Attached files
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EX-32.1 - CHINA SKY ONE MEDICAL, INC. | v166478_ex32-1.htm |
EX-32.2 - CHINA SKY ONE MEDICAL, INC. | v166478_ex32-2.htm |
EX-31.1 - CHINA SKY ONE MEDICAL, INC. | v166478_ex31-1.htm |
EX-31.2 - CHINA SKY ONE MEDICAL, INC. | v166478_ex31-2.htm |
UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
WASHINGTON,
D.C. 20549
FORM 10-Q
(Mark
One)
x
|
QUARTERLY REPORT PURSUANT TO
SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
|
For
the quarterly period ended
|
September 30,
2009
|
OR
¨
|
TRANSITION REPORT PURSUANT TO
SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
|
For the
transition period from ________________________________ to
____________________________________
Commission
File Number:
|
000-26059
|
CHINA
SKY ONE MEDICAL, INC.
|
(Exact
Name of Registrant as Specified in Its
Charter)
|
Nevada
|
87-0430322
|
|
(State
or Other Jurisdiction of Incorporation or Organization)
|
(I.R.S.
Employer Identification No.)
|
Room
1706, Di Wang Building, No. 30 Gan Shui Road,
|
||
Nangang
District, Harbin, People’s Republic of China
|
150001
|
|
(Address
of Principal Executive Offices)
|
(Zip
Code)
|
86-451-53994069
(China)
|
(Registrant’s
Telephone Number, Including Area Code)
|
(Former
Name, Former Address and Former Fiscal Year, if 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 preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
x Yes ¨ No
Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate Web site, if any, every Interactice Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this
chapter) during the preceding 12 months (or for such shorter period that the
registrant was required to submit and post such files).
¨ Yes ¨ No
Indicate
by check mark 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 filed,”
“accelerated filer” and “smaller reporting company in Rule 12b-2 of the Exchange
Act.
Large
accelerated filer ¨
|
Accelerated
filer ¨
|
Non-accelerated
filer ¨
(Do
not check if a smaller reporting company)
|
Smaller
reporting company x
|
Indicate
by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act).
¨ Yes x No
The
registrant had 16,661,423 shares of Common Stock issued and outstanding as of
October 15, 2009.
QUARTERLY
REPORT ON FORM 10-Q
OF
CHINA SKY ONE MEDICAL, INC. AND SUBSIDIARIES
FOR
THE PERIOD ENDED SEPTEMBER 30, 2009
TABLE
OF CONTENTS
PAGE
|
|||||
PART I
|
-
|
FINANCIAL
INFORMATION
|
|||
Item
1.
|
Financial
Statements
|
||||
Condensed
Consolidated Balance Sheets as of September 30, 2009 (unaudited) and
December 31, 2008
|
1
|
||||
Condensed
Consolidated Statements of Operations and Comprehensive Income for the
Three and Nine Months Ended September 30, 2009 and 2008
(unaudited)
|
2
|
||||
Condensed
Consolidated Statements of Cash Flows for the Nine Months Ended
September 30, 2009 and 2008 (unaudited)
|
3
|
||||
Notes
to Condensed Consolidated Financial Statements (unaudited)
|
4
|
||||
Item
2.
|
Management’s
Discussion and Analysis of Financial Condition and Results of
Operations
|
24
|
|||
Item
3.
|
Quantitative
and Qualitative Disclosures About Market Risk
|
36
|
|||
Item
4.
|
Controls
and Procedures
|
36
|
|||
PART II
|
-
|
OTHER
INFORMATION
|
|||
Item
1.
|
Legal
Proceedings
|
37
|
|||
Item
2.
|
Unregistered
Sales of Equity Securities and Use of Proceeds
|
37
|
|||
Item
3.
|
Defaults
Upon Senior Securities
|
37
|
|||
Item
4.
|
Submission
of Matters to a Vote of Security Holders
|
37
|
|||
Item
5.
|
Other
Information
|
38
|
|||
Item
6.
|
Exhibits
|
38
|
|||
Signatures
|
39
|
PART
I. FINANCIAL INFORMATION
Item
1. Financial Statements
China
Sky One Medical, Inc. and Subsidiaries
Condensed
Consolidated Balance Sheets
September
30,
|
December 31,
|
|||||||
2009
|
2008
|
|||||||
(Unaudited)
|
(Audited)
|
|||||||
ASSETS
|
||||||||
Current
Assets
|
||||||||
Cash
and cash equivalents
|
$ | 56,303,043 | $ | 40,288,116 | ||||
Accounts
receivable, net
|
23,670,142 | 14,978,648 | ||||||
Inventories
|
3,099,451 | 462,351 | ||||||
Prepaid
and other current assets
|
132,372 | 106,386 | ||||||
Land
and construction deposit
|
8,533,952 | 8,513,284 | ||||||
Total
current assets
|
91,738,960 | 64,348,785 | ||||||
Property
and equipment, net
|
30,429,508 | 21,058,779 | ||||||
Intangible
assets, net
|
14,872,618 | 15,851,765 | ||||||
$ | 137,041,086 | $ | 101,259,329 | |||||
LIABILITIES
AND STOCKHOLDERS' EQUITY
|
||||||||
Current
Liabilities
|
||||||||
Accounts
payable and accrued expenses
|
$ | 6,911,404 | $ | 2,937,068 | ||||
Taxes
payable
|
5,763,146 | 3,362,888 | ||||||
Deferred
revenues
|
- | 26,079 | ||||||
Total
current liabilities
|
12,674,550 | 6,326,035 | ||||||
Commitments
and Contingencies
|
- | - | ||||||
Stockholders'
Equity
|
||||||||
Preferred
stock ($0.001 par value, 5,000,000 shares authorized, none issued and
outstanding)
|
- | - | ||||||
Common
stock ($0.001 par value, 50,000,000 shares authorized, 16,661,423 and
16,306,184 issued and outstanding, respectively)
|
16,661 | 16,306 | ||||||
Additional
paid-in capital
|
40,133,948 | 40,105,134 | ||||||
Accumulated
other comprehensive income
|
5,812,108 | 5,566,806 | ||||||
Retained
earnings
|
78,403,819 | 49,245,048 | ||||||
Total
stockholders' equity
|
124,366,536 | 94,933,294 | ||||||
$ | 137,041,086 | $ | 101,259,329 |
See accompanying summary of accounting policies and notes to the condensed consolidated financial statements.
1
China
Sky One Medical, Inc. and Subsidiaries
Condensed
Consolidated Statements of Operations and Comprehensive Income
(Unaudited)
Three Months Ended September 30,
|
Nine
Months Ended September 30,
|
|||||||||||||||
2009
|
2008
|
2009
|
2008
|
|||||||||||||
Revenues
|
$ | 43,227,171 | $ | 29,699,282 | $ | 100,242,453 | $ | 65,861,304 | ||||||||
Cost
of Goods Sold
|
10,897,185 | 7,366,059 | 24,690,474 | 15,748,801 | ||||||||||||
Gross
Profit
|
32,329,986 | 22,333,223 | 75,551,979 | 50,112,503 | ||||||||||||
Operating
Expenses
|
||||||||||||||||
Depreciation
and amortization
|
447,170 | 308,023 | 1,347,836 | 523,375 | ||||||||||||
Research
and development
|
4,884,925 | 1,866,409 | 10,979,619 | 3,881,312 | ||||||||||||
Selling,
general and administrative
|
10,967,649 | 7,596,953 | 26,061,465 | 18,140,807 | ||||||||||||
Total
operating expenses
|
16,299,744 | 9,771,385 | 38,388,920 | 22,545,494 | ||||||||||||
Other
Income (Expense)
|
||||||||||||||||
Other
(expense)
|
(483 | ) | - | (1,611 | ) | - | ||||||||||
Interest
income (expense)
|
20,900 | (1,494 | ) | 47,854 | (135,136 | ) | ||||||||||
Total
other income (expense)
|
20,417 | (1,494 | ) | 46,243 | (135,136 | ) | ||||||||||
Net
Income Before Provision for Income Tax
|
16,050,659 | 12,560,344 | 37,209,302 | 27,431,873 | ||||||||||||
Provision
for Income Taxes
|
||||||||||||||||
Current
|
3,591,719 | 2,616,909 | 8,050,531 | 5,512,860 | ||||||||||||
Net
Income
|
$ | 12,458,940 | $ | 9,943,435 | $ | 29,158,771 | $ | 21,919,013 | ||||||||
Basic
Earnings Per Share
|
$ | 0.75 | $ | 0.64 | $ | 1.76 | $ | 1.50 | ||||||||
Basic
Weighted Average Shares Outstanding
|
16,655,697 | 15,464,084 | 16,535,924 | 14,657,059 | ||||||||||||
Diluted
Earnings Per Share
|
$ | 0.74 | $ | 0.60 | $ | 1.76 | $ | 1.39 | ||||||||
Diluted
Weighted Average Shares Outstanding
|
16,741,745 | 16,492,414 | 16,606,576 | 15,745,542 | ||||||||||||
Comprehensive
Income
|
||||||||||||||||
Net
Income
|
$ | 12,458,940 | $ | 9,943,435 | $ | 29,158,771 | $ | 21,919,013 | ||||||||
Foreign
currency translation adjustment
|
121,913 | 441,809 | 245,302 | 3,597,598 | ||||||||||||
Comprehensive
Income
|
$ | 12,580,853 | $ | 10,385,244 | $ | 29,404,073 | $ | 25,516,611 |
See
accompanying summary of accounting policies and notes to the condensed
consolidated financial statements.
2
China
Sky One Medical, Inc. and Subsidiaries
Condensed
Consolidated Statements of Cash Flows
(Unaudited)
Nine Months Ended September 30,
|
||||||||
2009
|
2008
|
|||||||
Cash
flows from operating activities
|
|
|
||||||
Net
Income
|
$ | 29,158,771 | $ | 21,919,013 | ||||
Adjustments
to reconcile net cash provided by operating activities:
|
||||||||
Depreciation
and amortization
|
1,752,927 | 523,375 | ||||||
Share-based
compensation expense
|
- | 30,351 | ||||||
Net
change in assets and liabilities
|
||||||||
Accounts
receivables
|
( 8,659,683 | ) | 1,618,365 | |||||
Inventories
|
( 2,634,086 | ) | ( 1,431,757 | ) | ||||
Prepaid
expenses and other current assets
|
( 14,948 | ) | ( 10,763 | ) | ||||
Accounts
payable and accrued expenses
|
3,938,248 | 1,589,409 | ||||||
Taxes
payable
|
2,390,378 | 2,475,042 | ||||||
Deferred
revenues
|
- | ( 24,504 | ) | |||||
Net
cash provided by operating activities
|
25,931,607 | 26,688,531 | ||||||
Cash
flows from investing activities
|
||||||||
Purchase
of fixed assets
|
( 122,093 | ) | ( 784,137 | ) | ||||
Purchase
of subsidiary-Tianlong and Haina
|
- | ( 10,917,280 | ) | |||||
Purchase
of construction in progress
|
( 9,926,849 | ) | - | |||||
Purchase
of intangible assets
|
- | ( 7,139 | ) | |||||
Net
cash used in investing activities
|
( 10,048,942 | ) | ( 11,708,556 | ) | ||||
Cash
flows from financing activities
|
||||||||
Sale
of common stock for cash, net of offering costs
|
- | 23,487,963 | ||||||
Proceeds
from warrants conversion
|
29,169 | 1,044,169 | ||||||
Net
cash provided by financing activities
|
29,169 | 24,532,132 | ||||||
Effect
of exchange rate changes on cash
|
103,091 | 2,245,553 | ||||||
Net
increase in cash and cash equivalents
|
16,014,926 | 41,757,660 | ||||||
Cash
and cash equivalents at beginning of period
|
40,288,117 | 9,190,870 | ||||||
Cash
and cash equivalents at end of period
|
$ | 56,303,043 | $ | 50,948,530 | ||||
Supplemental
disclosure of cash flow information
|
||||||||
Interest
paid
|
$ | - | $ | 135,136 | ||||
Taxes
paid
|
$ | 6,569,901 | $ | 5,512,860 |
On
April 3, 2008, the Company acquired a 100% ownership interest in
Heilongjiang Tianlong Pharmaceutical. Approximate net assets acquired
(see
note 2) consisted of the following:
|
||||
Fixed
assets
|
$
|
6,314,871
|
||
Intangible
assets
|
1,786,990
|
|||
Other
|
170,000
|
|||
Net
assets acquired
|
$
|
8,271,861
|
||
On
April 18, 2008, the Company acquired Heilongjiang Haina ("Haina")
Pharmaceutical Inc. Approximate net assets acquired (see note 2) consisted
of the following:
|
||||
|
||||
Intangible
assets
|
$
|
437,375
|
||
On
September 5, 2008, the Company acquired a 100% ownership interest in Peng
Lai Jin Chuang Company. Approximate net assets acquired (see note 2)
consisted of the following:
|
||||
Fixed
assets
|
$
|
4,176,922
|
||
Intangible
assets
|
2,917,386
|
|||
Net
assets acquired
|
$
|
7,094,308
|
See
accompanying summary of accounting policies and notes to the condensed
consolidated financial statements.
3
China
Sky One Medical, Inc. and Subsidiaries
Notes
to Unaudited Condensed Consolidated Financial Statements
1.
|
Description
of Business
|
The
accompanying unaudited consolidated financial statements of China Sky One
Medical, Inc., a Nevada corporation, and subsidiaries, have been prepared in
accordance with generally accepted accounting principles ("U.S. GAAP") for
interim financial information and with the instructions to Form 10-Q and Article
10 of Regulation S-X. Accordingly, they do not include all of the information
and notes required by U.S. GAAP for complete financial statements. The financial
statements for the periods ended September 30, 2009 and 2008 are unaudited and
include all adjustments necessary for a fair statement of the results of
operations for the periods then ended. All such adjustments are of a normal
recurring nature. The results of the company's operations for any interim period
are not necessarily indicative of the results of the company's operations for a
full fiscal year. For further information, refer to the financial statements and
notes thereto included in the company's annual report on Form 10-K for the year
ended December 31, 2008 as filed with the Securities and Exchange Commission
("SEC") on April 15, 2009.
China Sky
One Medical, ("China Sky One" or the “Company”), a Nevada corporation, was
formed on February 7, 1986, and formerly known as Comet Technologies, Inc.
(“Comet”). On July 26, 2006, the Company changed the name of the reporting
company from "Comet Technologies, Inc." to "China Sky One Medical, Inc."
