Attached files
file | filename |
---|---|
EX-31.1 - CHINA MEDICINE CORP | v178945_ex31-1.htm |
EX-31.2 - CHINA MEDICINE CORP | v178945_ex31-2.htm |
EX-32.1 - CHINA MEDICINE CORP | v178945_ex32-1.htm |
U.S.
SECURITIES AND EXCHANGE COMMISSION
Washington,
D.C. 20549
FORM
10-K
(Mark
One)
þ
|
ANNUAL
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
|
For the
Fiscal Year Ended December 31, 2009
o
|
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 000-51379
China
Medicine Corporation
(Name of
small business issuer in its charter)
Nevada
|
51-0539830
|
|
(State
or other jurisdiction of
|
(IRS.
Employer
|
|
incorporation
or organization)
|
Identification
No.)
|
|
Guangri
Tower, Suite 702
No.
8 Siyou South 1st Street
Yuexiu
District
Guangzhou,
China 510600
|
||
(Address
of principal executive
offices)
|
Issuer’s
telephone number, including area code (8620) 8739-1718 and (8620)
8737-8212
Securities
registered pursuant to Section 12(b) of the Act: None.
Securities
registered pursuant to Section 12(g) of the Act: Common Stock $.0001 par
value.
Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined in
Rule 405 of the Securities Act. Yes ¨ No þ
Indicate
by check mark if the registrant is not required to file reports pursuant to
Section 13 or Section 15(d) of the Act. Yes ¨ No þ
Indicate
by check mark whether the registrant (1) has filed all reports required to
be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes þ No ¨
Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding
12 months (or for such shorter period that the registrant was required to
submit and post such files). Yes ¨ No ¨
Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K is not contained herein, and will not be contained, to the
best of registrant’s knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K þ
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company.
(as defined in Rule 12b-2 of
the Exchange Act). Check one:
Large
accelerated filer
|
o
|
Non-accelerated
filer
|
o
|
|||
Accelerated
Filer
|
o
|
Smaller
reporting company
|
þ
|
Indicate
by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the
Act). Yes ¨ No þ
The
aggregate market value of the voting and non-voting common equity held by
non-affiliates of the registrant (9,901,139 shares) based on the closing
price of the registrant’s common stock as quoted on the FINRA Over-the-Counter
Bulletin Board on June 30, 2009 of $1.85, was $18,317,107. For
purposes of this computation, all officers, directors, and 10% beneficial owners
of the registrant are deemed to be affiliates. Such determination
should not be deemed to be an admission that such officers, directors, or 10%
beneficial owners are, in fact, affiliates of the registrant.
As of
March 26, 2010, there were outstanding 20,431,139 shares of the registrant’s
common stock, par value $.0001 per share, and 1,920,000 shares of the
registrant’s Redeemable Convertible Preferred Stock, par value $.0001 per
share.
Documents
incorporated by reference: Portions of the registrant’s Proxy Statement related
to the 2010 Meeting of Stockholders, which is expected to be filed with the
Securities and Exchange Commission on or before April 30, 2010, are incorporated
by reference into Part III of this Form 10-K.
China
Medicine Corporation
Form
10-K
Table of
Contents
Page
|
|||
PART
I
|
|||
Item
1.
|
Description
of Business
|
1
|
|
Item
1A.
|
Risk
Factors
|
14
|
|
Item
1B
|
Unresolved
Staff Comments
|
25
|
|
Item
2.
|
Properties
|
25
|
|
Item
3.
|
Legal
Proceedings
|
25
|
|
Item
4.
|
[Removed
and Reserved]
|
26
|
|
PART
II
|
|||
Item
5.
|
Market
for Registrant’s Common Equity, Related Stockholder Matters and Issuer
Purchases of Equity Securities.
|
26
|
|
Item
6.
|
Selected
Financial Data.
|
28
|
|
Item
7.
|
Management's
Discussion and Analysis of Financial Condition and Results of
Operations
|
28
|
|
Item
7A.
|
Quantitative
and Qualitative Disclosures About Market Risk.
|
36
|
|
Item
8.
|
Financial
Statements and Supplementary Data
|
F-1
|
|
Item
9.
|
Changes
in and Disagreements with Accountants on Accounting and
Financial Disclosure
|
37
|
|
Item
9A (T).
|
Controls
and Procedures
|
37
|
|
Item
9B.
|
Other
Information
|
39
|
|
PART
III
|
|||
Item
10.
|
Directors,
Executive Officers and Corporate Governance
|
39
|
|
Item
11.
|
Executive
Compensation
|
39
|
|
Item
12.
|
Security
Ownership of Certain Beneficial Owners and Management and Related
Stockholder Matters
|
39
|
|
Item
13.
|
Certain
Relationships and Related Transactions, and Director
Independence
|
40
|
|
Item
14.
|
Principal
Accountant Fees and Services
|
40
|
|
PART
IV
|
|||
Item
15.
|
Exhibits,
Financial Statement Schedules.
|
40
|
|
Signatures
|
42
|
i
PREDICTIVE
STATEMENTS AND ASSOCIATED RISK
Certain statements in this Report, and
the documents incorporated by reference herein, constitute predictive
statements. Such predictive statements involve known and unknown risks,
uncertainties and other factors which may cause deviations in actual results,
performance or achievements to be materially different from any future results,
performance or achievements expressed or implied. Such factors include, but are
not limited to: market and customer acceptance and demand for our products; our
ability to market our products; the impact of competitive products and pricing;
the ability to develop and launch new products on a timely basis; the regulatory
environment, including government regulation in the People’s Republic of China
(the “PRC”); our ability to obtain the requisite regulatory approvals to
commercialize our products; fluctuations in operating results, including
spending for research and development and sales and marketing activities; and
other risks detailed from time-to-time in our filings with the Securities and
Exchange Commission.
