistributed profits (after tax) will be distributed to EET and lent back to
Erye by EET for use by Erye in connection with the construction of a new plant
for Erye; (ii) 45% of the net profit (after tax) will be provided to Erye as
part of the new plant construction fund, which will be characterized as paid-in
capital for Merger Sub's 51% interest in Erye; and (iii) 6% of the net profit
will be distributed to Merger Sub directly for NeoStem's operating expenses. In
the event of the sale of all of the assets of Erye or liquidation of Erye,
Merger Sub will be entitled to receive the return of such additional paid-in
capital before distribution of Eyre's assets is made based upon the ownership
percentages of NeoStem and EET, and upon an initial public offering of Erye
which raises at least $7,300,000 (RMB 50,000,000), Merger Sub will be entitled
to receive the return of such additional paid-in capital. CBC will receive
$300,000 from the settlement proceeds from the settlement of the litigation in
Hong Kong and Canada by RACP Pharmaceutical Holdings Limited, a wholly-owned
subsidiary of CBC, against Li Xiaobo and certain other defendants in connection
with the acquisition of shares of Enshi (the "LXB Litigation") and use it as
working capital.
- 24 -
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.
- 25 -
As reported on our Current Report on Form 8-K dated November 6, 2008, On
November 2, 2008, we entered into an Agreement and Plan of Merger (the "Merger
Agreement") with NeoStem, Inc., a Delaware corporation ("NeoStem"), China
Biopharmaceuticals Corp., a British Virgin Islands corporation and our
wholly-owned subsidiary ("CBC"), and CBH Acquisition LLC, a Delaware limited
liability company and wholly-owned subsidiary of NeoStem ("Merger Sub"). The
Merger Agreement contemplates our merger with and into Merger Sub, with Merger
Sub as the surviving entity (the "Merger"); provided, that prior to the
consummation of the Merger, we will spin off all of our shares of capital stock
of CBC to our stockholders in a liquidating distribution so that the only
material assets of us following such spin-off will be our 51% ownership interest
in Suzhou Erye Pharmaceuticals Company Ltd. ("Erye"), a Sino-foreign joint
venture with limited liability organized under the laws of the People's Republic
of China (the "PRC"), plus net cash which shall not be less than $550,000.
Pursuant to the terms and subject to the conditions set forth in the Merger
Agreement, all of our shares of common stock, par value $.01 per share ("CBH
Common Stock"), issued and outstanding immediately prior to the effective time
of the Merger (the "Effective Time") will be converted into the right to
receive, in the aggregate, 7,500,000 shares of common stock, par value $.001 per
share, of NeoStem (the "NeoStem Common Stock") (of which 150,000 shares will be
held in escrow pursuant to the terms of an escrow agreement to be entered into
between CBH and NeoStem). Subject to the cancellation of outstanding warrants to
purchase shares of CBH Common Stock held by RimAsia Capital Partners, L.P.
("RimAsia"), a current holder of approximately 14% of the outstanding shares of
NeoStem Common Stock and the sole holder of shares of Series B Convertible
Preferred Stock, par value $0.01 per share, of CBH (the "CBH Series B Preferred
Stock"), all of the shares of CBH Series B Preferred Stock issued and
outstanding immediately prior to the Effective Time will be converted into (i)
5,383,009 shares of NeoStem Common Stock, (ii) 6,977,512 shares of Series C
Convertible Preferred Stock, without par value, of NeoStem, each with a
liquidation preference of $1.125 per share and convertible into shares of
NeoStem Common Stock at a conversion price of $.90 per share, and (iii) warrants
to purchase 2,400,000 shares of NeoStem Common Stock at an exercise price of
$0.80 per share. At the Effective Time, in exchange for cancellation of all of
the outstanding shares of CBH Series A Convertible Preferred Stock, par value
$.01 per share, of CBH (the "CBH Series A Preferred Stock") held by Stephen
Globus, a director of CBH, and/or related persons, NeoStem will issue to Mr.
Globus and/or related persons an aggregate of 50,000 shares of NeoStem Common
Stock. NeoStem also will issue 60,000 shares of NeoStem Common Stock to Mr.
Globus and 40,000 shares of NeoStem Common Stock to Chris Peng Mao, the Chief
Executive Officer of CBH, in exchange for the cancellation and the satisfaction
in full of indebtedness in the aggregate principal amount of $90,000, plus any
and all accrued but unpaid interest thereon, and other obligations of CBH to
Globus and Mao. NeoStem will bear 50% of up to $450,000 of CBH's expenses
post-merger, and satisfaction of the liabilities of Messrs. Globus and Mao will
count toward that obligation. NeoStem also will issue 200,000 shares to CBC to
be held in escrow, payable if NeoStem successfully consummates its previously
announced acquisition of control of Shandong New Medicine Research Institute of
Integrated Traditional and Western Medicine Limited Liability Company.