American
California Pharmaceutical Group, Inc. (“ACPG”), our non operating United
States holding company subsidiary, was incorporated on December 16, 2003, in the
State of California, under the name “QQ Group, Inc.” QQ Group, Inc. changed its
name to “American California Pharmaceutical Group, Inc.” in anticipation of the
Stock Exchange Agreement with China Sky One (then known as “Comet Technologies,
Inc.”) and TDR, described herein. On December 8, 2005, ACPG completed a stock
exchange transaction with TDR a People’s Republic of China (“PRC”) based
operating company and TDR’s subsidiaries (the “TDR Acquisition”), each of which
were fully operating companies in the PRC. Under the terms of the agreement,
ACPG exchanged 100% of its issued and outstanding common stock for 100% of the
capital stock of TDR and its subsidiaries, described below.
Thereafter,
on May 11, 2006, ACPG entered into a Stock Exchange Agreement (the “Exchange
Agreement”) with the shareholders of China Sky One. The terms of the Exchange
Agreement were consummated and the acquisition was completed on May 30, 2006. As
a result of the transaction, the Company issued a total of 10,193,377 shares of
its common voting stock to the stockholders of ACPG, in exchange for 100% of the
capital stock of ACPG resulting in ACPG becoming our wholly-owned subsidiary.
The transaction is treated as a reverse merger for accounting
purposes.
TDR,
formerly known as “Harbin City Tian Di Ren Medical Co.,” was originally formed
in 1994 and maintained its principal executive office in Harbin City of
Heilongjiang Province, in the PRC. TDR was reorganized and incorporated as a
limited liability company on December 29, 2000, under the laws of the PRC. At
the time of the TDR Acquisition by ACPG in December of 2005, TDR had two
wholly-owned subsidiaries, Harbin First Bio-Engineering Company Limited and
Kangxi Medical Care Product Factory, until July, 2006, when the two were merged,
with Harbin First Bio-Engineering Company Limited (“First”) as the surviving
subsidiary of TDR. The principal activities of TDR and First are the research,
manufacture and sale of over-the-counter non-prescription health care products.
TDR commenced its business in the sale of branded nutritional supplements and
over-the-counter pharmaceutical products in the Heilongjiang Province. TDR has
subsequently evolved into an integrated manufacturer, marketer, and distributor
of external use natural Chinese medicine products sold primarily to and through
China’s various domestic pharmaceutical chain stores.
China Sky
One is a holding company whose principal operations are through its wholly-owned
subsidiaries. It has no revenues separate from its subsidiaries, and has nominal
expenses related to its status as a public reporting company and to its 100%
ownership interest in ACPG and TDR.
On
September 30, 2008 (the “Record Date”), we obtained the written consent of the
holders of 8,158,251 shares of our common stock, which as of the Record Date,
represented 51.3% of our outstanding voting securities, to increase our number
of authorized shares of common stock from twenty million (20,000,000) to fifty
million (50,000,000) shares.
4
China
Sky One Medical, Inc. and Subsidiaries
Notes
to Unaudited Condensed Consolidated Financial Statements
2.
|
Acquisition
of Businesses
|
On April
3, 2008, TDR completed an acquisition pursuant to an Equity Transfer Agreement
dated February 22, 2008, between TDR and Heilongjiang Tianlong Pharmaceutical,
Inc., a corporation with a multitude of SFDA approved medicines and new medicine
applications, organized under the laws of the PRC (“Tianlong”), which is in the
business of manufacturing external-use pharmaceuticals. Our TDR subsidiary
previously acquired the Beijing sales office of Tianlong in mid-2006. Pursuant
to the Equity Transfer Agreement, TDR acquired 100% of the issued and
outstanding capital stock of Tianlong from its sole stockholder Wu Jiechen, a
resident of China, in consideration for an aggregate purchase price of
approximately $8,300,000, consisting of (i) $8,000,000 in cash, and (ii) 23,850
shares of China Sky One (value at $12 per share of approximately $286,000). The
acquisition received regulatory approval and closed on April 3,
2008.
The
following table summarizes the approximate estimated fair values of the assets
acquired in the Tianlong acquisition.
Fixed
assets
|
$ | 6,314,871 | ||
Intangible
assets
|
1,786,990 | |||
Other
|
170,000 | |||
Net
assets acquired
|
$ | 8,271,861 |
On April
18, 2008, China Sky One through its subsidiary TDR consummated a share
acquisition pursuant to an Equity Transfer Agreement with the shareholders of
Heilongjiang Haina Pharmaceutical Inc., a recently formed corporation organized
under the laws of the PRC (“Haina”) licensed as a wholesaler of TCMs,
bio-products, medicinal devices, antibiotics and chemical medicines. Haina did
not have an established sales network and was acquired for its primary asset, a
Good Supply Practice (GSP) license (License No. A-HLJ03-010) issued by the
Heilongjiang office of the State Food and Drug Administration (SFDA). The SFDA
recently started issuing such licenses to resellers of medicines that maintain
certain quality controls. The GSP license was issued as of December 21, 2006 and
will expire on January 29, 2012 and will enable the Company to expand its sales
of medicinal products without having to go through a lengthy license application
process. Upon the Company’s acquisition of Haina, the value of the GSP license
was deemed to be nominal and the purchase price was allocated to
goodwill.
The
following table summarizes the approximate estimated fair values of the assets
acquired in the Haina acquisition.
Intangible
assets
|
$ | 437,375 |
Pursuant
to the Equity Transfer Agreement, TDR acquired 100% of the issued and
outstanding capital stock of Haina from its three stockholders in consideration
for payment of 3,000,000 RMB (approximately $437,000). TDR has been overseeing
the operations of Haina since January of 2008 as part of its due diligence prior
to closing of this acquisition.
On June
9, 2008, TDR entered into a Merger and Acquisition Agreement (the “Acquisition
Agreement”) with Peng Lai Jin Chuang Company, a corporation organized under the
laws of the PRC (“Peng Lai”), which organized to develop, manufacture and
distribute pharmaceutical, medicinal and diagnostic products in the PRC.
Pursuant to the Acquisition Agreement, TDR acquired all of the assets of
Peng Lai in consideration for an aggregate of approximately (i) US$2.5 million
in cash, and (ii) 381,606 shares of the Company’s common stock with a fair value
of approximately $4.6 million (value at $12 per share). The
acquisition of Peng Lai closed on September 5, 2008.
The
following table summarizes the approximate estimated fair values of the assets
acquired in the Peng Lai acquisition.
Fixed
assets
|
$ | 4,176,922 | ||
Intangible
assets
|
2,917,386 | |||
Net
assets acquired
|
$ | 7,094,308 |
5
China
Sky One Medical, Inc. and Subsidiaries
Notes
to Unaudited Condensed Consolidated Financial Statements
3.
|
Summary
of Significant Accounting Policies
|
Principles of Consolidation –
The accompanying consolidated financial statements include the accounts of the
Company and its wholly-owned subsidiaries, ACPG, TDR, First, Haina, Tianlong,
and Peng Lai. All significant inter-company transactions and balances were
eliminated.
These
financial statements are stated in U.S. Dollars and have been prepared in
accordance with accounting principles generally accepted in the United States of
America. This basis of accounting differs from that used under applicable
accounting requirements in the PRC. No material adjustment was
required.
Certain
items in the 2008 financial statements have been reclassified to conform with
the 2009 financial statements presentation.
Use of estimates – The
preparation of these financial statements in conformity with U.S. GAAP, requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities, disclosure of contingent assets and liabilities at the
dates of the financial statements, and the reported amounts of revenues and
expenses during the reported periods.
Significant
estimates include the assigned lives to long-lived assets, uncollectible
accounts receivable, and our impairment testing of goodwill and long-lived
assets. Actual results may differ from these estimates.
Earnings per share - Basic
earnings per common share is computed by dividing net earnings applicable to
common shareholders by the weighted-average number of common shares outstanding
during the period. When applicable, diluted earnings per common share is
determined using the weighted-average number of common shares outstanding during
the period, adjusted for the dilutive effect of common stock equivalents,
consisting of shares that might be issued upon exercise of common stock options
and warrants.
Potential
common shares issued are calculated using the treasury stock method, which
recognizes the use of proceeds that could be obtained upon the exercise of
options and warrants in computing diluted earnings per share. It assumes that
such proceeds would be used to purchase common stock at the average market price
of the common stock during the period.
Cash and cash equivalents –
The Company
considers all highly liquid instruments purchased with a maturity period of
three months or less to be cash equivalents. The carrying amounts reported in
the accompanying consolidated balance sheets for cash and cash equivalents
approximate their fair value.
A
significant amount of our cash and cash equivalents are held in commercial bank
checking accounts in the PRC and earned an annual interest income yield of
approximately 0.36% for the nine months ended September 30, 2009. For all the
bank accounts in the PRC, the Company earned interest income of
approximately $48,000 and $79,000 for the nine months ended September 30, 2009
and 2008, respectively.
Accounts receivable – Accounts receivable are
stated at net realizable value, net of an allowance for doubtful accounts. The
allowance for estimated bad debts is based upon the periodic analysis of
individual customer balances including an evaluation of days of sales
outstanding, payment history, recent payment trends, and perceived credit
worthiness. At September 30, 2009 and December 31, 2008, the Company’s allowance
for doubtful accounts was $50,000.
Inventories – Inventories
include finished goods, raw materials, freight-in, packing materials, labor, and
overhead costs and are valued at the lower of cost or market using the first-in,
first-out method. Inventory units are valued using the weighted average method.
Provisions are made for slow moving, obsolete and/or damaged inventory based
upon the periodic analysis of individual inventory items including an evaluation
of historical usage and/or movement, age, expiration date, and general
conditions. There is no inventory reserve provision recorded at September 30,
2009 and December 31, 2008.
6
China
Sky One Medical, Inc. and Subsidiaries
Notes
to Unaudited Condensed Consolidated Financial Statements
3.
|
Summary
of Significant Accounting Policies
(Continued)
|
Property and equipment –
Property and equipment are stated at historical cost less accumulated
depreciation. Depreciation on property and equipment is provided using the
straight-line method over the estimated useful lives of the assets. The Company
uses an estimated residual value of 5% of cost, or valuation for both financial
and income tax reporting purposes. The estimated lengths of useful lives are as
follows:
Building
and Improvements
|
30
years
|
|
Land
use rights
|
50
years
|
|
Furniture
& Equipment
|
5
to 7 years
|
|
Transportation
Equipment
|
5
to 15 years
|
|
Machinery
and Equipment
|
7
to 14 years
|
Expenditures
for renewals and betterments are capitalized while repairs and maintenance costs
are normally charged to the statement of operations in the year in which they
were incurred. In situations where it can be clearly demonstrated that the
expenditure has resulted in an increase in the future economic benefits expected
to be obtained from the use of the asset, the expenditure is capitalized as an
additional cost of the asset. Upon sale or disposal of an asset, the historical
cost and related accumulated depreciation or amortization of such asset is
removed from their respective accounts, and any gain or loss is recorded in the
consolidated statements of operations.
Property
and equipment are evaluated for impairment in value whenever an event or change
in circumstances indicates that the carrying values may not be recoverable. If
such an event or change in circumstances occurs and potential impairment is
indicated because the carrying values exceed the estimated future undiscounted
cash flows of the asset, the Company will measure the impairment loss as the
amount by which the carrying value of the asset exceeds its fair value. The
Company did not record any impairment charges during the three and nine months
ended September 30, 2009 and 2008.
Construction-in-progress –
Properties currently under development are accounted for as
construction-in-progress. Construction-in-progress is recorded at acquisition
cost, including land rights cost, development expenditures, professional fees,
and capitalized interest costs during the course of construction.
Upon
completion and readiness for use of the project, the cost of
construction-in-progress is transferred to the facility. In the case of
construction-in-progress, management takes into consideration the estimated cost
to complete the project when making the lower of cost or market calculation (see
Note 14).
Intangible assets – Intangible
assets consists of patents and goodwill, as follows:
Patents
|
$ | 14,112,631 | ||
Goodwill
|
759,987 | |||
Total
|
$ | 14,872,618 |
Intangible
assets are accounted for in accordance with ASC topic 350, “Intangibles –
Goodwill and Other.” Intangible assets with finite useful lives are amortized
while intangible assets with indefinite useful lives are not amortized. The
Company reviews its long-lived assets, including property and equipment and
finite-lived intangible assets for impairment on at least an annual basis or
whenever events or changes in circumstances indicate that the carrying amount of
the assets may not be fully recoverable. To determine recoverability of its
long-lived assets, the Company evaluates the probability that future
undiscounted net cash flows will be less than the carrying amount of the assets.
Impairment costs, if any, are measured by comparing the carrying amount of the
related assets to their fair value. The Company recognizes an impairment loss
based on the excess of the carrying amount of the assets over their respective
fair values. Fair value is determined by discounted future cash flows,
appraisals or other methods. If the assets determined to be impaired are to be
held and used, the Company recognizes an impairment loss thru a charge to
operating results to the extent the present value of anticipated cash flows
attributable to the assets are less than the asset’s carrying value. The Company
would depreciate the remaining value over the remaining estimated useful life of
the asset to operating results. The Company did not record any impairment
charges during the three and nine months ended September 30, 2009 and
2008.
7
China
Sky One Medical, Inc. and Subsidiaries
Notes
to Unaudited Condensed Consolidated Financial Statements
3.
|
Summary
of Significant Accounting Policies
(Continued)
|
The
Company has registered the trademark “Kang Xi” in the PRC. However, the Company
has never had an appraisal done on this trademark or assigned any value to it.
Additionally, none of the costs associated with the trademark have been
capitalized.
As of
September 30, 2009, the weighted average amortization period for our patents is
9 years.
Foreign Currency - The Company’s principal
country of operations is in the PRC. The financial position and results of
operations of the Company are recorded in Renminbi (“RMB”) as the functional
currency. The results of operations denominated in foreign currency are
translated at the average rate of exchange during the reporting
period.
Assets
and liabilities denominated in foreign currencies at the balance sheet date are
translated at the market rate of exchange at that date. The registered equity
capital denominated in the functional currency is translated at the historical
rate of exchange at the time of the capital contribution. All translation
adjustments resulting from the translation of the financial statements into U.S.
Dollars are recorded as accumulated other comprehensive income, a component of
stockholders’ equity.
Revenue recognition - Revenue
is recognized when the following criteria are met: (1) persuasive evidence
of an arrangement exists; (2) the product has been shipped and the customer
takes ownership and assumes the risk of loss; (3) the selling price is
fixed or determinable; and (4) collection of the resulting receivable is
reasonably assured. The Company believes that all of these criteria are
satisfied upon shipment from its facilities. Historically, the Company’s
estimated returns, allowances and claims have been deemed immaterial. The
Company’s sale agreements only allow a return if the product has quality related
issues. In such event, the Company accepts the return for equivalent product
exchange from inventory only.