The words "believe, expect, anticipate,
intend and plan" and similar expressions identify predictive statements. These
statements are subject to risks and uncertainties that cannot be known or
quantified and, consequently, actual results may differ materially from those
expressed or implied by such predictive statements. Readers are cautioned not to
place undue reliance on these predictive statements, which speak only as of the
date they are made.
Unless otherwise noted, all currency
figures in this filing are in U.S. dollars. References to "yuan" or "RMB" are to
the Chinese yuan (also known as the renminbi). According to the currency
exchange website www.xe.com, as of December 31, 2009, US $1.00 = 6.8280
yuan.
PART I
ITEM 1. BUSINESS
Through Guangzhou Konzern Medicine Co.,
Ltd. (“Konzern”), our wholly-owned subsidiary organized under the laws of the
PRC, we distribute approximately 2,100 products in China. The products include
prescription and over-the-counter drugs, Chinese herbs, traditional Chinese
medicines made from Chinese herbs, nutritional supplements, dietary supplements
and medical instruments.
We also
entered the pharmaceutical manufacturing field in 2009, through Guangzhou
LifeTech Pharmaceutical Co., Ltd. (“LifeTech”), our wholly-owned subsidiary
organized under the laws of PRC. LifeTech holds 39 manufacturing
approvals for its drugs, which include Traditional Chinese Medicines and dried
powder injections.
History
of the Company
We were a Delaware corporation
incorporated on February 10, 2005, under the name Lounsberry Holdings III, Inc.
(“Lounsberry”).
On February 8, 2006, Lounsberry
acquired an operating business by entering into a reverse merger
transaction. Under the terms of a share exchange agreement (the
“Exchange Agreement”) with the stockholders of Konzern, we acquired all of the
equity of Konzern, which is a distributor of pharmaceutical products in the PRC
organized under the laws of the PRC, in exchange for issuing 6,530,000 shares of
common stock, representing approximately 88.5% of our outstanding common stock,
to the owners of Konzern. Prior to July 25, 2000, Konzern was a
state-owned medicine distribution company located in the City of Guangzhou,
China. On July 25, 2000, Konzern was privatized through a sale of all of its
capital stock by a PRC government-owned holding company.
As a result of the reverse merger,
beginning February 8, 2006, we have been engaged, through our wholly-owned
subsidiary Konzern, in pharmaceutical distribution in the PRC. We serve as a
holding company for Konzern.
Also on February 8, 2006, we raised
$3.9 million through the issuance and sale of (i) 3,120,000 shares of Series A
Preferred Stock and (ii) warrants to purchase 7,389,476 shares of our common
stock. Each share of our Series A preferred stock is convertible into one share
of common stock subject to adjustments.
1
On May 10, 2006, we changed our name to
China Medicine Corporation.
On July 7, 2006, we formed a PRC
joint-venture company with Guangzhou Ji’nan Science & Technology Industrial
Group (“JSIG”) and Mr. Dongsheng Yao, to develop applications for
aflatoxin-detoxifizyme, or rADTZ, an enzyme designed to eliminate a harmful
toxin from food and animal feed. The new company is called Co-Win
Bio-Engineering Ltd. (“Co-Win”). Co-Win is still a development-stage
company and has not undertaken significant operating activities as of
December 31, 2009. The PRC has granted three patents to Co-Win related to rADTZ.
In 2007, Co-Win applied for international patents in 12 different countries
including Australia, Canada, Indonesia, Israel, Japan, South Korea, Mexico,
Russia, South Africa, the U.S., Hong Kong and India and in the European Union.
Co-Win plans to apply for additional patents in single member states of the
European Union after receiving the approval from the European Union patent
authorities. Co-Win obtained the patents for rADTZ from Australia, South Africa
and South Korea in 2008 and patents for rADTZ in Russia and Mexico in 2009. The
patent applications in other countries and regions are under review as of the
date of this report.
In September 2007, Konzern US Holding
Corporation, a New Jersey corporation (“Konzern Holding”), became a wholly owned
subsidiary of Konzern as a result of an equity investment of $200,000. Konzern
Holding is expected to engage in distribution and marketing of drugs, medical
supplies and medical equipment in the United States. Konzern Holding is still in
the development stage and no sales activity has yet occurred.
Beginning in 2007, in an effort to help
consolidate the provincial medicine acquisition market and promote a transparent
bidding process, the provincial government of Guangdong Province established an
on-line bidding system called the “Guangdong Sunshine Medicine Public Internet
Bidding System,” referred to herein as the “Bidding System.” We believe the
Bidding System provides us with greater opportunities to compete for
distribution rights in Guangdong Province. We obtained the rights to sell and
distribute a total of 516 products through the Bidding System in 2008. We
obtained distribution rights for 661 products through the Bidding System in
2009, which included renewals of the distribution rights for some of
the products that we had in 2008 and obtaining some new distribution rights. We
are registered to participate in the Bidding System and we renewed our
registration as a distributor of pharmaceutical products to public medical
facilities for the period from 2009 to 2010. We expect to renew or obtain rights
for most of our existing products in 2010 and expect the revenue from the sale
of these products to increase in 2010 from sales of products under distribution
rights obtained through the Bidding System. These products should
represent an important growth driver for us in 2010.
In May 2008, we entered into agreements
with Aohai Biotech Company Ltd. (“ABC”) relating to acquisition from ABC of
distribution rights to a multivitamin pack and manufacturing by ABC of the
multivitamin pack and our proprietary products such as various formulations of
herbal tea. Pursuant to the agreements, we made the payment of approximately
$2.3 million as follows: $0.9 million as consideration for the 15-year exclusive
distribution rights to the multivitamin pack, $0.3 million as prepayment for its
manufacturing, and $1.1 million as prepayment for manufacturing of herbal
tea.