- 26 -
Also at the Effective Time, subject to acceptance by the holders of all
of the outstanding warrants to purchase shares of CBH Common Stock (other than
warrants held by RimAsia), such warrants shall be canceled and the holders
thereof shall receive warrants to purchase up to an aggregate of up to 2,012,097
shares of NeoStem Common Stock at an exercise price of $2.50 per share.
The transactions contemplated by the Merger Agreement are subject to the
authorization for listing on the American Stock Exchange (or any other stock
exchange on which shares of NeoStem Common Stock are listed) of the shares to be
issued in connection with the Merger, shareholder approval, approval of
NeoStem's acquisition of 51% ownership interest in Erye by relevant PRC
governmental authorities, receipt of a fairness opinion and other customary
closing conditions set forth in the Merger Agreement. As part of the Merger
negotiation, CBC will receive $300,000 from the settlement proceeds from the
settlement of the LXB Litigation and use it as working capital. The Merger
currently is expected to be consummated in the first quarter of 2009. Further
description of the Merger terms and related agreements can be found in Current
Report on Form 8-K dated November 6, 2008 and in the Merger Agreement, which was
filed as Exhibit 2.1 to the said Form 8-K hereto and is incorporated herein by
reference.
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 former subsidiary RACP
filed a lawsuit against the Defendants alleging fraud and is pursuing rescission
and damages (the "LXB Litigation"). Enshi's operations have been severely
hindered 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.
- 27 -
Therefore, the results of Enshi's operations and cash flows for the three
months and nine months ended September 30, 2007 were reported as discontinued
operations in our consolidated financial statements.
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.
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 $1,405,533 as of September 30, 2008 from $1,260,760 as of December
31, 2007. This increase is mainly resulted from additional allowance reserved
for accounts receivable balance outstanding for over one year, and change in the
exchange rate of RMB to USD. As of September 30, 2008, accounts receivable, net
of allowance for doubtful accounts, amounted to $4,228,598.
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
Current period bad debt allowance 58,966
Foreign currency translation adjustment 85,807
----------
As of September 30, 2008 (unaudited) $1,405,533
==========
- 28 -
The following list the aging of our accounts receivable excluding bad debt
allowance, as of September 30, 2008:
3 months 6 months 9 months Over 9 months Over 1 year
Total Amount % Amount % Amount % Amount % Amount %
- --------- --------------- ----------- ------------ ------------- ---------------
5,634,132 4,395,220 78.0 43,419 0.8 34,078 0.6 9,960 0.2 1,151,455 20.4
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 accounts receivable 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.
- 29 -
New Accounting Pronouncements
In February 2007, the FASB issued SFAS 159, The Fair Value Option for Financial
Assets and Financial Liabilities--Including an amendment of FASB Statement No.
115. SFAS 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 SFAS 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.
SFAS 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.
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 adopted FSP EITF 07-3 on January 1, 2008 and there is no material effect
on financial statements.
In December 2007, the FASB issued SFAS 160, "Noncontrolling Interests in
Consolidated Financial Statements - an amendment of Accounting Research Bulletin
No. 51", 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.
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In December 2007, SFAS 141(R), Business Combinations, was issued. SFAS No. 141R
replaces SFAS 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 believes adopting SFAS No. 141R might materially impact the accounting
treatment for any future merger or acquisition consummated January 1, 2009.
In March 2008, the FASB) issued SFAS 161, Disclosures about Derivative
Instruments and Hedging Activities - An Amendment of SFAS No. 133. 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.
In June 2008, the FASB issued EITF 07-5 Determining whether an Instrument (or
Embedded Feature) is indexed to an Entity's Own Stock. This Issue is effective
for financial statements issued for fiscal years beginning after December 15,
2008, and interim periods within those fiscal years. Early application is not
permitted. Paragraph 11(a) of SFAS 133 "Accounting for Derivatives and Hedging
Activities" specifies that a contract that would otherwise meet the definition
of a derivative but is both (a) indexed to the Company's own stock and (b)
classified in stockholders' equity in the statement of financial position would
not be considered a derivative financial instrument. EITF 07-5 provides a new
two-step model to be applied in determining whether a financial instrument or an
embedded feature is indexed to an issuer's own stock and thus able to qualify
for the SFAS 133 paragraph 11(a) scope exception. The Company believes adopting
this statement will have a material impact on the financial statements because
among other things, any option or warrant previously issued and all new
issuances denominated is US dollars will be required to be carried as a
liability and marked to market each reporting period.