The
Company occasionally applies to various government agencies for research grants.
Revenue from such research grants is recognized when earned. In situations where
the Company receives payment in advance for the performance of research and
development services, such amounts are deferred and recognized as revenue as the
related services are performed.
Deferred revenues - The
Company recognizes revenues as earned. Amounts billed in advance of the period
in which goods are delivered are recorded as a liability under “Deferred
revenues.”
Research and development -
Research and development expenses include the costs associated with the
Company’s internal research and development as well as research and development
conducted by third parties. These costs primarily consist of salaries, clinical
trials, outside consultants, and materials. All research and development costs
are expensed as incurred.
Third-party
expenses reimbursed under non-refundable research and development contracts are
recorded as a reduction to research and development expense in the consolidated
statement of operations.
The
Company recognizes in-process research and development in accordance with ASC
topic 730, “Research and Development.” Assets to be used in research and
development activities, specifically, compounds that have yet to receive new
drug approval and would have no alternative use, should approval not be given,
are immediately charged to expense when acquired. Certain assets and other
technologies acquired that has foreseeable future cash flows are capitalized as
intangible assets. Such intangible assets are amortized starting from the year
revenue is generated and amortized over an estimated period of 10 years. Should
under any circumstances these capitalized intangible assets have no future
benefit; the Company will record an immediate write-off for the remaining net
carrying value within the consolidated statement of operations.
The
Company incurred $4,884,925, $10,979,619 in research and development costs for
the three and nine months ended September 30, 2009, respectively. The Company
incurred $1,866,409 and $3,881,312 in research and development costs for the
three and nine months ended September 30, 2008, respectively.
8
China
Sky One Medical, Inc. and Subsidiaries
Notes
to Unaudited Condensed Consolidated Financial Statements
3.
|
Summary
of Significant Accounting Policies
(Continued)
|
Advertising – Advertising and trade
show costs are expensed in the period in which the service is used. The Company
signs contracts with agents who then place its advertising in the mediums of
television, radio and internet. Advertising costs for the three months ended
September 30, 2009 and 2008 was $5,031,001 and $2,091,802,
respectively. Advertising costs for the nine months ended September 30,
2009 and 2008 was $11,244,959 and $5,257,228,
respectively. Advertising costs are reported as part of selling, general
and administrative expenses in the statements of operations.
Taxation – The Company uses
the asset and liability method of accounting for deferred income taxes. The
Company’s provision for income taxes includes income taxes currently payable and
those deferred because of temporary differences between the financial statement
and tax bases of assets and liabilities. The Company records liabilities
for income tax contingencies based on our best estimate of the underlying
exposures.
The
Company periodically estimates its tax obligations using historical experience
in tax jurisdictions and informed judgments. There are inherent uncertainties
related to the interpretation of tax regulations in the jurisdictions in which
the Company transacts business. The judgments and estimates made at a point in
time may change based on the outcome of tax audits, as well as changes to, or
further interpretations of, regulations. The Company adjusts income tax expense
in the period in which these events occur.
Provision
for the PRC enterprise income tax is calculated at the prevailing rate based on
the estimated assessable profits less available tax relief for losses brought
forward. The
Company does not accrue taxes on unremitted earnings from foreign operations as
it is the Company’s intention to invest these earnings in the foreign operations
indefinitely.
Enterprise income
tax
Under the
Provisional Regulations of the PRC Concerning Income Tax on Enterprises
promulgated by the PRC, income tax is payable by enterprises at the statutory
rate of 25% of their taxable income. Preferential tax treatment may, however, be
granted pursuant to any law or regulations from time to time promulgated by the
State Council.
According
to “Enterprise Income Tax and Certain Preferential Policies Notice” published by
the Ministry of Finance and the National Tax Affairs Bureau, if the enterprise
is authorized by the State Council as a special entity, the enterprise income
tax rate is reduced to 15%. In 2009, the income tax rate for TDR, Tianlong,
and First is 15% based on State Council approval. The income tax rate
for Haina is 25%. The income tax rate for Peng Lai is regulated by local
government at 2% of total revenue commencing January 1, 2009.
In 2008,
the income tax rate for TDR and Tianlong was 15% and 12%, respectively. The
income tax rate for First, Haina, and Peng Lai was 25%.
Value added
tax
The
Provisional Regulations of PRC Concerning Value Added Tax promulgated by the
State Council came into effect on January 1, 1994. Under these regulations and
the Implementing Rules of the Provisional Regulations of the PRC Concerning
Value Added Tax, value added tax is imposed on goods sold in, or imported into,
the PRC and on processing, repair and replacement services provided within the
PRC.
Value
added tax payable in the PRC is charged on an aggregated basis at a rate of 13%
or 17% (depending on the type of goods involved) on the full price collected for
the goods sold or, in the case of taxable services provided, at a rate of 17% on
the charges for the taxable services provided, but excluding, in respect of both
goods and services, any amount paid in respect of value added tax included in
the price or charges, and less any deductible value added tax already paid by
the taxpayer on purchases of goods and services in the same financial
year.
9
China
Sky One Medical, Inc. and Subsidiaries
Notes
to Unaudited Condensed Consolidated Financial Statements
3.
|
Summary
of Significant Accounting Policies
(Continued)
|
According
to “Agriculture Product Value Added Tax Rate Adjustment and Certain Items’ Value
Added Tax Waiver” published by the Ministry of Finance and the National Tax
Affairs Bureau, the value added tax for agriculture related products is to be
taxed at 13%. Furthermore, traditional Chinese medicine and medicinal plant are
by definition agriculture related products.
We may
from time-to-time be assessed interest or penalties by major tax jurisdictions,
although such assessments historically have been minimal and immaterial to our
financial results. Our policy is to recognize interest and penalties accrued on
any unrecognized tax benefits as a component of income tax expense.
The
Company files corporate income tax returns in the U.S. for China Sky One and
ACPG. ACPG wholly owns 100% of TDR and subsidiaries in the PRC. China Sky One
and ACPG are holding companies and do not generate business revenues and
management’s intent is not to distribute dividend income from TDR and
subsidiaries to either China Sky One or ACPG. As such, management has
established a full valuation allowance for the net operating losses incurred by
China Sky One and ACPG. The Company files income tax returns in the U.S. for
China Sky One and ACPG and in the PRC for TDR and its subsidiaries. The Company
is subject to audit for each of the three years ended December 31,
2008.
Comprehensive income –
Comprehensive income consists of net income and other gains and losses
affecting stockholders’ equity that, under generally accepted accounting
principles are excluded from net income. For the Company, such items consist
entirely of foreign currency translation gains and losses.
Related companies – A
related company is a company in which the director has beneficial interests in
and in which the Company has significant influence.
Retirement benefit costs –
According to the PRC regulations on pension plans, the Company contributes to a
defined contribution retirement plan organized by municipal government in the
province in which the Company was registered and all qualified employees as
defined by statutory regulations are eligible to participate in the
plan.
Contributions
to the pension or retirement plan are calculated at 22.5% of the employees’
salaries above a fixed threshold amount. The employees contribute between 2% to
8% to the pension plan, and the Company contributes the balance. The Company has
no other material obligations for the payment of retirement benefits beyond the
annual contributions under this plan. The Company incurred costs of $35,626 and
$37,513 for the three months ended September 30, 2009 and
2008, respectively. The Company incurred costs of $125,598 and
$62,699 for the nine months ended September 30, 2009 and
2008, respectively.
Fair value of financial instruments
– The carrying amounts of
certain financial instruments, including cash and cash equivalents, accounts
receivable, other receivables, accounts payable, accrued expenses, and other
payables approximate their fair values at September 30, 2009 and 2008
because of the relatively short-term maturity of these instruments.
Subsequent
Events
The
Company evaluated subsequent events through November 16, 2009, the date of
filing of this Form 10-Q in accordance with the Subsequent Events Topic of the
FASB Accounting Standards Codification under ASC topic 855.
10
China
Sky One Medical, Inc. and Subsidiaries
Notes
to Unaudited Condensed Consolidated Financial Statements
3.
|
Summary
of Significant Accounting Policies
(Continued)
|
New
Pronouncements
On July
1, 2009, the Accounting Standards Codification (“ASC”) became FASB’s officially
recognized source of authoritative U.S. GAAP applicable to all public and
non-public non-governmental agencies, superseding existing FASB, AICPA, EITF and
related literature. Rules and interpretive releases of the SEC under the
authority of federal securities law are also sources of authoritative GAAP for
SEC registrants. All other accounting literature is considered
non-authoritative. The switch to the ASC affects the way companies refer to U.S.
GAAP in financial statements and accounting policies. Citing particular content
in the ASC involves specifying the unique numeric path to the content through
the Topic, Section and Paragraph structure.
The fair
value requirements for nonfinancial assets and liabilities not recognized or
disclosed at fair value in an entity’s financial statements on a recurring basis
was deferred, until January 1, 2009 by The Fair Value Measurements and
Disclosures Topic of the FASB Accounting Standards Codification under ASC topic
820. Implementation of the fair value requirements for these items
did not have a material impact on our financial statements.
The
Business Combinations Topic of the FASB Accounting Standards Codification under
ASC topic 805, includes new requirements that became effective for us in 2009.
The definitions of a business and business combination were expanded and all
assets and liabilities of an acquired business (for full, partial and step
acquisitions) are required to be recorded at fair values, with limited
exceptions. Earn-outs and other contingent consideration are required to be
recorded at fair value on acquisition date and contingencies to be recorded at
fair value on acquisition date with provision for subsequent remeasurement.
Acquisition costs must be expensed as incurred and restructuring costs must
generally be expensed in periods after the acquisition date. Amounts previously
called “negative goodwill” which result from a bargain purchase in which
acquisition date fair value of identifiable net assets acquired exceeds the fair
value of consideration transferred plus any noncontrolling interest in the
acquirer are required to be recognized in earnings as a gain attributable to the
acquirer. The effects of the new requirements will depend on the nature and
significance of acquisitions subsequent to our adoption of the new
requirements.
The
Consolidation Topic of the FASB Accounting Standards Codification under ASC
topic 810 contains new requirements that became effective for us in 2009.
Noncontrolling interests are required to be reported in the equity section of
consolidated financial statements and consolidated net income is required to
include the amounts attributable to both the parent and the noncontrolling
interest with disclosure on the face of the consolidated income statement of net
income attributable to the parent and to the noncontrolling interests, with any
losses attributable to the noncontrolling interests in excess of the
noncontrolling interests equity to be allocated to the noncontrolling interests.
Calculation of earnings per share amounts in the consolidated financial
statements continue to be based on amounts attributable to the parent. The
adoption of the new requirements resulted in presentation differences but did
not have a material effect on our consolidated financial
statements.
The
Subsequent Events Topic of the FASB Accounting Standards Codification under ASC
topic 855 includes accounting and disclosure requirements for events that occur
after the balance sheet date but before the issuance of financial statements
effective for financial statements for periods ending after June 15, 2009. The
adoption of these disclosure requirements did not affect our consolidated
financial statements.
4.
|
Concentrations
of Business and Credit Risk
|
The
Company maintains certain bank accounts in the PRC which are not protected by
FDIC insurance or other insurance. As of September 30, 2009 the Company held
approximately $2,125,000 of cash balances within the U.S. of which was all
insured. At September 30, 2009, the Company had approximately $54,178,000, in
PRC bank deposits, which are not insured. Historically, the Company has not
experienced any losses in such accounts. The Company will record all losses
associated with these risks at such time a loss is incurred. The Company
believes that the chances of such losses actually take place are very
remote.
11
China
Sky One Medical, Inc. and Subsidiaries
Notes
to Unaudited Condensed Consolidated Financial Statements
4.
|
Concentrations
of Business and Credit Risk
(Continued)
|
Nearly
all of the Company’s sales are concentrated in PRC. Accordingly, the Company is
susceptible to fluctuations in its business caused by adverse economic
conditions in this country. Difficult economic conditions in other geographic
areas into which the Company may expand may also adversely affect its business,
operations and finances.
The
Company provides credit in the normal course of business. Substantially all
customers are located in PRC. The Company performs ongoing credit evaluations of
its customers and maintains allowances for doubtful accounts based on factors
surrounding the credit risk of specific customers, historical trends, and other
information.
Substantially
all of the Company's long lived assets and business operations are located in
the PRC.
The
Company is self-insured for all risks and carries no liability or property
insurance coverage of any kind. The
Company does not set aside any reserves for product liability risks or other
potential claims. The Company’s
policy is to record losses associated with its lack of insurance coverage at
such time as a realized
loss is incurred. Historically, the Company has not had any material losses in
connection with its lack of
insurance coverage and was not party to any material pending legal proceedings
as of September 30, 2009.
Management’s intention is to use the Company’s working capital to fund any such
losses incurred due to the
Company’s exposure to inadequate insurance coverage.
The
Company is not a party to any material legal proceedings as of September 30,
2009.
Payments
of dividends may be subject to some restrictions due to the Company’s operating
subsidiaries all being located in the PRC.
Major
Customers
For the
nine months ended September 30, 2009, Harbin Shiji Baolong and Shanxi Xintai
accounted for 14% and 13% respectively of sales revenues. For the nine months
ended September 30, 2008, no individual customer accounted for more than 10% of
sales revenues. As of September 30, 2009 and 2008, Harbin Shiji Baolong
accounted for 25% and 20% of our outstanding accounts receivables, respectively.
Hangzhou Jiupin accounted for approximately 11% of our outstanding accounts
receivables as of September 30, 2008. No other customer accounted for more than
10% of our outstanding accounts receivables.
Major
Suppliers
Heilongjiang
Kangda Medicine Co. and Harbin Zhongjia Chem accounted for approximately 40% and
16% respectively of the Company’s inventory purchases for the nine months ended
September 30, 2009. Heilongjiang Kangda Medicine Co. accounted for 45% of the
Company’s inventory purchases for the nine months ended September 30,
2008.
12
China
Sky One Medical, Inc. and Subsidiaries
Notes
to Unaudited Condensed Consolidated Financial Statements
5.
|
Earnings
per Share
|
The
Company calculates its earnings per share under ASC topic 260, Earnings per
Share. Basic earnings per share are computed by dividing net earnings available
to common shareholders (the numerator) by the weighted average number of common
shares (the denominator) for the period presented. The computation of diluted
earnings per share is similar to basic earnings per share, except that the
denominator is increased to include the number of additional common shares that
would have been outstanding if the potentially dilutive common shares had been
issued.