In July 2008, we began to introduce to
the U.S. market one of our products, a food supplement called BeThin Tablets,
which is designed for use as a weight-loss aid. BeThin Tablets were developed by
Konzern and manufactured by a Hong Kong pharmaceutical manufacturer which has
the certificate of Original Equipment Manufacturer (OEM). We are also actively
exploring the Hong Kong market. We have obtained trademark protection from the
Hong Kong government for our Konzern and BeThin trademarks and have registered
with the Hong Kong Trade Development Council to search for potential
distributors in Hong Kong.
On October 20, 2008, Co-Win entered
into a technology development agreement with Guangzhou Municipal Microbe
Research Institute (the “Research Institute”). Under the agreement which has a
term from October 20, 2008 to December 30, 2010, Co-Win engaged the Research
Institute for the further development of rADTZ in consideration for a research
fee of approximately $175,800 to be paid over the term of the agreement. Co-Win
is also providing the Research Institute with the equipment necessary to
undertake this project. Co-Win shall be the owner of the intellectual property
rights on the technology to be developed. In the third quarter of
2008, we purchased and installed equipment to conduct a rADTZ research project
with the Research Institute for a total purchase price of $2.5
million.
2
We obtained approval from local
government authorities for the distribution of medical supplies and devices
throughout Guangdong Province in November 2006. We received the
approval from the Guangdong Food & Drug Administration for the distribution
of dental equipment and instruments within the territory of Guangdong Province
in December 2008. Co-Win has received a manufacturing license for
premixed feed additive and a manufacturing license for feed additive for its
production facility in Guangzhou in April 2009.
On April 6, 2009, China unveiled its
blueprint for healthcare reform for the next decade, detailing plans to fix the
ailing medical system and ensure fair and affordable healthcare for all 1.3
billion citizens. China’s central and local governments will spend $124 billion
(RMB850 billion) in the next three years on wide-reaching healthcare reform. In
the new medical reform plan, the government has proposed to put medical
technology innovation as one of the most important national technology
development projects. The new plan encourages technology progress in China’s
medical system, encourages proprietary technology innovation; increases R&D
funding for treatment and prevention of key diseases; and promotes R&D to
combine TCM and Western medicine technology.
This is China’s most comprehensive
health care reform in the past 30 years. In addition, the plan outlines the
roles of the government and enterprises in terms of addressing the country’s
social benefit and healthcare issues. In the next three years, the Chinese
government has committed to building approximately 2,000 county-level hospitals.
The healthcare reform will cover 34,000 town-level clinics, 695,000 village
health care centers, 3,700 city-level health care centers and 11,000 community
service centers. The management believes that the Chinese government’s plan to
focus on innovation in the medical and healthcare industry in China will reward
our long-term growth strategy.
The impact of the new healthcare reform
on China’s pharmaceutical industry is mainly in two areas: medical care and drug
regulation. On one hand, the pharmaceutical market will grow with the medical
care system improving continuously. According to the new plan, 90% of urban and
rural residents will be covered under the healthcare system by 2020. By then,
there will be 1.28 billion Chinese enjoying benefits from the new system. It is
also estimated that the drug sales will reach RMB200 billion by year 2020, which
will represents approximately 40% of China’s pharmaceutical industry revenue. On
the other hand, the healthcare reform will encourage pharmaceutical companies
and related enterprises to conduct research and development on new drugs and
will also raise the GSP standard on drug quality control and eliminate
unqualified pharmaceutical entities. Based on an article in People’s Daily
Online, it is estimated within next three years, one third of pharmaceutical
manufacturers and half of all drugs distributors in China will be eliminated.
The pharmaceutical market will be more centralized, consisting of primarily of
higher profile enterprises.
On May 20, 2009, Guangzhou Konzern
Bio-Tech Co., Ltd. (“Konzern Bio-Tech”) was incorporated with the registered
capital of RMB 500,000. Konzern Bio-Tech was established for the
purpose of engaging in research and development and utilizing the supports from
the Chinese Government for domestic high technology companies. Bio-Tech is still
a development-stage company and has not undertaken significant operating
activities.
On June 10, 2009, we moved our legal
domicile from Delaware to Nevada.
Levocarnitine Dried Powder Injection
(“Levocarnitine”), one of our major self-owned pharmaceutical products, was
registered with Ministry of Health of Pakistan on September 25, 2009. Konzern
entered into a two year Distribution and Supply Agreement of Levocarnitine with
RG Pharmaceutica (Pvt.) Ltd. (“RGP”), a Pakistani pharmaceutical distributor.
The said agreement stipulates that RGP will be responsible for the product
registration, importation and marketing within Pakistan. Levocarnitine is used
to treat coronary heart disease and acute myocardial infarction. Currently,
there are no pharmaceutical products similar to Levocarnitine in Pakistan and
the potential market for Levocarnitine in Pakistan is estimated at 2 million
vials per year. We expect to launch Levocarnitine in Pakistan in
2010.
On December 4, 2009, we acquired
LifeTech which enhanced our business by adding a research and development force
and manufacturing facilities and expanding our sales channels and distribution
network. On October 26, 2009, Konzern entered into an Equity
Ownership Transfer Agreement (the “Transfer Agreement”) with Sinoform Limited, a
company registered under the laws of the British Virgin Islands (“Sinoform”), to
acquire 100% of Sinoform’s equity interests in LifeTech, a wholly-owned
subsidiary of Sinoform. LifeTech is a developer
and manufacturer of pharmaceutical products with a focus on vascular medicines,
anti-inflammatory medicines, women’s health and other general health traditional
Chinese medicines. LifeTech was founded in 1992, and its corporate
headquarters are located in Guangzhou, China. Pursuant to the Transfer
Agreement, on December 4, 2009 Sinoform transferred all of its equity interests
in LifeTech for a cash payment of RMB57,000,000 (approximately $8,344,800, using
the exchange rate RMB1=$0.1464 on October 26, 2009, which also applies to the
following currency conversions) in addition to the assumption of RMB89,800,000
(approximately $13,146,720) of LifeTech’s outstanding bank
debt.