- 31 -
In June 2008, FASB issued EITF 08-4, Transition Guidance for Conforming Changes
to Issue No. 98-5. The objective of EITF 08-4 is to provide transition guidance
for conforming changes made to EITF 98-5, Accounting for Convertible Securities
with Beneficial Conversion Features or Contingently Adjustable Conversion
Ratios, that result from EITF 00-27 "Application of Issue No. 98-5 to Certain
Convertible Instruments", and SFAS 150, Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity. This Issue is
effective for financial statements issued for fiscal years ending after December
15, 2008. Early application is permitted. Management is currently evaluating the
impact the adoption of EITF 08-4 will have on its consolidated financial
statements.
On October 10, 2008, the FASB issued FSP.157-3, Determining the Fair Value of a
Financial Asset When the Market for That Asset Is Not Active, which clarifies
the application of SFAS 157 in a market that is not active and provides an
example to illustrate key considerations in determining the fair value of a
financial asset when the market for that financial asset is not active. FSP
157-3 became effective on October 10, 2008, and its adoption did not have a
material impact on the Company's financial position or results for the quarter
ended September 30, 2008.
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RESULTS OF OPERATIONS - THREE MONTHS ENDED SEPTEMBER 30, 2008 AS COMPARED TO
THREE MONTHS ENDED SEPTEMBER 30, 2007
REVENUE
Revenue for the three months ended September 30, 2008 was $12,552,437 while the
revenue for the three months ended September 30, 2007 was $8,586,051,
representing an approximately 46.2% increase. The increase is mainly attributed
to the following reasons:
First and foremost is the rise in selling price and sales volume of Erye's raw
material Drugs, in Which oxacillin sodium sales are more than 90% coverage in
domestic; Second, the reform of medical insurance system in rural areas of China
helps to promote the sales of Erye's drugs. Third, the selling price of the
freeze-dried drugs has increased. At present, the low-price products have been
replaced by the high-price products, and the variety of products are changing
gradually. In addition, as market coverage is expanded, products awareness
drives sales.
COST OF GOODS SOLD
Cost of goods sold for the three months ended September 30, 2008 was $8,580,330
as compared to $5,968,079 for the three months ended September 30, 2007. Cost of
goods sold as a percentage of sales revenues was approximately 68.4% for the
three months ended September 30, 2008 as compared to approximately 69.5% for the
three months ended September 30, 2007. The increase in cost of goods sold in
terms of dollar amount is mainly attributed to the increase of sales.
GROSS PROFIT
Gross profit in the three months ended September 30, 2008 amounted to
$3,972,107, as compared to $2,617,972 for the three months ended September 30,
2007, representing approximately 51.7% increase. The gross profit margin for the
three months ended September 30, 2008 was 31.6% as compared to approximately
30.5% for the three months ended September 30, 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 September 30, 2008 was $1,306,293
as compared to $2,483,056 for the three months ended September 30, 2007,
representing 47.4% decrease. The decrease is attributed mainly to operating
expenses of Erye. During current period, due to Chinese Government's effort to
improve the Chinese Pharmaceutical market, Erye reduced operating expenses such
as advertising and meeting expenses.
RESEARCH AND DEVELOPMENT
Research and development costs for the three months ended September 30, 2008
were $102,701 as compared to $315,335 for the three months ended September 30,
2007. This decrease was primarily attributed to R&D expense of Erye. During the
last three months of current period, Erye decreased R&D expense spending.
INCOME FROM OPERATIONS
Income from operations in the three months ended September 30, 2008 amounted to
$2,665,814, as compared to $134,916 for the three months ended September 30,
2007, representing approximately 1,875.9% increase. The increase is mainly
attributable to Erye's strong performance in sales and decreased operating
expense
NET INCOME
Net income for the three months ended September 30, 2008 was $838,327 as
compared to net loss of $11,610,406 for the three months ended September 30,
2007. The net loss in 2007 was mainly caused by loss from discontinued
operations of $10,788,868 from Shenyang Enshi. Excluding loss form discontinued
operations, for the three months ended September 30, 2007, the Company had a net
loss of $821,955. The net income increase is mainly attributed to Erye's strong
operating performance and decreased legal expenses in relation to the
discontinued operation.
- 33 -
RESULTS OF OPERATIONS - NINE MONTHS ENDED SEPTEMBER 30, 2008 AS COMPARED TO NINE
MONTHS ENDED SEPTEMBER 30, 2007 REVENUE
Revenue for the nine months ended September 30, 2008 was $36,866,222 while the
revenue for the nine months ended September 30, 2007 was $22,502,081,
representing an approximately 63.8% increase. The increase is mainly attributed
to Erye's significant revenue growth. The current industry environment provides
a great opportunity for Erye to grow its core business. Erye consistently
expands its market share in rural area in China.