Stock
warrants to purchase 750,000 shares of common stock were outstanding and
exercisable as of September 30, 2009. Stock warrants and options to
purchase 1,572,245 shares of common stock, all were exercisable and outstanding
as of September 30, 2008. These common stock equivalents were included in the
computation of diluted earnings per share because the option exercise prices
were less than the average market price of our common stock during these
periods.
The
dilutive potential common shares on warrants and options is calculated in
accordance with the treasury stock method, which assumes that proceeds from the
exercise of all warrants and options are used to repurchase common stock at
market value. The amount of shares remaining after the proceeds are exhausted
represent s the potential dilutive effect of the securities.
The
following table sets forth our computation of basic and diluted net income per
share:
For
the three months ended September 30,
|
||||||||
2009
|
2008
|
|||||||
Numerator:
|
||||||||
Net
income used in calculation of basic and diluted earnings per
share
|
$ | 12,458,940 | $ | 9,943,435 | ||||
Denominator:
|
||||||||
Weighted-average
common shares outstanding used in calculation of basic earnings per
share
|
16,655,697 | 15,464,084 | ||||||
Effect
of dilutive securities:
|
||||||||
Stock
options and equivalents
|
86,048 | 1,028,330 | ||||||
Weighted-average
common shares used in calculation of diluted earnings (loss) per
share
|
16,741,745 | 16,492,414 | ||||||
Net
income per share:
|
||||||||
Basic
|
$ | 0.75 | $ | 0.64 | ||||
Diluted
|
$ | 0.74 | $ | 0.60 |
13
China
Sky One Medical, Inc. and Subsidiaries
Notes
to Unaudited Condensed Consolidated Financial Statements
5.
|
Earnings
per Share (Continued)
|
The
following table sets forth the Company’s computation of basic and diluted net
income per share:
For
the nine months ended September 30,
|
||||||||
2009
|
2008
|
|||||||
Numerator:
|
||||||||
Net
income used in calculation of basic and diluted earnings per
share
|
$ | 29,158,771 | $ | 21,919,013 | ||||
Denominator:
|
||||||||
Weighted-average
common shares outstanding used in calculation of basic earnings per
share
|
16,535,924 | 14,657,059 | ||||||
Effect
of dilutive securities:
|
||||||||
Stock
options and equivalents
|
70,652 | 1,088,483 | ||||||
Weighted-average
common shares used in calculation of diluted earnings (loss) per
share
|
16,606,576 | 15,745,542 | ||||||
Net
income per share:
|
||||||||
Basic
|
$ | 1.76 | $ | 1.50 | ||||
Diluted
|
$ | 1.76 | $ | 1.39 |
6.
|
Equity
and Share-based Compensation
|
In July
2006, the Company’s stockholders approved the 2006 Stock Incentive Plan (the
“2006 Plan”). The 2006 Plan, provides for the grant of stock options, restricted
stock awards, and performance shares to qualified employees, officers,
directors, consultants and other service providers. The 2006 Plan originally
authorized the Company to grant options and/or rights to purchase up to an
aggregate of 1,500,000 shares of common stock. As of September 30, 2009,
non-qualified options to purchase a total of 113,500 shares have been granted
under the 2006 Stock Incentive Plan. All options were granted in October 2006.
All options had an exercise price of $3.65 per share, the weighted fair market
value on the date of grant was $4.25 per share. Of these 113,500 options a total
of 60,500 were granted to employees and a total of 53,000 were granted to
consultants. These options were valued using the Black-Scholes option-pricing
model with the following assumptions: no dividends; risk-free interest rate of
4%; a contractual life of 5 years and volatility of 39%. All 113,500 options
vested over various periods for the options granted to employees and
consultants. As of September 30, 2009, all 113,500 options have been exercised
on a cashless basis for a total of 85,295 shares of the Company’s common
stock.
In
connection with closing of the Stock Exchange Agreement, the Company agreed to
grant warrants to advisors for the services they already performed for the
reverse merger in July 2006, entitling them to purchase up to 500,000 shares on
or before July 31, 2009, at a price of $2.00 per share and options to purchase
up to 50,000 shares on or before December 20, 2008 at a price of $3.00 per
share. The fair value of these warrants and options were determined to be
$772,275 and deducted as expenses using the Black-Scholes option-pricing model
with the following weighted assumptions: no dividends; risk-free interest rate
of 4%; a contractual life of 2.5-3.5 years and volatility of 39%. The Company
based its estimate of expected volatility on the historical, expected or implied
volatility of similar entities whose share or option prices are publicly
available. As of September 30, 2009, all of these warrants had been
exercised.
During
the nine months ended September 30, 2009, warrant holders exercised 8,334 shares
of their warrants, at an exercise price of $3.50 per share, for total proceeds
of $29,169. Warrant holders also exercised 300,000 shares of warrants on a
cashless basis for a total of 261,610 shares of the Company’s common
stock.
14
China
Sky One Medical, Inc. and Subsidiaries
Notes
to Unaudited Condensed Consolidated Financial Statements
7.
|
Securities
Purchase Agreement and Related
Transaction
|
On
January 31, 2008, China Sky One entered into a Securities Purchase Agreement
(the “Securities Purchase Agreement”) with certain accredited investors, for the
purchase and sale of units consisting of: (i) one (1) share of the Company’s
common stock, $0.001 par value per share (“Common stock”); and (ii) 750,000
Class A Warrants exercisable at $12.50 per share, and expiring on July 31, 2011
(the “Class A Warrants”), for a purchase price of $10.00 per Unit (the “Unit
Purchase Price”), or gross offering proceeds of $25.0 million (the “2008
Offering”). The Company received net proceeds of approximately $23.5 million in
connection with the 2008 offering.
Pursuant
to the Purchase Agreement, among other things, if, and whenever, within twelve
(12) months of the Closing Date, the Company issued or sold, or was deemed to
have issued or sold, any shares of common stock, or securities convertible into
or exercisable for shares of common stock, or modified any of the foregoing
which may be outstanding (with the exception of certain excluded securities), to
any person or entity at a price per share, or conversion or exercise price per
share less than the Unit Purchase Price, then the Company was required to issue,
for each such occasion, additional shares of its common stock to the Investors
in such number so that the average per share purchase price of the shares of
common stock purchased by the Investors in the 2008 Offering would automatically
be reduced to such other lower price per share. The Company did not issue any
equity which would trigger this event within twelve (12) months of the Closing
Date.
In
addition, as of the Closing Date, the Company entered into a Make Good Agreement
(the “Make Good Agreement”) with Liu Yan-Qing, its Chairman, Chief Executive
Officer and President, and a principal shareholder of the Company, (the
“Principal Shareholder”) and the Investors (collectively, the “Make Good
Parties”), pursuant to which the Principal Shareholder deposited 3,000,000
shares of his common stock of the Company (the “Escrow Shares”) into escrow, to
be released to the Investors in an amount pro rata pro to their initial
investments in the 2008 Offering, in the event the Company failed to attain
earnings per share, as adjusted, of at least (i) $1.05 per share for the fiscal
year ending December 31, 2007 (based on an aggregate of 13,907,696 shares
outstanding), and/or (ii) $1.63 per share for the fiscal year ending December
31, 2008 (based on 16,907,696 shares outstanding).
The
Company deemed the Escrow Shares arrangement as analogous to the issuance of a
fixed number of warrants in an equity transaction. Under the Make Good
Agreement these Escrow Shares would have been reallocated on a pro rata
basis to the Investors only if certain earnings targets were not achieved in
years 2007 and 2008. If the earnings targets were met, the Escrow Shares
would automatically be released to the Principal Shareholder. As of January
31, 2008, the date the common shares were placed into escrow, the Company
achieved the 2007 earnings target and, based upon internal forecasts, was
confident the 2008 target would also be met. Based upon certain
assumptions, including the low probability that the Escrow Shares would be
released to the Investors and not be returned to the Principal Shareholder, the
Company considered the fair value of the right held by the Investors through the
Escrow Shares provision under the Make Good Agreement to be immaterial. As
of December 31, 2008, the Company satisfied the earnings per common share
targets for each of fiscal 2007 and 2008 as defined under the Make Good
Agreement and, as such, the Escrow Shares had been released in May
2009.
The Class
A Warrants represent the right to purchase an aggregate of 750,000 shares of
common stock, at an exercise price of $12.50 per share. Additional information
relating to these Class A Warrants is provided in Note 8.
15
China
Sky One Medical, Inc. and Subsidiaries
Notes
to Unaudited Condensed Consolidated Financial Statements
8.
|
Outstanding
Warrants and Options
|
Shares
Underlying
Warrants
|
Weighted
average
Exercise
Price
Warrants
|
Shares
underlying
Options
|
Weighted
average
Exercise
Price
Options
|
|||||||||||||
Outstanding
as of January 1, 2006
|
25,000 | $ | 1.50 | - | ||||||||||||
Granted
|
1,650,000 | 2.58 | 163,500 | $ | 3.45 | |||||||||||
Exercised
|
- | - | - | - | ||||||||||||
Expired
or cancelled
|
- | - | - | - | ||||||||||||
Outstanding
as of December 31, 2006
|
1,675,000 | 2.57 | 163,500 | $ | 3.45 | |||||||||||
Granted
|
- | - | - | - | ||||||||||||
Exercised
|
- | - | - | - | ||||||||||||
Expired
or cancelled
|
(161,667 | ) | 3.19 | - | - | |||||||||||
Outstanding
as of December 31, 2007
|
1,513,333 | $ | 2.48 | 163,500 | $ | 3.45 | ||||||||||
Granted
|
750,000 | 12.50 | - | - | ||||||||||||
Exercised
|
(1,204,999 | ) | (50,000 | ) | - | |||||||||||
Expired
or cancelled
|
- | - | - | - | ||||||||||||
Outstanding
as of December 31, 2008
|
1,058,334 | $ | 9.50 | 113,500 | $ | 3.65 | ||||||||||
Granted
|
- | - | - | - | ||||||||||||
Exercised
|
(308,334 | ) | (113,500 | ) | ||||||||||||
Expired
or cancelled
|
- | - | - | - | ||||||||||||
Outstanding
as of September 30, 2009
|
750,000 | $ | 12.50 | - | $ | - |
The
following table summarizes information about stock warrants outstanding and
exercisable as of September 30, 2009.
Exercise
Price
|
Outstanding
September
30,
2009
|
Weighted
Average
Remaining
Life
in
Years
|
Number
exercisable
|
|||||||||||
$ | 12.50 | 750,000 | 1.75 | 750,000 | ||||||||||
750,000 | 750,000 |
Out of
the 750,000 outstanding warrants, all were exercisable as of September 30, 2009.
These Class A Warrants represent the right to purchase an aggregate of 750,000
shares of Common Stock of the Company, at an exercise price of $12.50 per share
(the “Exercise Price”), and have the following additional
characteristics:
|
·
|
The
Class A Warrants were exercisable beginning on the six-month anniversary
of the closing of the January 2008 Offering and will expire July 31,
2011.
|
16
China
Sky One Medical, Inc. and Subsidiaries
Notes
to Unaudited Condensed Consolidated Financial Statements
8.
|
Outstanding
Warrants and Options (Continued)
|
|
·
|
Commencing
on the one-year anniversary of the Closing Date, in the event the shares
underlying the Class A Warrants (the “Warrant Shares”) may not be freely
sold by the holders of the Class A Warrants due to the Company’s failure
to satisfy its registration requirements, and an exemption for such sale
is not otherwise available to the warrant holders under Rule 144, the
Class A Warrants will be exercisable on a cashless
basis.
|
|
·
|
The
Exercise Price and number of Warrant Shares will be subject to adjustment
for standard dilutive events, including the issuance of common stock, or
securities convertible into or exercisable for shares of common stock, at
a price per share, or conversion or exercise price per share less than the
Class A Warrant exercise price of $12.50 per
share.
|
|
·
|
At
anytime following the date a Registration Statement covering the Warrant
Shares is declared effective, the Company will have the ability to call
the Class A Warrants at a price of $0.01 per Class A Warrant, upon thirty
(30) days prior written notice to the holders of the Class A Warrants,
provided (i) the closing price of the Common stock exceeded $18.75 for
each of the ten (10) consecutive trading days immediately preceding the
date that the call notice is given by the Company, and (ii) the Company
has attained an adjusted earnings per share of at least $1.75 per share
for the fiscal year ending December 31, 2008, as set forth in our audited
financial statements of the
Company.
|
|
·
|
If,
among other things, the Company fails to cause a Registration Statement
covering the Warrant Shares to be declared effective prior to the
applicable dates set forth in the Registration Rights Agreement, the
expiration date of the Class A Warrants shall be extended one day for each
day the registration default continues. To date, the Company has not
satisfied its registration requirements. The Company retained an
independent third party to calculate the changes in fair value of the
Class A Warrants due to its failure to register the Warrant Shares. The
change in fair value for the nine months ended September 30, 2009 was
deemed immaterial.
|
The
Company’s outstanding warrants provide for an extension of the scheduled
expiration date due to the Company’s failure to satisfy its
obligation to register the Warrant Shares for resale. Pursuant to the
terms of the warrants, the expiration date extends one day for each day the
registration default continues, subject to certain limitations. This extension
of the expiration date is the only penalty related to the Company’s failure to
register the Warrant Shares on a timely basis.
The
registration rights do not require a cash settlement and the warrants can be
settled in unregistered shares. The Company retained an independent third party
to calculate the changes in the fair value of the warrants due to its failure to
register the Warrant Shares. The change in fair value (since the registration
default date) as of September 30, 2009 is deemed to be immaterial.
9.
|
Inventories
|
The
Company values its inventories at the lower of cost and market method.
Inventories are accounted for using the first-in, first-out method. Inventories
include packing materials, raw materials, supplemental materials,
work-in-process, and finished products.
17
China
Sky One Medical, Inc. and Subsidiaries
Notes
to Unaudited Condensed Consolidated Financial Statements
9.
|
Inventories
(Continued)
|
As of
September 30, 2009 and December 31, 2008, inventories consist of the
following:
September
30,
|
December
31,
|
|||||||
2009
|
2008
(Audited)
|
|||||||
Raw
Material
|
$ | 1,486,072 | $ | 330,275 | ||||
Work-in-Process
|
611,920 | 76,462 | ||||||
Finished
Products
|
1,001,459 | 55,614 | ||||||
Total
Inventories
|
$ | 3,099,451 | $ | 462,351 |
Historically,
the Company’s inventory is at its lowest levels at the end of each calendar
year. Since a lower volume of sales activity normally occurs during the first
quarter of each calendar year, the Company believes it is prudent to avoid
incurring unnecessary inventory carrying costs. At the appropriate time in the
first calendar quarter of each fiscal year, the Company begins to ramp up its
inventory levels to prepare for increased demand during the coming stronger
selling periods.