3
On December 31, 2009, we entered into a
Stock Subscription Agreement (the “Subscription Agreement”) with OEP CHME
Holdings, LLC, a Delaware limited liability company (“OEP”), and Mr. Yang
Senshan, our chief executive officer and chairman of our board of directors,
pursuant to which OEP agreed to purchase, subject to satisfaction of certain
closing conditions, 4,000,000 shares of our common stock, par value
US$.0001 per share at $3.00 per share and 1,920,000 shares of our redeemable
convertible preferred stock, par value $.0001 per share at $30.00 per share, for
an aggregate purchase price of $69,600,000. This transaction was
completed on January 29, 2010 resulting in gross proceeds to the Company of
$69,600,000 and net proceeds of approximately $66,500,000 pursuant to the
Subscription Agreement.
Locations
Our executive offices and Konzern’s
executive offices are located at Room 702, Guangri Mansion, No. 9, South Wuyang
Xin Chengsi, Guangzhou, China 510600, and the telephone numbers are (8620)
8739-1718 and (8620) 8737-8212. Our website is located at
www.konzern.com.cn. Information contained on our website, or any
other website, is not part of this annual report on Form 10-K.
Our
Business
We are a distributor of pharmaceutical
and medical products in the PRC, including prescription and over-the-counter
drugs, Chinese herbs, traditional Chinese medicines made from Chinese herbs,
nutritional supplements, dietary supplements, and medical instruments. We are
also engaged in proprietary research and development with the aim of creating
new pharmaceutical products and intellectual property that we may sell in the
future. In 2009, 99% of our total revenues of approximately $64 million came
from product sales and 1% came from sales of intellectual property.
Through our subsidiary, LifeTech, we
also develop and manufacture vascular medicines, anti-inflammatory medicines,
women’s health and other general health traditional Chinese
medicines.
Distribution
Products We
Distribute
As of December 31, 2009, we sell or
distribute approximately 2,100 pharmaceutical and medical products, including:
(i) western and traditional Chinese medicine (“TCM”) drugs and supplements
(including prescription and over the counter medicines), (ii) medical equipment
and substances including herbs, and (iii) dietary supplements. In 2009, western
and TCM drugs and supplements accounted for $61.4 million, or 94.9%, of total
revenues. In 2009 revenue from sales of medical equipment and substances was
$1.52 million or 2.3% of total revenues; revenue from sales of dietary
supplements was $0.99 million or 1.5% of total revenues. Our sales of Medical
Technology amounted to $0.63 million in 2009 or 0.97% of total
revenues.
We have exclusive rights to nationwide
distribution of seven products made by our suppliers, which accounted for
approximately 22.7% of our sales in fiscal year 2009 and 29.4% of our sales in
fiscal year 2008. The most significant products among them are Iopamidol
Injection 370 and 300, prescription medicines that are used for angiography and
CT scanning. For the years ended December 31, 2009 and 2008, our total revenue
from these products amounted to $8.9 million and $6.1 million respectively,
which were 13.7% and 11.4% of our annual sales for the years ended December 31,
2009 and 2008, respectively.
4
Although we face competition from large
state-owned medicine distributors that are better capitalized than we are, we
believe that our unique competitive advantages include our ownership of
high-quality research and development facilities, our after-sale customer
service, and our exclusive nationwide or region-wide distribution rights to
certain pharmaceutical products. Our competitive pricing and our
ability to provide timely delivery are also important competitive features that
we use to attract and retain customers.
Prescription and Over the Counter
Medicines. Prescription and over the counter western medicines account
for the majority of our sales, representing sales of approximately $38.95
million, or 60.2%, of our revenues for the year ended December 30, 2009; and
$34.93 million, or 65.1%, of our revenues for the fiscal year ended December 31,
2008.
Our
prescription and over the counter medicines are approved by the PRC State Food
and Drug Administration Bureau for treatment of various conditions and
illnesses. Our five best-selling pharmaceutical medicines for the year ended
December 31, 2009, together with the sales volume for the period,
are:
·
|
Iopamidol
Injection 370, a liquid preparation used for stomach radiography, which
accounted for sales of approximately
$4,622,350.
|
·
|
Cinepazide
Maleate Injection, an injectable antibiotic, which accounted for sales of
approximately $3,369,079.
|
·
|
Iopamidol
Injection 300, a liquid preparation used for stomach radiography, which
accounted for sales of approximately
$2,740,479.
|
·
|
Xintemie,
an injectable liquid use in the treatment of infection, which accounted
for sales of approximately
$1,195,481.
|
·
|
Levocarnitine,
an injectable liquid used in the treatment of cardiac muscle disease, bone
dysfunction, and high cholesterol, which accounted for sales of
approximately $1,091,880.
|
Our five
best-selling pharmaceutical medicines for the year ended December 31, 2008,
together with the sales volume for the period, are:
·
|
Iopamidol
Injection 370, a liquid preparation used for stomach radiography, which
accounted for sales of approximately
$2,714,369.
|
·
|
Iopamidol
Injection 300, a liquid preparation used for stomach radiography, which
accounted for sales of approximately
$2,283,208.
|
·
|
Xintemie,
an injectable liquid use in the treatment of infection, which accounted
for sales of approximately
$1,654,446.
|
·
|
Levocarnitine,
an injectable liquid used in the treatment of cardiac muscle disease, bone
dysfunction, and high cholesterol, which accounted for sales of
approximately $1,470,333.
|
·
|
Fengduoxin
Cefamandolenafate Injection, an injectable antibiotic, which accounted for
sales of approximately $1,406,959.