COST OF GOODS SOLD
Cost of goods sold for the nine months ended September 30, 2008 was $25,506,662
as compared to $16,532,703 for the nine months ended September 30, 2007. Cost of
goods sold as a percentage of sales revenues was approximately 69.2% for the
nine months ended September 30, 2008 as compared to approximately 73.5% for the
nine months ended September 30, 2007. The increase in cost of goods sold in
terms of dollar amount is mainly attributed to the cost of good sold of Erye
which had a high growth in its sales in 2008.
GROSS PROFIT
Gross profit in the nine months ended September 30, 2008 amounted at
$11,359,560, as compared to $5,969,378 for the nine months ended September 30,
2007, representing approximately 90.3% increase. The gross profit margin for the
nine months ended September 30, 2008 was 30.8% as compared to approximately
26.5% for the nine months ended September 30, 2007. The increase in gross profit
as percentage to sales is mainly due to the Company has adjusted its product
mixture and increased the sales volume of products with higher GP%.
OPERATING EXPENSES
Operating expenses for the nine months ended September 30, 2008 was $3,864,801
as compared to $4,546,626 for the nine months ended September 30, 2007,
representing 15.0% decrease. The decrease is attributed mainly to lower sales
expenses of Suzhou Erye such as promotional meeting and commission etc.
RESEARCH AND DEVELOPMENT
Research and development costs for the nine months ended September 30, 2008 were
$362,048 as compared to $329,603 for the nine months ended September 30, 2007,
representing approximately 9.8% increase.
- 34 -
INCOME FROM OPERATIONS
Income from operations in the nine months ended September 30, 2008 amounted at
$7,494,759, as compared to $1,422,752 for the nine months ended September 30,
2007, representing approximately 426.8% increase. The increase is mainly
attributable to Erye's strong performance in sales and increased gross margin.
NET INCOME
Net income for the nine months ended September 30, 2008 was $2,141,956 as
compared to net loss of $11,727,964 for the nine months ended September 30,
2007. The net loss in 2007 was mainly caused by loss from discontinued
operations of $10,810,942 from Enshi. Excluding loss form discontinued
operations, for the nine months ended September 30, 2007, the Company had a net
loss of $917,022. The net income increase is mainly attributed to Erye's strong
operating performance and increased profit margin. Legal expenses relating to
discontinued Enshi decrease also contributed to the net income increase.
LIQUIDITY AND CAPITAL RESOURCES
As of September 30, 2008, total current assets were $21,471,985 and total
current liabilities were $34,097,681. Cash and cash equivalents on September 30,
2008 was $4,857,211, an increase of $4,187,512 from the $669,699 reported on
December 31, 2007.
For the nine months ended September 30, 2008, net cash provided by continuing
operating activities was $7,509,779, net cash used in investing activities was
$5,482,021, and net cash provided by financing activities was $2,224,754. Cash
provided by operating activities results primarily from the Company's strong
performance in sales and increase in its profit margin. Cash used for investing
activities during the nine months ended September 30, 2008 results mainly from
the construction of the new plant and purchase of equipments.
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 former 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 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 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.
-35 -
Our main manufacturing unit, Erye, recorded a significant growth of 46.1% in
sales revenue for the nine months ended September 30, 2008, along the line with
our expectation.
As we entered into the Merger Agreement, going forward, our primary requirements
for cash consist of: (1) Stabilize and streamline the Erye operation;(2)
relocation of Erye to a new factory which is under construction;(3) continue R&D
for more selected new drug projects; and (4) build up sales network for new drug
distribution. Our current operating activities may not enable us to meet the
anticipated cash requirements. In the event that the Merger is not consummated,
external source of capital may be needed for our expansion.
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. If the Merger is not consummated, 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.
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. As of September 30,
2008, the value of the Renminbi to the U.S. dollar was translated at 6.85 RMB to
$1.00 USD.
- 36 -
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
Not applicable.
Item 4T. Controls and Procedures
Disclosure Controls and Procedures. As of September 30, 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. 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.
- 37 -
2. 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. 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 10KSB, 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 September 30, 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's former subsidiary RACP filed a lawsuit alleging
fraud and is pursuing rescission and damages 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. In
October 17, 2008, RACP has entered into a settlement with Mr. Li and the
Defendants (the "Settlement"). Pursuant to the Settlement RACP was to receive an
amount of $8,125,000 to be paid by Mr. Li Xiaobo (the "Consideration"). Of the
Consideration, $7,310,815 was paid by November 12, 2008 including fortification
and other security deposits. An amount of $5,725,000 was used to pay for legal
expenses in connection with the above described litigation.
- 38 -
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 September 30, 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
- 39 -
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: November 14, 2008
By: /s/ ZHANG Jian
-------------------------------------------
Name: ZHANG Jian
Title: Chief Financial Officer
Date: November 14, 2008
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