Management
calculates its inventory turnover rate using total inventory rather than just
finished goods, because its production cycle is of an extremely short
duration.
As of
September 30, 2009 and December 31, 2008, the Company had no inventory
reserve.
10.
|
Property
and Equipment
|
As of
September 30, 2009 and December 31, 2008, Property and Equipment, net consist of
the following:
September
30,
|
December
31,
|
|||||||
2009
|
2008
(Audited)
|
|||||||
Buildings
and improvements
|
$ | 9,560,041 | 9,961,820 | |||||
Machinery
and equipment
|
5,484,426 | 4,946,247 | ||||||
Land
use rights
|
1,906,916 | 1,945,209 | ||||||
Transportation
equipment
|
888,031 | 885,880 | ||||||
Furniture
and equipment
|
322,168 | 299,467 | ||||||
Construction
in progress (See Note 14)
|
14,261,723 | 4,317,265 | ||||||
Total
Property and Equipment
|
32,423,305 | 22,355,888 | ||||||
Less:
Accumulated Depreciation
|
(1,993,797 | ) | (1,297,109 | ) | ||||
Property
and Equipment, Net
|
$ | 30,429,508 | $ | 21,058,779 |
For the
nine months ended September 30, 2009 and 2008, depreciation expense totaled
$736,030 and $290,716 respectively. Depreciation expense of approximately
$405,000 and $187,000 are included as part of cost of goods sold for
the nine months ended September 30, 2009 and 2008,
respectively.
18
China
Sky One Medical, Inc. and Subsidiaries
Notes
to Unaudited Condensed Consolidated Financial Statements
11.
|
Intangible
Assets
|
As of
September 30, 2009 and December 31, 2008, the Company’s net unamortized
intangible assets consist of:
September 30,
|
December 31,
|
|||||||
2009
|
2008 (Audited)
|
|||||||
Patents
|
$ | 14,112,631 | $ | 15,093,718 | ||||
Goodwill
|
759,987 | 758,047 | ||||||
Total
Intangible Assets, net
|
$ | 14,872,618 | $ | 15,851,765 |
Amortization
expense for the nine months ended September 30, 2009 and 2008 was $1,016,897 and
$232,659 respectively. As of September 30, 2009, the weighted average
amortization period is 9 years.
The
Company has registered the trademark “Kang Xi” in the PRC. However, the Company
has never had an appraisal done on this trademark or assigned any value to it.
Additionally, none of the costs associated with the trademark have been
capitalized.
12.
|
Taxes
Payable
|
Taxes
payable consists of the following:
September
30,
2009
|
December
31,
2008
(Audited)
|
|||||||
Value
Added Tax, net
|
$ | 1,980,827 | $ | 1,179,383 | ||||
Enterprise
Income Tax
|
3,593,829 | 2,106,956 | ||||||
City
Tax
|
80,056 | 32,013 | ||||||
Other
Taxes and additions
|
108,434 | 44,536 | ||||||
Total
Taxes Payable
|
$ | 5,763,146 | $ | 3,362,888 |
13.
|
Income
Taxes
|
Under the
Provisional Regulations of PRC Concerning Income Tax on Enterprises promulgated
by the PRC, income tax is payable by enterprises at a rate of 25% of their
taxable income. Preferential tax treatment may, however, be granted pursuant to
any law or regulations from time to time promulgated by the State
Council.
According
to “Enterprise Income Tax and Certain Preferential Policies Notice” published by
the Ministry of Finance and the National Tax Affairs Bureau, if the enterprise
is authorized by the State Council as a special entity, the enterprise income
tax rate is reduced to 15%. In 2009, the income tax rate for TDR, Tianlong, and
First is 15% based on State Council approval. The income tax rate
for Haina is 25%. The income tax rate for Peng Lai is regulated by local
government at 2% of total revenue commencing January 1, 2009. In 2008, the
income tax rate for TDR and Tianlong was 15% and 12%, respectively. The income
tax rate for First, Haina, and Peng Lai was 25%.
Tianlong
had a preferential income tax rate of 12% in the year 2008. This income tax rate
is approved by the local government for the purpose of providing favorable
policies to attract enterprises to settle in its own region. The difference
between the 12% assigned and the stated 15% tax rate is paid by the local
government. Tianlong’s 12% tax rate expired on December 31, 2008 and its tax
rate effective January 1, 2009 is 15%.
19
China
Sky One Medical, Inc. and Subsidiaries
Notes
to Unaudited Condensed Consolidated Financial Statements
13.
|
Income
Taxes (Continued)
|
We record
a full valuation allowance to reduce our deferred tax assets to the amount that
is more likely than not to be realized. While we have considered future taxable
income and ongoing prudent and feasible tax planning strategies in assessing the
need for the valuation allowance, in the event we were to determine that we
would be able to realize our deferred tax assets in the future in excess of its
net recorded amount, an adjustment to the deferred tax asset would increase
income in the period such determination was made.
Pursuant
to Sections 382 and 383 of the Internal Revenue Code (“IRC”), annual use of the
Company’s net operating losses and tax credit carryforwards may be limited
because of cumulative changes in ownership of more than 50% that have
occurred.
Provision
for the PRC enterprise income tax is calculated at the prevailing rate based on
the estimated assessable profits less available tax relief for losses brought
forward. The
Company does not accrue taxes on unremitted earnings from foreign operations as
it is the Company’s intention to invest these earnings in the foreign operations
indefinitely.
Based on
all known facts and circumstances and current tax law, the Company believes that
the total amount of unrecognized tax benefits as of September 30, 2009, is not
material to its results of operations, financial condition or cash flows. The
Company also believes that the total amount of unrecognized tax benefits as of
September 30, 2009, if recognized, would not have a material effect on its
effective tax rate. The Company further believes that there are no tax positions
for which it is reasonably possible, based on current Chinese tax law and
policy, that the unrecognized tax benefits will significantly increase or
decrease over the next 12 months producing, individually or in the aggregate, a
material effect on the company’s results of operations, financial position or
cash flows.
Net
operating loss (“NOL”) carryforwards only apply to the Company’s U.S. holding
companies because they incurred certain general and administrative costs without
generating any revenue and, therefore, suffered a loss. The Company has no
current intentions to distribute dividend income from its PRC-based subsidiaries
to the U.S. holding companies. Therefore, the Company has established a full
valuation allowance for the NOL carryforwards incurred by the U.S. holding
companies. As of September 30, 2009, the Company’s PRC-based subsidiaries have
no NOL carryforwards. The Company’s temporary income tax differences for its
non-U.S. entities in 2009 and 2008 are deemed immaterial.
The
Company’s corporate tax returns are subject to examination in both the PRC and
the U.S. for the years 2006 through 2008.
14.
|
Land
Use Rights Purchase Agreement and Construction in
Progress
|
During
the second quarter in 2007, TDR entered into an agreement with the Development
and Construction Administration Committee of Harbin Song Bei New Development
District to purchase certain land use rights for 50 years in conjunction with
the Company’s development of a new headquarter and a new biotech engineering
lab. The cost of this land use rights amounted to approximately $2.5 million.
Terms of the agreement called for a deposit of 30% within 15 days after signing
the agreement, 40% payment 7 days prior to the start of construction and the
balance of 30% 7 days after getting the formal land use right.
20
China
Sky One Medical, Inc. and Subsidiaries
Notes
to Unaudited Condensed Consolidated Financial Statements
14.
|
Land
Use Rights Purchase Agreement and Construction in
Progress
|
The
project consists of two phases:
(1)
|
Construction
of a main workshop, R&D center and our principle corporate office
using land area of 30,000 square meters. Construction started in May 2007
and is estimated to be completed by the end of
2009.
|
(2)
|
Construction
of second workshop and show room using land area of 20,000 square meters.
Construction is expected to start in September 2008 and is estimated to be
completed by December 2009.
|
As of
September 30, 2009, the Company remitted deposits totaling $8,533,952 under the
terms of the above agreement. Within this deposit, there are approximately $5.8
million for construction. Upon the completion of the project, this construction
deposits shall be released and returned to the Company.
The cost
outlays for our constructions shall be entirely funded without borrowed
funds.
15.
|
Commitments
and Contingencies
|
The
formulation, manufacturing, processing, packaging, labeling, advertising,
distribution and sale of external use Chinese medicine such as those sold by the
Company are subject to regulations by one or more federal agencies. The
principal federal agencies include the State Food and Drug Administration of the
Government of the PRC, the Food and Drug Administration (the “FDA”),
Heilongjiang Provincial Food and Drug Administration of the PRC (PFDA), National
Biology Products Inspection Institute (NBPI) and the National Food and Drug
Administration (NFDA) of the PRC and, to a lesser extent, the Consumer Product
Safety Commission. These activities are also regulated by various governmental
agencies for the countries, states and localities in which the Company’s
products are sold.
Although
management believes that the Company is in material compliance with the
statutes, laws, rules and regulations of every jurisdiction in which it
operates, no assurance can be given that the Company’s compliance with the
applicable statutes, laws, rules and regulations will not be challenged by
governing authorities or private parties, or that such challenges will not lead
to material adverse effects on the Company’s financial position, results of
operations, or cash flows.
The
Company, like any other distributor or manufacturer of products is exposed to
the inherent risk of product liability claims in the events of possible injuries
caused by the use of its products. The Company does not have liability insurance
with respect to product liability claims. The insurance environment of PRC is
neither sufficient nor mature. Inadequate insurance or lack of contractual
indemnification from parties supplying raw materials or marketing its products,
and product liabilities related to defective products could have a material
adverse effects on the Company.
The
Company is not involved in any legal matters arising in the normal course of
business.
The
Company’s rental commitment is for office space in Harbin City, PRC for the year
2009 is approximately $25,000. The Company is expecting the corporate
headquarters currently under construction to be completed by 2009. As a result,
there is no rental commitment made by the Company for the year 2010 and
thereafter.
21
China
Sky One Medical, Inc. and Subsidiaries
Notes
to Unaudited Condensed Consolidated Financial Statements
16.
|
Revenues
by Product Line
|
A
break-down of the Company’s revenues by product line for each of the three
months ended September 30, 2009 and 2008 is as follows:
For the Three Months Ended September 30
|
|||||||||||||||||||
2009
|
2008
|
||||||||||||||||||
Product
(Number of
Product)
|
Subsidiary
|
Sales
(USD)
|
% of Sales
|
Product
(Number of
Product)
|
Sales
(USD)
|
% of Sales
|
|||||||||||||
Patch
(5)
|
TDR
|
$ | 11,783,217 | 27.3 |
Patch (4)
|
$ | 12,923,972 | 43.6 | |||||||||||
Ointment
(18)
|
TDR,
Tianlong and Peng Lai
|
10,823,036 | 25 |
Ointment
(16)
|
7,842,089 | 26.4 | |||||||||||||
Spray
(15)
|
TDR
and Tianlong
|
6,775,336 | 15.6 |
Spray
(15)
|
3,178,237 | 10.7 | |||||||||||||
Bio-Engineering
(3)
|
FIRST
|
2,622,515 | 6.1 |
Bio-Engineering
(3)
|
2,415,360 | 8.1 | |||||||||||||
Others
(48)
|
TDR,
Tianlong and Peng Lai
|
11,223,067 | 26.0 |
Others
(35)
|
3,339,624 | 11.2 | |||||||||||||
Total
(89 products)
|
$ | 43,227,171 | 100 |
Total
(73 products)
|
$ | 29,699,282 | 100 |
In 2008,
before TDR acquired Tianlong, the majority of the Company’s contract sales
consisted of products purchased from Tianlong. In 2009, TDR discontinued
contract sales as part of its strategic goals. Revenues derived from the sale of
a Tianlong product before and after the acquisition have been reallocated to
each of the appropriate product categories to present a more appropriate
measure of our revenues by product line.
Due to
the Company’s acquisitions of Tianlong and Peng Lai, there have been material
changes to its product portfolio in the three months ended September 30,
2009, as compared to the same period of 2008. For example, due to a shift
of the Company’s marketing strategy, while its revenues from the sale of patch
products increased, they decreased as a percentage of our overall sales in the
first nine months of 2009, compared to the same period in 2008.
The
increase of other products as a percentage of the Company’s overall sales is
primarily due to its promotion of Peng Lai’s products, such as Naftopidil
Dispersible Tablets, that accounted for approximately 4% of the Company’s total
sales revenue for the three months ended September 30, 2009, as well as certain
Tianlong products such as the Compound Camphor Cream, which accounted for
approximately 13% of the Company’s total sales revenue for the three months
ended September 30, 2009. The Company did not sell any of Peng Lai’s products In
fiscal 2008.
22
China
Sky One Medical, Inc. and Subsidiaries
Notes
to Unaudited Condensed Consolidated Financial Statements
16.
|
Revenues
by Product Line (Continued)
|
A
break-down of the Company’s revenues by product line for each of the nine months
ended September 30, 2009 and 2008 is as follows:
For the Nine Months Ended September 30
|
|||||||||||||||||||
2009
|
2008
|
||||||||||||||||||
Product
(Number of
Product)
|
Subsidiary
|
Sales
(USD)
|
% of
Sales
|
Product
(Number of
Product)
|
Sales
(USD)
|
% of
Sales
|
|||||||||||||
Patch
(5)
|
TDR
|
$ | 30,842,381 | 30.8 |
Patch (4)
|
$ | 25,497,334 | 38.7 | |||||||||||
Ointment
(18)
|
TDR
and Tianlong
|
23,563,160 | 23.5 |
Ointment
(16)
|
17,230,711 | 26.2 | |||||||||||||
Spray
(15)
|
TDR
and Tianlong
|
14,486,062 | 14.4 |
Spray
(15)
|
8,056,295 | 12.2 | |||||||||||||
Bio-Engineering
(3)
|
FIRST
|
9,411,281 | 9.4 |
Bio-Engineering
(3)
|
6,398,220 | 9.7 | |||||||||||||
Other
(48)
|
TDR,
Tianlong and Peng Lai
|
21,939,569 | 21.9 |
Other
(35)
|
8,678,744 | 13.2 | |||||||||||||
Total
(89 products)
|
$ | 100,242,453 | 100 |
Total
(73 products)
|
$ | 65,861,308 | 100 |
As shown
in the table above, revenues for all products increased during the nine months
ended September 30, 2009 as compared to the same period in 2008. Contract sales
in 2008 of $6,401,019 for the nine months ended September 30, 2008 have been
reallocated to each of the appropriate product categories to present a more
appropriate measure of our revenues by product line.