|
Traditional Chinese
Medicines. Our five best-selling traditional Chinese medicines for the
year ended December 31, 2009, together with the sales volume for the period,
were:
·
|
Hongjin
Xiaojie Capsule, which is used for the treatment of coughs, accounted for
approximately $4,237,686 in sales.
|
·
|
Xiasang
Ju Granules, which are used for treatment of flu and various ailments,
accounted for approximately $2,008,572 in
sales.
|
5
·
|
999
Ganmaoling, which is used for the treatment of flu, accounted for
approximately $1,040,717 in sales.
|
·
|
Xue
Shuan Tong, which is used for the treatment of strokes, accounted for
approximately $869,243 in sales.
|
·
|
Pingxuan
Capsule, which is used for treatment of cardiovascular disease, accounted
for approximately $329,692 in
sales.
|
Our five
best-selling traditional Chinese medicines for the year ended December 31, 2008,
together with the sales volume for the period, were:
·
|
Xue
Shuan Tong, which is used for the treatment of strokes, accounted for
approximately $3,242,061 in sales.
|
·
|
Hongjin
Xiaojie Capsule, which is used for the treatment of coughs, accounted for
approximately $2,657,936 in sales.
|
·
|
Xiasang
Ju Granules, which are used for treatment of flu and various ailments,
accounted for approximately $2,190,106 in
sales.
|
·
|
Pingxuan
Capsule, which is used for the treatment of vertigo, accounted for
approximately $411,017 in sales.
|
·
|
Chuanbei
Piba Gao (Milian), which is used for treatment of coughs, accounted for
approximately $329,692 in sales.
|
Process of
Distribution
Within our home province of Guangzhou,
we distribute products primarily using our own trucks and other vehicles.
Outside of Guangzhou, we distribute primarily through delivery companies with
whom we contract. The terms of our agreements with delivery companies cover
storage temperature, insurance provisions, and indemnification for loss among
other provisions.
In the US, we intend to focus on food
supplements. Currently, we are exploring opportunities to launch BeThin Tablets,
our weight control supplement, in several dietary supplements stores in Boston.
Within the US, we currently seek regional distributors or an exclusive
distributor able to promote the sales of our supplement products in retail
stores.
Principal
Suppliers
We purchase most of the products we
distribute from five PRC drug manufacturers. These suppliers accounted for
approximately 54.5%, and 47.2% of our purchases for the fiscal years ended
December 31, 2009 and 2008, respectively. In 2009, our five largest suppliers
were Shanghai Bracco Sino Pharmaceutical Corporation, Guangzhou Pharmaceutical
Holdings Limited, the Guangdong office of Guangdong Jiuzhoutong Pharmaceutical
Limited, Guangdong Liyuan Pharmaceutical Co., Ltd and Guangzhou Caizhilin
Pharmaceutical Co., Ltd, which accounted for 21.8%, 17.5%, 6.7%, 6.1%, and
4.8% of our purchases during 2009, respectively.
Neither we nor Konzern has experienced
any supply disruptions in the past. We believe that we will be able to procure
supplies for each of our major products from alternative suppliers in the event
that procurement from our regular suppliers becomes unavailable. However, there
is no guarantee that this will be the case.
6
Principal
Customers
We have approximately 800 customers.
Our customers are primarily pharmaceutical product wholesalers, hospitals and
retail drug stores. Our five largest customers accounted for approximately 45.0%
of our revenues for the year ended December 31, 2009 and 37.9% of our revenues
for the year ended December 31, 2008.
Marketing
We have a
staff of approximately 70 marketing and sales employees. We do not sell to
individual patients or consumers. We advertise and participate in promotional
events with regard to over-the-counter products and supplements. We generate
business by marketing directly to wholesale pharmaceutical product companies,
hospitals and retail drug stores, which constitute substantially all of our
customers. Konzern had a distribution network in place when it was privatized in
2000, and we used this network as the basis of our current distribution network.
We also market our products to drug wholesalers and retail drug stores at two
national medicine trade shows. The marketing activities of our marketing
personnel consist primarily of phone calls, on-line marketing, the creation and
distribution of promotional materials, and visits to customer locations. During
2009, we spent approximately $555,696 on marketing, primarily as advertising and
promotion expense and expenses of extension of sales network. During 2008, we
spent approximately $536,674 on marketing.
We are
currently focusing our marketing and sales efforts on large pharmaceutical
wholesalers from whom we can collect our cash soon after delivery. Nonetheless,
we continue to allocate our marketing efforts to hospitals because the revenue
from hospitals constitutes a large percentage of our total revenue.
After Sales Service
Network
We
contact individual patients and consumers directly to collect their feedback on
the quality of our products and distribution services. All of our 70 sales and
marketing personnel are responsible for providing after-sale services, including
on-site visits to the hospitals and follow up with customers. In addition, our
on-staff physician communicates with hospitals regarding dosages, side-effects
and patients’ feedback on particular products.
Seasonality of
Business
We
allocate considerable marketing resources to negotiation with hospitals during
the bidding period of the Bidding System, which affects the sales during that
time. Sales are usually highest during the last three months of each calendar
year because most of the pharmaceutical companies and hospitals do more buying
at this time. Sales in the first three months of the calendar year are usually
the lowest due to the occurrence of the Chinese New Year holiday, when only
patients with very serious conditions tend to seek treatment. Our revenue and
operating results have fluctuated from quarter to quarter significantly in the
past. For example, our sales revenue for the quarters ended March 31, 2009 and
2008 amounted to $10.1 million and $7.1 million, respectively, while sales
revenue for the quarters ended December 31, 2009 and 2008 were substantially
higher, amounting to $20.4 million and $24.3 million, respectively.
Competition
Competition
in the sale of pharmaceutical products among distributors in the PRC is intense
because there are a large number of licensed distributors. We believe that our
major competitors are large, state-owned medicine distributors, such as
Guangzhou Medicine Company, Guangzhou Medicine Import and Export Corporation and
Guangdong Pharmaceutical Co., Ltd. These companies tend to be better
capitalized, which allows them to seek hospital customers that have a six-month
payment cycle. However, such state-owned companies do not have their own
research and development facilities, relevant technical support and customer
service, while Konzern does, and most of them do not provide after-sale
customer service. We believe these two aspects of our business are competitive
advantages.
In the
US, there is generally an intense competition in the sale of weight control
supplements. In 2008 we applied for a US patent for the formula of our product,
BeThin Tablets, which application is currently pending. The patent when approved
will give us exclusive rights for this formulation which may (depending on
market perception) give us advantages with regard to the
pricing.
7
We have
exclusive distribution rights to at least one medical product sold by each of
our five largest suppliers, which we believe assists us in marketing our
products. However, since other distributors offer comparable products, our
ability to compete successfully is also dependent upon other factors, such as
price, service and the ability to provide timely delivery.
The
acquisition of LifeTech has given us the ability to manufacture certain
pharmaceutical products ourselves. This enables us to better control
costs for these products, which (depending on pricing of competitive products)
should improve our gross margin.
We
believe that our ability to develop proprietary products through our current
research and development efforts and to manufacture our own products through
LifeTech may provide further competitive advantages.
Product
Development and Technology Transfers
In
addition to the sale and distribution of our medical products, we engage in the
development of intellectual property relating to new pharmaceutical products
which we may use ourselves (which we refer to as product development) or may
sell to other pharmaceutical companies (which we refer to as technology
transfers).
Product
Development
On July
7, 2006, we created a PRC joint-venture with Guangzhou Ji'nan Science &
Technology Industrial Group (“JSIG”) and Professor Dongsheng Yao. The purpose of
the new company, Guangzhou Co-win Bioengineering Co., Ltd. (“Co-Win”), is to
develop applications for aflatoxin-detoxifizyme, or rADTZ, an enzyme that can
eliminate aflatoxin from food and animal feed. Aflatoxin, a toxic substance that
causes liver, stomach and lung cancers in animals and humans, is produced by the
common aspergillus fungus and frequently affects cereal grains, oilseeds,
spices, peanuts and other nuts. Prof. Yao owns the intellectual
property rights, holding four patents in the PRC, and JSIG is an agent for the
entity that holds those patents, Ji'nan University. Konzern owns a 70% equity
interest in Co-Win, and each of JSIG and Prof. Yao has a 15% equity interest.
The agreement with JSIG and Prof. Yao governing the creation of Co-Win, which
was signed as of July 7, 2006, provides that (i) Konzern is to invest a total of
approximately $2.2 million, which we have fully paid as of December 31, 2008,
and (ii) Co-Win will own the intellectual property rights to any products
developed by the joint venture pursuant to the agreement. The formation of
Co-Win was approved and licensed by the Guangzhou Industrial and Commerce Bureau
on October 27, 2006.
Technology
Transfers
Technology
transfers generated approximately $0.63 million or 1.0% of total sales for the
year ended December 31, 2009, and approximately $1.3 million, or 2.5% of our
total revenues for the year ended December 31, 2008. Our customers for
technology transfers are pharmaceutical manufacturers, research centers and
medicine distribution companies. We anticipate that our technology transfers,
which began in 2003, will continue to be a significant segment of our business
in the foreseeable future.
Intellectual
Property
Patents
We have
obtained patents for the production methods we have developed or control for the
following four products. Patent certificates were issued on May 9, 2007 with
patents rights for 20 years from the filing date:
·
|
Xiao
Shu Oral Liquid, an oral medication designed to reduce the effects of heat
exhaustion;
|
·
|
Jian
Pi Xiao Ji Oral Liquid, an oral medication to treat
indigestion;
|
·
|
An
unnamed oral medicine treatment for symptoms related to computer over-use;
and
|
·
|
An
unnamed method of improving the effectiveness of oral
medicines.
|
8
The table
below sets forth information relating to these four patents.
Name
|
Inventor
|
Application
No.
|
Filing
date
|
Publication
date
|
Patent
No.
|
Authorization
date
|
||||||||
1
|
Xiao
Shu Oral Liquid
|
Jinkun
Xie,
Minhua
Liu
|
20041005239600
|
2004.11.26
|
2005.8.10
|
ZL200410052396.0
|
2007.5.9
|
|||||||
2
|
Jian
Pi Xiao Ji Oral Liquid
|
Jinkun
Xie,
Minhua
Liu
|
200410052398
|
2004.11.26
|
2005.8.10
|
ZL200410052398.X
|
2007.5.9
|
|||||||
3
|
An
oral treatment for symptoms associated with over-use of
computers
|
Jinkun
Xie,
Minhua
Liu
|
200510032608.3
|
2005.1.5
|
2005.10.12
|
ZL12005132607.9
|
2007.10.03
|
|||||||
4
|
A
method of improving oral medicines
|
Jinkun
Xie,
Minhua
Liu
|
200510032607.9
|
2005.1.5
|
2005.10.12
|
ZL200510032608.3
|
2007.10.03
|
Co-Win
has obtained the following patents for rADTZ in China.
·
|
Detoxification
technology to remove AFT from the raw materials of
condiments;
|
·
|
Biosensor
and its manufacturing method for the inspection of AFT and versicolorin;
and
|
·
|
Detoxifizyme
with the function to convert the activity of AFT and the gene to code the
aforesaid detoxifizyme.
|
The table
below sets forth the information relating to these three patents:
Name
|
Filing
date
|
Publication
date
|
Patent
No.
|
Authorization
date
|
||||||
1
|
Detoxification
technology to remove AFT from the raw materials of
condiments
|
2001.1.12
|
2002.8.21
|
ZL01107435.3
|
2005.11.16
|
|||||
2
|
Biosensor
and its manufacturing method for the inspection of AFT and
versicolorin
|
2004.7.9
|
2006.1.11
|
ZL200410028018.9
|
2007.9.26
|
|||||
3
|
Detoxifizyme
which functions to convert the activity of AFT and the gene to
code the aforesaid detoxifizyme
|
2004.8.17
|
2005.12.28
|
ZL200410051120.0
|
2007.1.10
|
9
Furthermore,
Co-Win has obtained international patents for rADTZ in Australia, South Africa,
Russia, Mexico and South Korea. In addition, Co-Win has 10
international patent applications pending for rADTZ, in countries such as the
United States, Japan and Israel, as well as several of the member states in the
European Union.