Due to
the Company’s acquisitions of Tianlong and Peng Lai, there have been material
changes to its product portfolio in the nine months ended September 30,
2009, as compared to the same period of 2008. For example, due to a
shift of the Company’s marketing strategy, while its revenues from the sale of
patch products increased, they decreased as a percentage of our overall sales in
the first nine months of 2009, compared to the same period in 2008.
The
increase of other products as a percentage of the Company’s overall sales is
primarily due to its promotion of Peng Lai’s products, such as Naftopidil
Dispersible Tablets, that accounted for approximately 3% of the Company’s total
sales revenue for the nine months ended September 2009, as well as Tianlong
products such as the Compound Camphor Cream, which accounted for approximately
10% of the Company’s total sales revenue for the three months ended September
2009.
23
Item
2. Management’s Discussion and Analysis of Financial Condition and
Results of Operations
FORWARD
LOOKING STATEMENTS
The
following discussion should be read in conjunction with the information
contained in the our consolidated financial statements and the notes thereto
appearing elsewhere herein and in the risk factors and “Forward Looking
Statements” summary set forth in the forepart of our Annual Report for the year
ended December 31, 2008 (“Annual Report”). This quarterly report on Form 10-Q
contains forward-looking statements and is afforded the safe harbor provisions
of Section 27A of the Securities Act and Section 21E of the Securities
Exchange Act of 1934, as amended. Readers should carefully review the risk
factors disclosed in our Annual Report and other documents filed by us with the
SEC.
DISCUSSION
General
We
primarily generate revenues, through our China-based indirect subsidiaries
described below, in the development, manufacture, marketing and sale of
over-the-counter, branded nutritional supplements and over-the-counter plant and
herb based pharmaceutical and medicinal products. Our principal products are
external use Traditional Chinese Herbal Remedies/Medicines commonly referred to
in the industry as “TCMs.” We have evolved into an integrated manufacturer,
marketer and distributor of external use Chinese medicine products sold
primarily in the People’s Republic of China (“PRC”) and have been expanding our
worldwide sales efforts as well. Historically, we sold both our own manufactured
products, as well as medicinal and pharmaceutical products manufactured by
others in the PRC. However, at the end of fiscal 2008, we discontinued sales of
third party products (contract sales).
We have
achieved continued growth of our line of products. For the three months ended
September 30, 2009, total revenue was $43,227,171, a 46% increase over the same
period in 2008, and net income was $12,458,940, or $0.74 per share,
compared to net income of $9,943,435, or $0.60 per share on a diluted basis in
the same period in 2008. For the nine months ended September 30, 2009, total
revenue was $100,242,453, a 52% increase over the same period in 2008, and net
income was $29,158,771, or $1.76 per common share, compared to net income
of $21,919,013, or $1.39 per common share on a diluted basis in the same period
in 2008.
All of
our business is conducted through our wholly-owned subsidiary, American
California Pharmaceutical Group, Inc. (“ACPG”), a California corporation, which,
in turn, wholly owns Harbin Tian Di Ren Medical Science and Technology Company
(“TDR”), a company organized in the PRC, and TDR’s subsidiaries. China Sky One
Medical, Inc. is a holding company (“China Sky”), organized under the laws of
Nevada, and directly owns 100% of ACPG. China Sky and ACPG do not generate any
revenues from product sales.
TDR,
formerly known as “Harbin City Tian Di Ren Medical Co.,” was originally formed
in 1994 with its principal executive office in Harbin City of Heilongjiang
Province, in the PRC. TDR was reorganized and incorporated as a limited
liability company on December 29, 2000, under the laws of the PRC. At the time
of the TDR’s acquisition by ACPG in December of 2005, TDR had two wholly-owned
subsidiaries, Harbin First Bio-Engineering Company Limited and Kangxi Medical
Care Product Factory, until July, 2006, when the two were merged, with Harbin
First Bio-Engineering Company Limited (“First” or “Harbin Bio Engineering”) as
the surviving subsidiary of TDR.
Year
2008 Business Acquisitions
On April
3, 2008, TDR completed its acquisition of Heilongjiang Tianlong Pharmaceutical,
Inc., a corporation with a variety of medicines approved by the PRC’s State Food
and Drug Administration (“SFDA”) and new medicine applications, organized under
the laws of the PRC (“Tianlong”), which is in the business of manufacturing
external-use pharmaceuticals. TDR previously acquired the Beijing sales office
of Tianlong in mid-2006. TDR acquired 100% of the issued and outstanding capital
stock of Tianlong from its sole stockholder, in consideration for an aggregate
purchase price of approximately $8,300,000, consisting of $8,000,000 in cash and
23,850 shares of our common stock.
24
On April
18, 2008, TDR consummated its acquisition of Heilongjiang Haina Pharmaceutical
Inc., a corporation which had been organized under the laws of the PRC
(“Haina”), licensed as a wholesaler of TCM, bio-products, medicinal devices,
antibiotics and chemical medicines. Haina did not have an established sales
network and was acquired for its primary asset, a Good Supply Practice (“GSP”)
license (License No. A-HLJ03-010), issued by the Heilongjiang province office of
the SFDA. The SFDA recently started issuing such licenses to resellers of
medicines that maintain certain quality controls. The GSP license was issued as
of December 21, 2006 and will expire on January 29, 2012, and will enable us to
expand its sales of medicinal products without having to go through a lengthy
license application process. TDR acquired 100% of the issued and outstanding
capital stock of Haina from its three stockholders in consideration for payment
of approximately $437,000. TDR had been overseeing the operations of Haina
Pharmaceutical since January of 2008, as part of our due diligence prior to
closing of this acquisition.
On
September 5, 2008, TDR acquired Peng Lai Jin Chuang Pharmaceutical Company
(“Peng Lai”), a corporation organized under the laws of the PRC, from Peng Lai
Jin Chuang Group Corporation (the “Seller”). Peng Lai, which received Good
Manufacturing Practice certification from the SFDA, was organized to develop,
manufacture and distribute pharmaceutical, medicinal and diagnostic products in
the PRC. In connection with the acquisition of Peng Lai, TDR acquired all of
Peng Lai’s assets, including, without limitation, franchise, production and
operating rights to a portfolio of twenty (20) medicines approved by the SFDA,
for an aggregate purchase price of approximately $7.1 million, consisting of
approximately $2.5 million in cash and 381,606 shares of our common
stock.
Testing
Kits and Other Products in Production
As of
September 30, 2009, we have 89 products in the market. The majority of our
products are TCMs, which are produced in various forms including patches,
ointments, sprays, suppositories, injections, tablets, capsules, eye and nasal
drops, and syrups.
We also
produce and sell diagnostic kits. Our AMI Diagnostic Kit, Human Urinary Albumin
Elisa Kit and Early Pregnancy Diagnostic Kit are being sold through drug stores,
hospitals, examination stations and independent sales agents throughout the
PRC.
Our AMI
Diagnostic Kit, which entered markets in 2007, is used for early
diagnosis of Myocardial Infarction (MI), also known as heart disease. All the
test kits require users to place a blood or urine sample on the marker and a
positive (+) or negative (-) reaction signal will result, showing if a user
should consult his or her doctor for further testing. According to the China
Medical Newspaper, several million people die from MI every year. MI often
occurs to people who are, but not limited to, smokers, over-weight and diabetic.
There are approximately 8 million new MI patients in the PRC every year. Recent
medical studies have shown that heart failure or heart attacks are increasing
among younger people in the PRC. This is a result from a more modern life style,
the fast pace of city life and increased pressure from work or school. The use
of AMI Diagnostic Kits will help in early detection that can help in reducing
these statistics.
Our Human
Urinary Albumin Elisa Kit is designed for testing kidney illness in its very
early stage when it is still reversible through right treatment. The kidney
illness can be caused by the disorder of other organs. With this Urinary Albumin
Elisa Kit, the patient can benefit from an easy testing procedure and be aware
of any illness in its very early stage so as to prevent from getting to the
irreversible stage.
We are
continuing our marketing efforts with respect to these testing kits which have
contributed to increase sales of these products in 2009 versus 2008. Sales of
these products during the nine month period ended September 30, 2009 and 2008
amounted to approximately $9,411,281 and $6,398,220, respectively.
We have
been focusing on increasing the sales of our current product portfolio and have
not introduced any significant new products into the market in fiscal
2009.
25
Summary
of Our Research and Development Activities
We
currently conduct all of our research and development (“R&D”) activities,
either internally or through collaborative arrangements with universities and
research institutions in the PRC. We have our own TCM research, development and
laboratory facilities located at TDR’s principal executive office.
At
present, our ongoing research is divided into five general areas:
·
|
the
development of an enzyme linked immune technique to prepare extraneous
diagnostic kits;
|
·
|
the
development of an enzyme linked gold colloid technique to prepare
extraneous rapid diagnostic test
strip;
|
·
|
the
development of a gene recombination technique to prepare gene
drug;
|
·
|
the
development of a biology protein chip for various tumor diagnostic
applications; and
|
·
|
the
development of a cord blood stem cell bank, as more fully described in
other reports we filed.
|
We are
also working on several other projects including Monoclonal Antibody, Endostatin
and Microalbuminuria, Technology of Percutaneous Absorption, and Technology of a
Breast Cancer Drug which is intended to treat lobular hyperplasia in woman. We
have been collaborating with Harbin Medical University and its Clinical Science
Centres to complete all our clinical trials.
In
addition, we are also working to establish a stem cell bank within our new
research and development facility as part of our construction in progress
project for our new corporate headquarters located in Harbin City, Heilongjiang
Province, PRC. Management believes each of these projects may have high
market potential that will contribute to future cash flow through our existing
and developing market channels covering both domestic and international
markets.
The
Company incurred research and development costs of $10,979,619 and $3,881,312
during each of the nine month periods ended September 30, 2009 and 2008,
respectively. The increased research and development costs are mainly due
to the projects from the businesses we acquired in fiscal 2008, as well as the
projects we acquired in the last quarter of 2008, such as the Monoclonal
Antibody and Technology of Breast Cancer Drug.
For the
nine months ended September 30, 2008, we received government grant of $838,242
for our research and development projects. This government grant is offset by
the total research and development cost in our consolidated financial statements
for the three and nine months ended September 30, 2008. We did not have any
government grant for the three and nine months ended September 30,
2009.
Due to
continuous advancements in technology, management cannot guarantee any of the
above research and development activities will be successful or generate future
revenues.
Significant
Accounting Estimates and Policies
The
discussion and analysis of our financial condition and results of operations is
based upon our financial statements which have been prepared in accordance with
accounting principles generally accepted in the United States of America
(“GAAP”). The preparation of these financial statements requires us to make
estimates and judgments that affect the reported amounts of assets and
liabilities. On an on-going basis, we evaluate our methodologies and assumptions
used to derive these estimates. Estimates include the reserve allowance for
doubtful accounts and inventories, our impairment test for long-lived assets and
goodwill, income taxes and contingencies and the remaining useful lives of our
long-lived assets. We base our estimates on historical experience and on other
assumptions that we believes to be reasonable under the circumstances, the
results of which form our basis for making judgments about the carrying values
of assets and liabilities that are not readily apparent from other sources.
Actual results may differ from these estimates. Our significant estimates
include the following:
26
Long-lived
assets are evaluated for impairment whenever indicators of impairment exist.
Accounting standards require that if an impairment indicator is present, we must
assess whether the carrying amount of the asset is unrecoverable by estimating
the sum of the future cash flows expected to result from the asset, undiscounted
and without interest charges. If the recoverable amount is less than the
carrying amount, an impairment charge must be recognized based on the fair value
of the asset.
As part
of the process of preparing our financial statements, we are required to
estimate our income taxes. This process involves estimating our current tax
exposure together with assessing temporary differences resulting from differing
treatment of items for tax and accounting purposes. These differences result in
deferred tax assets and liabilities. We have deemed our temporary tax
differences related to our principal business operations in the PRC to be
immaterial. We must then assess the likelihood that our deferred tax assets will
be recovered from future taxable income, and, to the extent we believe that
recovery is not likely, we must establish a valuation allowance. To the extent
that we establish a valuation allowance or increase this allowance in a period,
we must include a tax provision or reduce our tax benefit in the statements of
operations. We use our judgment to determine our provision or benefit for income
taxes, deferred tax assets and liabilities and any valuation allowance recorded
against our net deferred tax assets. We believe, based on a number of factors
including the continued historical operating losses of China Sky and ACPG, that
we will not realize the future benefits of a significant portion of our net
deferred tax assets and we have accordingly provided a full valuation allowance
against our deferred tax assets. However, various factors may cause those
assumptions to change in the near term.
We cannot
predict what future laws and regulations might be passed that could have a
material effect on our results of operations. We assess the impact of
significant changes in laws and regulations on a regular basis and update the
assumptions and estimates used to prepare our financial statements when we deem
it necessary.
We review
our accounting policies on a periodic basis to ensure compliance with GAAP. Our
most significant accounting policies are those related to intangible assets and
research and development.
Intangible assets – Our
intangible assets consist of patents and goodwill. Patent costs are
amortized over an estimated life of approximately ten years which management
believes is the estimated life span of our patents. Although patent related to
the drug lot number may still actively generate revenue beyond 10 years time
span, the amortization period will be within the 10 years.
Intangible
assets with finite useful lives are amortized while intangible assets with
indefinite useful lives are not amortized. Goodwill and intangible assets are
tested periodically for impairment. Accordingly, the Company reviews its
long-lived assets, including property and equipment and finite-lived intangible
assets for impairment whenever events or changes in circumstances indicate that
the carrying amount of the assets may not be fully recoverable. To determine
recoverability of its long-lived assets, we evaluate the probability that future
undiscounted net cash flows will be less than the carrying amount of the assets.
Impairment costs, if any, are measured by comparing the carrying amount of the
related assets to their fair value.
We have
registered the trademark “Kang Xi” in the PRC. However, we have never had an
appraisal done on this trademark or assigned any value to it. Additionally, none
of the costs associated with the trademark have been capitalized.
As of
September 30, 2009, the weighted average amortization period of our patents is 9
years.
Research and
development—Research and development expenses include the costs
associated with the Company’s internal research and development as well as
research and development conducted by third parties. These costs primarily
consist of salaries, clinical trials, outside consultants, and materials. All
research and development costs are expensed as incurred.
Third-party
expenses reimbursed under non-refundable research and development contracts are
recorded as a reduction to research and development costs in the statement of
operations.
27
Assets to
be used in research and development activities, specifically, compounds that
have yet to receive new drug approval and would have no alternative use, should
approval not be given, are immediately charged to expense when acquired. Certain
assets and high technologies acquired that has a foreseeable future cash flows
are capitalized as intangible assets. Such intangible assets are amortized
starting from the year revenue is generated and amortized over its estimated
life. If a capitalized intangible asset is deemed to have no future benefit, the
unamortized carrying value will be expensed.