We also
have patents pending for the production methods we have developed or control
for 11 medicines. These patent applications have been approved
by the PRC State Health Department, and approvals by the PRC National
Intellectual Property Bureau are pending. Except for the BeThin weight control
component, we do not currently manufacture or sell any of these
medicines. Information relating to the BeThin pending patent
applications is set forth below.
Name
|
Inventor
|
Application
No.
|
Filing
date
|
Publication
date
|
|
|
||||||||
|
|
|
|
|
||||||||||
1
|
PCT international application of
a component of weight control
|
Jinkun Xie Minhua
Liu
|
PCT/CN2008/070057
|
2008.1.9
|
2007.12.26
|
|
||||||||
|
|
|
||||||||||||
2
|
Application in Hong Kong: a
component of weight control
|
Jinkun
Xie Minhua Liu
|
08113020.9
|
2008.11.28
|
|
|||||||||
|
|
|
||||||||||||
3
|
Application in US: a component of
weight control
|
Jinkun
Xie Minhua Liu
|
CHINA200710032895.7
|
2008-11-26
|
2009.2.7
|
We
also acquired four new patents as a result of the LifeTech
acquisition. The details of those patents are set forth
below:
Name
|
holdor
|
Application
No.
|
Filing
date
|
Patent
No.
|
Authorization
date
|
|||||||
1
|
The
uses of Huouerhaun’s extract on anti-allergy medicine, food and
cosmetics
|
Guangzhou
LifeTech Pharmaceutical
&
Technological Ltd.
|
200410077659.3
|
2004.12.29
|
ZL200410077659.3
|
2009.10.14
|
||||||
|
||||||||||||
2
|
New
uses of Houerhuan’s extract
|
Guangzhou
LifeTech Pharmaceutical
&
Technological Ltd.
|
200610033698.2
|
2006.2.21
|
ZL200610033698.2
|
2009.9.30
|
||||||
|
||||||||||||
3
|
Zhimu’s
extract and the method of extraction
|
Guangzhou
LifeTech Pharmaceutical
&
Technological Ltd.
|
03115509.X
|
2003.2.25
|
ZL03115509.X
|
2005.5.25
|
||||||
|
||||||||||||
4
|
New
flavan derivatives, its use and preparation method
|
Guangzhou
LifeTech Pharmaceutical
&
Technological Ltd.
|
200410051988.0
|
2004.10.29
|
ZL200410051988.0
|
2007.3.21
|
10
An application for an invention
patent for Lujiao Linzhi’s extraction and how to use it to create anti-tumor
drugs and food, was submitted in the PRC on March 25, 2005.
Trademarks
The
registered scope of use of the trademark is for pharmaceutical products,
nutritional liquids, dietary supplements, original materials, bio-chemical
medicines, medicinal oils, medicines treating dandruff, medicinal roots and
vitamins. The PRC Trademark law, adopted in 1982 and revised in 2001, protects
registered trademarks. A registered trademark is protected for a term of 10
years, renewable for another term of 10 years, so long as an application for
renewal is submitted to the PRC Trademark Offices within six months prior to the
expiration of the initial term.
Below is
a schedule of the trademarks held by Konzern and their effective
periods.
No.
|
Name
|
Application
No.
|
Registration
Status
|
Effective
period
|
||||
1
|
Konzern
|
1680414
|
received
|
2001.12.14
- 2011.12.13
|
||||
3
|
kefei
|
3564022
|
received
|
2005.09.28
- 2015.09.27
|
||||
6
|
kefei
|
3564020
|
received
|
2005.03.07
- 2015.03.06
|
||||
15
|
runxia
|
4411469
|
received
|
2007.06.14
- 2017.06.13
|
||||
20
|
buzhong
|
4411468
|
received
|
2007.06.21
- 2017.06.20
|
||||
23
|
qingshangqing
|
4411471
|
received
|
2007.06.14
- 2017.06.13
|
||||
28
|
wangyou
|
4519748
|
received
|
2007.10.07
-
2017.10.06
|
Konzern
is also the holder of the trademark (kefei) for nutritional supplements (product
category 30 of the PRC Trademark Offices) and medicine for external use (product
category 3 of the PRC Trademark Offices).
In
addition, Konzern has applied for the registration of the following trademarks,
for which we are awaiting further notice from the PRC Trademark
Offices:
Trademark
applied for
|
Application
date
|
Process
acceptance date
|
||
Shangqing
|
12/01/2004
|
02/23/2005
|
||
Buzhongbao
|
12/01/2004
|
02/23/2005
|
||
Erxianbaochun
|
12/01/2004
|
02/23/2005
|
||
Wangzeyou
|
03/02/2005
|
05/25/2005
|
||
Yutian
|
03/15/2005
|
05/25/2005
|
||
Qinghe
|
07/18/2005
|
09/27/2005
|
||
Co-win
|
05/28/2006
|
09/18/2006
|
||
Mushenghuo
|
2006
|
2006
|
||
Mushengtu
|
2006
|
2006
|
||
Jinshengshui
|
2006
|
2006
|
||
Tushengjin
|
2006
|
2006
|
||
Wubaohu
|
06/20/2007
|
09/17/2007
|
||
Konzern
|
01/13/2008
|
01/24/2008
|
||
BeThin
|
01/13/2008
|
01/24/2008
|
Below is
the schedule of the trademark held by LifeTech:
No.