For the
three months ended September 30, 2009 and 2008, we incurred $4,884,925 and
$1,866,409, respectively, in research and development expenditures. For the nine
months ended September 30, 2009 and 2008, we incurred $10,979,619 and
$3,881,312, respectively, in research and development expense. The increased
research and development costs are mainly due to the projects from the
businesses we acquired in fiscal 2008, as well as the projects we
acquired in the last quarter of 2008, such as the Monoclonal Antibody and
Technology of Breast Cancer Drug.
For the
nine months ended September 30, 2008, we received government grant of $838,242
for our research and development projects. This government grant is offset by
the total research and development cost in our consolidated financial statements
for the three and nine months ended September 30, 2008. We did not have any
government grant for the three and nine months ended September 30,
2009.
Trends
and Uncertainties
In 2008,
general worldwide economic conditions declined due to sequential effects of the
sub prime lending crisis, general credit market crisis, collateral effects on
the finance and banking industries, concerns about inflation, slower economic
activity, decreased consumer confidence, reduced corporate profits and capital
spending, adverse business conditions and liquidity concerns. However, since all
of our business operations, and most of our sales, are currently conducted in
the PRC, we have not been greatly affected by the economic
downtown.
We have
benefited from the overall economic development in the PRC in recent years and
the increase in the number of elderly people in China, which together have
resulted in increased expenditures on medicine in the PRC, including
TCMs.
In fiscal
2007, our sales model was focused on the creation of our own distribution
channels. Therefore, we sold products directly to many smaller distributors and
retail store locations. In fiscal 2008, we changed our business model and
entered into distribution agreements with larger regional sales agents, who
resell to smaller distributors and retail store locations. In addition, we
entered into contracts with nationwide chain pharmacies, such as Nepstar, Tong
Ren Tang, Jin Xiang, and Ren Min Tong Tai. Through the extensive sales networks
of these nationwide chains, we are able to reach all major metropolitan areas
throughout the PRC. These changes to our product distribution channels resulted
in our direct customer base decreasing from 943 customers at December 31, 2007
to 233 customers at December 31, 2008.
Our
change of sales strategy in fiscal 2008 was initiated to improve product channel
efficiencies, and to give us access to an increased number of ultimate
purchasers. We believe that these changes will lead to further increased revenue
by extending the reach of its distribution network. We also believe that, by
reducing the number of customers we sell to directly, we will be able to
streamline our accounts receivable management and collection, and reduce channel
distribution costs. These favorable cost variances are expected to be partially
offset by product price incentives we grant to the larger agents with which we
have contracted.
In fiscal
2007, 26.4% of our total revenues, or $12,998,152, was attributable to sales of
other manufacturers’ products on a contract basis. One of the main manufacturers
for which we resold products was Tianlong. On April 3, 2008, we acquired
Tianlong and were able to fully integrated Tianlong’s products, which we had
been previously selling on a contract basis, into our marketing and distribution
channels. Following the acquisition of Tianlong we continued to phase out our
contract sales and, as of the end of fiscal 2008, we no longer sell other
company’s products on a contract basis.
28
RESULTS
OF OPERATIONS
For
the three months ended September 30, 2009 as compared to September 30,
2008
Our
principal business operations are conducted through our wholly-owned subsidiary,
TDR, and TDR’s wholly-owned subsidiaries.
For Three Months Ended September 30
|
|||||||||||
2009
|
% of Sales
|
2008
|
% of Sales
|
||||||||
Revenues
|
$
|
43,227,171
|
100.0
|
$
|
29,699,282
|
100.0
|
|||||
Cost
of goods sold
|
10,897,185
|
25.2
|
7,366,059
|
24.8
|
|||||||
Gross
Profit
|
$
|
32,329,986
|
74.8
|
$
|
22,333,223
|
75.2
|
Total
revenues increased approximately $13.5 million or 46% during the three months
ended September 30, 2009 as compared to 2008. Our revenue increase is primarily
attributable to strong performances from our sales distribution channels, due to
our hiring of additional direct territory managers and sales agents to assure
that our products and their associated benefits are seen by those making or
influencing the purchasing decisions. In addition, the increases are due to
several successful business acquisitions we consummated in 2008, as previous
discussed.
We
acquired Tianlong on April 3, 2008. Tianlong’s product sales amounted to
$17,745,209 and $5,456,458 respectively for each of the three months ended
September 30, 2009 and 2008. The primary reason for this increase was that,
following the acquisition, we were able to fully integrate Tianlong’s products,
which we had been previously selling on a contract basis, into our marketing and
distribution channels and increase overall sales.
We
acquired Peng Lai on September 5, 2008. Peng Lai’s product sales amounted to
$3,789,992 for the three months ended September 30, 2009. Peng Lai had nominal
production prior to our acquisition. Following the acquisition of Peng Lai, we
started to promote Peng Lai’s products through our own nationwide sales
channel.
Primarily
all of our sales are made in the PRC. Our overseas sales accounted for 10.5% and
6.5% of our total revenues for the three months ended September 30, 2009 and
2008, respectively. We intend to put more effort behind promoting our products
to the overseas market by locating more qualified overseas sales
agents.
Overall,
our product gross margins were at approximately 74.8% and 75.2% during each of
the three months ended September 30, 2009 and 2008, respectively. Our lower
product gross margins in 2009 versus 2008 were principally attributable to our
reduction in the sales prices of certain of our products to be competitive in
the PRC market.
29
Revenues
by Product Line
A
break-down of our revenues by product line for each of the three months ended
September 30, 2009 and 2008 is as follows:
For the Three Months Ended September 30
|
|||||||||||||||||||
2009
|
2008
|
||||||||||||||||||
Product
(Number of
Product)
|
Subsidiary
|
Sales
(USD)
|
% of Sales
|
Product
(Number of
Product)
|
Sales
(USD)
|
% of Sales
|
|||||||||||||
Patch
(5)
|
TDR
|
$ | 11,783,217 | 27.3 |
Patch (4)
|
$ | 12,923,972 | 43.6 | |||||||||||
Ointment
(18)
|
TDR
and Tianlong
|
10,823,036 | 25 |
Ointment
(16)
|
7,842,089 | 26.4 | |||||||||||||
Spray
(15)
|
TDR
and Tianlong
|
6,775,336 | 15.6 |
Spray
(15)
|
3,178,237 | 10.7 | |||||||||||||
Bio-Engineering
(3)
|
FIRST
|
2,622,515 | 6.1 |
Bio-Engineering
(3)
|
2,415,360 | 8.1 | |||||||||||||
Others
(48)
|
TDR,
Tianlong and Peng Lai
|
11,223,067 | 26.0 |
Others
(35)
|
3,339,624 | 11.2 | |||||||||||||
Total
(89 products)
|
$ | 43,227,171 | 100 |
Total
(73 products)
|
$ | 29,699,282 | 100 |
In 2008,
before TDR acquired Tianlong, the majority of our contract sales consisted of
products purchased from Tianlong. In 2009, TDR discontinued contract sales as
part of its strategic goals. Revenues derived from the sale of a Tianlong
product before and after the acquisition have been reallocated to each of
the appropriate product categories to present a more appropriate measure of
our revenues by product line.
Due to
our acquisitions of Tianlong and Peng Lai, there have been material changes to
our product portfolio in the three months ended September 30, 2009, as
compared to the same period of 2008. For example, due to a shift of our
marketing strategy, while our revenues from the sale of patch products
increased, they decreased as a percentage of our overall sales in the first nine
months of 2009, compared to the same period in 2008. Despite this decrease, all
5 of our patch products are still ranked in the top 10 of our best selling
products.
The
increase of other products as a percentage of our overall sales is primarily due
to our promotion of Peng Lai’s products, such as Naftopidil Dispersible Tablets,
that accounted for approximately 4% of our total sales revenue for the three
months ended September 30, 2009, as well as certain Tianlong products such as
the Compound Camphor Cream, which accounted for approximately 13% of our total
sales revenue for the three months ended September 30, 2009. We did not sell any
of Peng Lai’s products In fiscal 2008.
Operating
Expenses
The
following table summarizes the changes in our operating expenses from $9,771,385
to $16,299,744 for each of the three months ended September 30, 2008 and 2009,
respectively:
30
For
the Three Month Ended September 30
|
|||||||||||
2009
|
%
of Sales
|
2008
|
%
of Sales
|
||||||||
Operating
Expenses
|
|||||||||||
Depreciation
and amortization
|
$
|
447,170
|
1.0
|
$
|
308,023
|
1.0
|
|||||
Research
and development
|
4,884,925
|
11.3
|
1,866,409
|
6.3
|
|||||||
Selling,
general and administrative
|
10,967,649
|
25.4
|
7,596,953
|
25.6
|
|||||||
Total
operating expenses
|
$
|
16,299,744
|
37.7
|
$
|
9,771,385
|
32.9
|
Depreciation
and amortization for the three months ended September 30, 2009 amounted to
approximately $447,000 as compared to $308,000 during the same period in
2008. The higher costs in 2009 are primarily attributable to the additional
depreciation and amortization costs associated with the long-lived assets
acquired under our 2008 strategic business acquisitions.
Research
and development expenses were approximately $4.9 million for the three
months ended September 30, 2009 as compared to $1.9 million for the same period
in 2008. The increased research and development costs in 2009 are primarily
associated with the projects from our acquired subsidiaries as well as the
projects we acquired during the last quarter of 2008 such as the Monoclonal
Antibody and Technology of Breast Cancer Drug.
Selling,
general and administrative expenses were $11.0 million for the three months
ended September 30, 2009 versus $7.6 million for the same period in 2008. The
higher selling, general and administrative expenses were primarily attributable
to higher overhead costs to support our increased revenue base in year 2009 and
increased marketing and selling costs to support our revenue growth from $30.0
million in 2008 to $43.2 million in 2009. Advertising and promotional costs
amounted to $5,031,001 and $2,091,802, respectively, for each of the three
months ended September 30, 2009 and 2008. The increases were primarily due to
our more aggressive advertising campaign. However, while the amount of selling,
general and administrative expenses have increased, they have remained
consistent as a percentage of revenues.
For
the nine months ended September 30, 2009 as compared to September 30,
2008
Our
principal business operations are conducted through our wholly-owned subsidiary,
TDR, and TDR’s wholly-owned subsidiaries.
For the Nine Months Ended September 30
|
|||||||||||
2009
|
% of Sales
|
2008
|
% of Sales
|
||||||||
Revenues
|
$
|
100,242,453
|
100.0
|
$
|
65,861,304
|
100.0
|
|||||
Cost
of goods sold
|
24,690,474
|
24.6
|
15,748,801
|
23.9
|
|||||||
Gross
Profit
|
$
|
75,551,979
|
75.4
|
$
|
50,112,503
|
76.1
|
Total
revenues increased by 52% during the nine months ended September 30, 2009 as
compared to 2008. The $34.4 million increase in revenue is primarily to
strong performances from our sales distribution channels, due to hiring
additional direct territory managers and sales agents to assure that our
products and their associated benefits are seen by those making or influencing
the purchasing decisions. In addition, the increases are due to several
successful business acquisitions we consummated in 2008, as previously
discussed.
31
We
acquired Tianlong on April 3, 2008. Tianlong’s product sales amounted to
$31,882,420 for the nine months ended September 30, 2009 and $8,808,400 from the
date of the acquisition, April 3, 2008, to September 30, 2008. Revenue derived
from Tianlong contract sales prior to our acquisition was $1,434,087. The
primary reason for this increase was that, following the acquisition, we were
able to fully integrate Tianlong’s products, which we had been previously
selling on a contract basis, into our marketing and distribution channels and
increase overall sales.
We
acquired Peng Lai on September 5, 2008. Peng Lai’s product sales amounted to
$7,374,363 for the nine months ended September 30, 2009. Peng Lai had nominal
production prior to our acquisition. Following the acquisition of Peng Lai, we
started to promote Peng Lai’s products into our own sales channel
nationwide.
Our
overseas sales accounted for 8.9% and 10.8% for the nine months ended September
30, 2009 and 2008, respectively. We intend to put more effort in promoting our
products to the overseas market by locating more qualified overseas sales
agents.
Overall,
our product gross margins were at 75.4% and 76.1% during the nine months ended
September 30, 2009 and 2008, respectively. Our lower product gross margins in
2009 versus 2008 were principally attributable to our reduction in the sales
prices of certain of our products to be competitive in the PRC
market.
Revenues
by Product Line
A
break-down of our revenues by product line for each of the nine months ended
September 30, 2009 and 2008 is as follows:
For the Nine Months Ended September 30
|
|||||||||||||||||||
2009
|
2008
|
||||||||||||||||||
Product
(Number of
Product)
|
Subsidiary
|
Sales
(USD)
|
% of
Sales
|
Product
(Number of
Product)
|
Sales
(USD)
|
% of
Sales
|
|||||||||||||
Patch
(5)
|
TDR
|
$ | 30,842,381 | 30.8 |
Patch (4)
|
$ | 25,497,334 | 38.7 | |||||||||||
Ointment
(18)
|
TDR
and Tianlong
|
23,563,160 | 23.5 |
Ointment
(16)
|
17,230,711 | 26.2 | |||||||||||||
Spray
(15)
|
TDR
and Tianlong
|
14,486,062 | 14.4 |
Spray
(15)
|
8,056,295 | 12.2 | |||||||||||||
Bio-Engineering
(3)
|
FIRST
|
9,411,281 | 9.4 |
Bio-Engineering
(3)
|
6,398,220 | 9.7 | |||||||||||||
Other
(48)
|
TDR, Tianlong
and Peng Lai
|
21,939,569 | 21.9 |
Other
(35)
|
8,678,740 | 13.2 | |||||||||||||
Total
(89 products)
|
$ | 100,242,453 | 100 |
Total
(73 products)
|
$ | 65,861,304 | 100 |
As shown
in the table above, revenues for all products increased during the nine months
ended September 30, 2009 as compared to the same period in 2008. Contract sales
in 2008 of $6,401,019 for the nine months ended September 30, 2008 have been
reallocated to each of the appropriate product categories to present a more
appropriate measure of our revenues by product line.
Due to
our acquisitions of Tianlong and Peng Lai, there have been material changes to
our product portfolio in the nine months ended September 30, 2009, as
compared to the same period of 2008. For example, due to a shift of our
marketing strategy, while our revenues from the sale of patch products
increased, they decreased as a percentage of our overall sales in the first nine
months of 2009, compared to the same period in 2008. Despite this decrease, all
5 of our patch products are still ranked in the top 10 of our best selling
products.
The
increase of other products as a percentage of our overall sales is primarily due
to our promotion of Peng Lai’s products, such as Naftopidil Dispersible Tablets,
that accounted for approximately 3% of our total sales revenue for the nine
months ended September 2009, as well as Tianlong products such as the Compound
Camphor Cream, which accounted for approximately 10% of our total sales revenue
for the three months ended September 2009.
32
In the
nine months ended September 30, 2009, we remained focused on expanding our
market coverage. Our sales representatives increased from approximately 1,300 to
1,500. Our total pharmacy coverage number in 2009 reached approximately 5,500
over 24 provinces in the PRC versus 4,500 over 22 provinces in the PRC in the
same period of 2008. We will continue our efforts in locating more sales
agents, distributors, and chain pharmacy stores with extensive market coverage
to increase our products presence nationwide.
Operating
Expenses
The
following table summarizes the changes in our operating expenses from
$22,545,494 to $38,388,920 for each of the nine months ended September 30, 2008
and 2009, respectively:
For the Nine Month Ended September 30
|
|||||||||||
2009
|
% of Sales
|
2008
|
% of Sales
|
||||||||
Operating
Expenses
|
|||||||||||
Depreciation
and amortization
|
$
|
1,347,836
|
1.3
|
$
|
523,375
|
0.8
|
|||||
Research
and development
|
10,979,619
|
11.0
|
3,881,312
|
5.9
|
|||||||
Selling,
general and administrative
|
26,061,465
|
26.0
|
18,140,807
|
27.5
|
|||||||
Total
operating expenses
|
$
|
38,388,920
|
38.3
|
$
|
22,545,494
|
34.2
|
Depreciation
and amortization for the nine months ended September 30, 2009 amounted to
approximately $1.3 million as compared to $523,000 during the same period in
2008. The higher costs in 2009 are primarily attributable to the additional
depreciation and amortization costs associated with our long-lived assets
acquired under our 2008 strategic business acquisitions.
Research
and development expenses were approximately $11.0 million for the nine
months ended September 30, 2009 compared to $3.9 million for 2008. The
increased costs in 2009 are primarily associated with the ongoing clinical
trials and studies under the patents acquired from our 2008 strategic business
acquisitions, as well as the projects we acquired during the last quarter of
2008 such as the Monoclonal Antibody and Technology of Breast Cancer
Drug. Management believes that continuous research and development
activities will provide us will a steady flow of new products and allow us stay
competitive.
Selling,
general and administrative expenses for the nine months ended September 30, 2009
amounted to approximately $26.1 million in 2009 versus approximately $18.1
million over the same period in 2008. The higher selling, general and
administrative expenses were primarily attributable to higher overhead costs to
support our increased revenue base in year 2009 and our continued investment in
research and development for new products and increased costs of marketing and
sales to support our product revenues growth from $65.9 million in 2008 to
$100.2 million in 2009. Advertising and promotion costs amounted to
approximately $11.2 million and approximately $5.3
million respectively for each of the nine months ended September 30, 2009
and 2008. The increases were primarily due to our more aggressive advertising
campaign. However, while the amount of selling, general and administrative
expenses have increased, they have remained consistent as a percentage of
revenues.
33
FULL
YEAR 2009 OUTLOOK
We are
affirming our 2009 annual guidance which was previously disclosed in our 2008
Annual Report.
We
estimate our total revenue in 2009 versus 2008 to increase by 40% or
approximately $37 million with growth in all categories of our product sales.
Our gross profit margin in 2009 is expected to be approximately 75.0% versus
75.5% in 2008. Operating expenses will increase due to higher percentage of
R&D investment as well as the additional operating costs to support our
expanding distribution channels as well as our sales growth. We estimate our
overall 2009 net profit margin to be approximately 29%.
Our new
corporate headquarter in Harbin City, Heilongjiang Province, PRC is currently
under construction and we plan to occupy the space by the end of 2009. As such,
we will no longer rent office space with the benefit of all organizational
departments now consolidated into one central location. This should create
a more productive and efficient working environment for management operations as
well as all other business activities. Our new headquarters will feature a
dining area, exercise facilities, dormitories, and guest rooms to provide
accommodations and services to our staff and guests visiting us. The cost
outlays for our new corporate headquarters is estimated at approximately $13.0
million and shall be entirely funded without borrowed funds.
LIQUIDITY
AND CAPITAL RESOURCES
Certain
of our liquidity and capital ratios for each of the nine month periods ended
September 30, 2009 and 2008 are outlined below :
2009
|
2008
|
|||||||
Working
capital ratio
|
7.2 | 6.8 | ||||||
Quick
ratio
|
6.3 | 6.6 | ||||||
Average
accounts receivable collection (days)
|
45.8 | 46.3 | ||||||
Average
inventory turnover (days)
|
16.6 | 18.9 | ||||||
Borrowed
funds
|
None
|
None
|
||||||
Stockholders’
equity per common share
|
7.5 | 5.4 | ||||||
The
following table summarizes our cash and cash equivalents
position, our working capital, and our cash flow activity as of September
30, 2009 and 2008 and for each of the nine month period then
ended:
|
||||||||
As
of September 30:
|
||||||||
Working
capital
|
$ | 79,064,410 | $ | 52,962,780 | ||||
Inventories
|
$ | 3,099,451 | $ | 1,803,429 | ||||
Nine
Months Ended September 30:
|
||||||||
Cash
provided by (used in):
|
||||||||
Operating
activities
|
$ | 25,931,607 | $ | 26,688,531 | ||||
Investing
activities
|
$ | (10,048,942 | ) | $ | (11,708,556 | ) | ||
Financing
activities
|
$ | 29,169 | $ | 24,532,132 |
As of
September 30, 2009, cash and cash equivalents were approximately $56.3
million.
34
As of
September 30, 2009, we have spent approximately $10.0 million in
construction costs for our corporate headquarters which is planned to be
completed by the end of 2009. We plan to fund our corporate headquarters
construction project using internal funds. The estimated total cost under this
project is approximately $13.0 million ($10.0 million of capital expenditure at
September 30, 2009).
Our
working capital ratio is 7.2 versus 6.8 and quick ratio is 6.3 versus
6.6 at September 30, 2009 and 2008, respectively. Management endeavors
to ensure that funds are available to take advantage of larger scale of market
campaign, research and development expenditures, new strategic business
alliances, and our future liquidity and capital needs.
Since
accountant receivables fluctuate over the course of each quarter, in order to
determine a more representative accountant receivables collection days,
management calculates the turnover rate on a quarter-by-quarter basis, and then
take the average of the resulting numbers.
Since
sales and cost of goods sold fluctuate over the course of each quarter, in order
to determine a more representative inventory turnover rate, management
calculates inventory turnover rate on a quarter-by-quarter basis, and then take
the average of the resulting numbers. Management calculates its inventory
turnover rate using total inventory rather than just finished goods, because its
production cycle is of an extremely short duration.
At
September 30, 2009, there are no restrictive bank deposits pledged as
security.
Cash
flows provided by operating activities was approximately $25.9 million for the
nine months ended September 30, 2009 compared to $26.7 million for the same
period in 2008.
Our
working capital position at September 30, 2009 was approximately $79.1 million,
compared to $53.0 million at September 30, 2008. Our increased working capital
position in 2009 was principally funded by the cash flows generated from our
operating activities of approximately $25.9 million in the nine months ended
September 30, 2009. Management considers current working capital and borrowing
capabilities adequate to cover our current operating and capital
requirements for the next twelve months.
In the
first quarter of fiscal 2008 we received aggregate net proceeds of approximately
$23.5 million from the consummation of a private placement of our securities.
The net proceeds from the private offering were used to fund three business
acquisitions we completed in fiscal 2008 and other working capital needs. There
was no similar equity capital raise during the nine month period ended September
30, 2009.
Currency
Exchange Fluctuations
All of
our revenues and majority of the expenses during the nine months ended September
30, 2009 and 2008 were denominated primarily in Renminbi (“RMB”), the currency
of the PRC, and were converted into U.S. dollars at the exchange rate of 6.84251
RMB and 6.99886 RMB to 1 U.S. Dollar, respectively. There could be no
assurance that RMB-to-U.S. dollar exchange rates will remain stable. A
devaluation of RMB relative to the U.S. dollar would adversely affect our
business, financial condition and results of operations. We do not engage in
currency hedging.
Off-Balance
Sheet Arrangements
We do not
have any off-balance sheet arrangements that are currently material or
reasonably likely to be material to our financial position or results of
operations.
35
Item
3. Quantitative and Qualitative Disclosures About Market
Risk.
We are a
smaller reporting company as defined by Rule 12b-2 of the Securities Exchange
Act of 1934 (the “Exchange Act”) and are not required to provide the information
under this item.
Item
4. Controls and Procedures.
Disclosure
Controls and Procedures
Our
management, with the participation of our chief executive officer and chief
financial officer, evaluated the effectiveness of our disclosure controls and
procedures pursuant to Rule 13a-15 under the Exchange Act as of September 30,
2009. In designing and evaluating the disclosure controls and procedures,
management recognizes that any controls and procedures, no matter how well
designed and operated, can provide only reasonable assurance of achieving the
desired control objectives. In addition, the design of disclosure controls and
procedures must reflect the fact that there are resource constraints and that
management is required to apply its judgment in evaluating the benefits of
possible controls and procedures relative to their costs.
Based
on our evaluation, our chief executive officer and chief financial officer
concluded that our disclosure controls and procedures are designed at a
reasonable assurance level and are effective to provide reasonable assurance
that information we are required to disclose in reports that we file or submit
under the Exchange Act is recorded, processed, summarized and reported within
the time periods specified in Securities and Exchange Commission rules and
forms, and that such information is accumulated and communicated to our
management, including our chief executive officer and interim chief financial
officer, as appropriate, to allow timely decisions regarding required
disclosure.
Changes
in Internal Control Over Financial Reporting
To
address concerns that were raised with respect to differences in the information
contained in financial reports we filed with the PRC’s State Administration for
Industry and Commerce ("SAIC") and the United States Securities and Exchange
Commission ("SEC"), our Audit Committee has enhanced the procedure we will
follow with regard to future filings with the SAIC so that all such filings will
be reviewed by our Chief Financial Officer prior to filing. As a result of the
Audit Committee's actions, it is contemplated that in future filings there will
be no material differences in the information contained in the financial
statements filed with the SAIC and the SEC.
There was
no other change in our internal control over financial reporting that occurred
during our third quarter of fiscal 2009, that has materially affected, or is
reasonably likely to materially affect, our internal control over financial
reporting.
36
PART
II - OTHER INFORMATION
Item
1. Legal Proceedings.
We are
not a party to any material pending legal proceedings.
Item
2. Unregistered Sales of Equity Securities and Use of
Proceeds.
In the
three-month period ended September 30, 2009, and subsequent period through the
date hereof, we did not engage in any unregistered sales of equity securities
other than as set forth below:
Cashless
Exercise of Stock Options
As of
August 26, 2009, stock options to purchase an aggregate of 12,500 shares of our
common stock, which we issued to pursuant to our 2006 Stock Incentive Plan on
October 25, 2006, were exercised on a cashless basis by nine (9) optionees. In
connection with the cashless exercises, the optionees were deemed to have paid
an amount equal to the difference between the exercise price ($3.65 per share)
and the fair market value of a share of our common stock on the date of exercise
($14.75 per share). As a result of such cashless exercises, we issued an
aggregate of 9,407 shares of our common stock to the optionees.
We
believe that these transactions are exempt from registration under the
Securities Act of 1933, as amended, pursuant to Section 4(2), or Regulation D
promulgated thereunder, as transactions by an issuer not involving a public
offering.
Item
3. Defaults Upon Senior Securities.
In the
three-month period ended September 30, 2009, and subsequent period through the
date hereof, we did not default upon any senior securities.
Item
4. Submission of Matters to a Vote of Security Holders.
In the
three-month period ended September 30, 2009, and subsequent period through the
date hereof, we did not submit any matters to a vote of our stockholders other
than as set forth below:
2009
Annual Meeting of Stockholders
On
September 24, 2009, we held our 2009 Annual Meeting of Stockholders (the “Annual
Meeting”). At the Annual Meeting, Mr. Liu Yan-qing, Ms. Han Xiao-yan, Mr.
Stanley Hao, Mr. Song Chun-fang, Mr. Qian Xu-feng, Mr. Zhao Jie and Mr. William
Wei Lee were nominated to serve as directors of the Company until the next
annual meeting of stockholders. The persons nominated were duly elected by the
votes set forth below:
Directors:
|
For
|
Withheld
|
||||||
Liu
Yan-qing
|
12,383,228 | 27,354 | ||||||
Han
Xiao-yan
|
12,378,869 | 31,713 | ||||||
Stanley
Hao
|
12,376,072 | 34,510 | ||||||
Song
Chun-fang
|
12,383,758 | 26,824 | ||||||
Qian
Xu-feng
|
12,380,629 | 29,953 | ||||||
Zhao
Jie
|
12,382,729 | 27,853 | ||||||
William
Wei Lee
|
12,378,861 | 31,721 |
Accordingly,
the foregoing nominees were elected as directors to serve until our next annual
meeting of stockholders and until their successors have been duly qualified and
elected.
37
Item
5. Other Information.
There was
no information we were required to disclose in a report on Form 8-K during the
three-month period ended September 30, 2009, or subsequent period through the
date hereof, which was not so reported.
Item
6. Exhibits
Exhibit No.
|
Description of Exhibit
|
|
31.1
|
Certification
of Principal Executive Officer pursuant to Rule 13a-14 and Rule 15d-14(a),
promulgated under the Securities and Exchange Act of 1934, as
amended*
|
|
31.2
|
Certification
of Interim Principal Financial and Accounting Officer pursuant to Rule
13a-14 and Rule 15d-14(a), promulgated under the Securities and Exchange
Act of 1934, as amended*
|
|
32.1
|
Certification
pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002 (Principal Executive
Officer)*
|
|
32.2
|
Certification
pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002 (Interim Principal Financial and Accounting
Officer)*
|
* Filed
herewith
38
SIGNATURES
Pursuant to the requirements of
Section 13 or 15(d) of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
CHINA
SKY ONE MEDICAL, INC.
|
||
Dated:
November 16, 2009
|
By:
|
/s/
Liu Yan Qing
|
Liu
Yan Qing
Chairman,
Chief Executive Officer and President
|
||
Dated:
November 16, 2009
|
By:
|
/s/
Stanley Hao
|
Stanley
Hao
Chief
Financial Officer and
Secretary
|
39