|
Name
|
Application
No.
|
Registration
Status
|
Effective
period
|
||||
1.
|
Graphics
|
3221243
|
received
|
September
21, 2003 to September 20, 2013
|
||||
2.
|
Vietech
Pharma
|
3716705
|
received
|
February
14, 2006 to February 13, 2016
|
||||
3.
|
LitPharma
|
3716706
|
received
|
April
14, 2006 to April 13, 2016
|
||||
4.
|
Lirenshuang
|
4355617
|
received
|
May
28, 2007 to May 27, 2017
|
||||
5.
|
Lirenle
|
4355615
|
received
|
May
28, 2007 to May 27, 2017
|
||||
6.
|
Lirenchun
|
4355616
|
received
|
July
14, 2007 to July 13, 2017
|
||||
7.
|
Lejiaren
|
4355618
|
received
|
July14,
2007 to July 13, 2017
|
||||
8.
|
Jilitai
|
4355612
|
received
|
January
7, 2008 to January 6, 2018
|
||||
9.
|
Tianlunle
|
4355623
|
received
|
January
7, 2008 to January 6, 2018
|
||||
10.
|
Lirenshuang
|
4355621
|
received
|
January
7, 2008 to January 6, 2018
|
||||
11.
|
Lirenchun
|
4355619
|
received
|
January
7, 2008 to January 6, 2018
|
||||
12.
|
Taimeina
|
4355613
|
received
|
January
7, 2008 to January 6, 2018
|
||||
13.
|
Lirenshuang
|
4286303
|
received
|
November
21, 2007 to November 20, 2017
|
||||
14.
|
Xintailai
|
4815271
|
received
|
January
14, 2009 to January 13, 2019
|
||||
15.
|
Dongfangyuansu
|
4815272
|
received
|
January
21, 2009 to January 20, 2019
|
||||
16.
|
Dongfangsu
|
4815273
|
received
|
January
21, 2009 to January 20, 2019
|
||||
17.
|
Laitai
|
3228479
|
received
|
September
28, 2003 to September 27, 2013
|
||||
18.
|
S&H&
Graphics
|
1648478
|
received
|
October
14, 2001 to October 13, 2011
|
||||
19.
|
Junshun
|
692355
|
received
|
June
7, 2004 to June 6,
2014
|
11
Below
is the schedule of the trademarks held by China Medicine Corporation and their
effective period:
No.
|
Name
|
Registration
No.
|
Registration
Date
|
Effective
period
|
||||
1
|
Konzern
|
3,550,633
|
12/23/2008
|
2008.12.23
- 2018.12.22
|
||||
3
|
BeThin
|
3,550,969
|
12/23/2008
|
2008.12.23
-
2018.12.22
|
Government
Regulation
The
operation of any business in the PRC, including the manufacture or distribution
of pharmaceutical products, is subject to government regulations. These
regulations cover a wide range of products, from Chinese herbal products sold
over-the-counter to pharmaceutical products which require a
prescription.
The
manufacture and sale of pharmaceutical products in the PRC is governed by the
PRC Drug Administration Law. Before the acquisition of LifeTech, we did not
manufacture any products. Instead, all of the products we distributed were
manufactured at a facility which had received a permit to operate as a drug
manufacturing facility. As a distributor of pharmaceutical products, we are
required to obtain a permit from the drug regulatory department of the
government of the province, autonomous region or municipality directly under the
PRC Central Government, where we are located. If a distributor distributes drugs
without a certificate, the distributor is banned from the
industry. We have obtained a permit to operate as a distributor, a
Certificate for Drug Distribution, from the Guangdong Food and Drug
Administration in the Province of Guangdong, China, with a five-year term from
October 27, 2009 to October 26, 2014. The certificate allows for the purchase of
raw materials, wholesale distribution of traditional Chinese medicines, chemical
medicines and the related medicines, antibiotics and related medicines. In
addition, we have a Certificate for Food Sanitation issued by Guangzhou Health
Bureau with a term of four years, commencing on August 29, 2008 and ending on
April 16, 2012, which grants us the right to engage in wholesale marketing and
distribution of nutritional supplements.
The Drug
Administration Law also governs other aspects of the drug manufacturing and
distribution business, including packaging, labeling, advertising and pricing.
The PRC Drug Administration Law and Pricing Law provide for the government to
determine and adjust prices of pharmaceutical products in order to ensure that
price is commensurate with quality, to eliminate excessively high prices, and
protect the legitimate interests of users. In general, the prices of our
products are determined by us and our customers through negotiation. We are
required to operate in accordance with Good Supply Practice (or “GSP”) for
pharmaceutical products, and we are subject to inspections organized by the
local drug regulatory department of the government of Guangdong Province. We
received a GSP Certificate from the Guangdong Province Administration Bureau for
Drugs with a term of five years beginning on October 27, 2008.
In order
to market a new pharmaceutical product, we must first obtain government approval
for the clinical trial. The government authority issues a list of hospitals
which are qualified to conduct the clinical trial, and we select one or more
hospitals from such list. If the results of the test are accepted by the PRC
State Food and Drug Administration, we must then apply for a production license
, or Drug Certificate so that the drug can be produced at a licensed
manufacturing facility. In accordance with relevant laws and regulations, the
Drug Certificate may be revoked if the pharmaceutical product is found to cause
adverse pharmacological effects or is found to be harmful to patients’ health,
or if it is found that other activities engaged in with respect to manufacturing
and marketing the drug are in violation of the laws. The Drug Certificate sets
forth the approved use of the pharmaceutical product. Four new products are
currently being developed by the research-center venture with Nanhua University.
After completion of laboratory testing, those products are subject to the
clinical trial process described above.
12
A typical
schedule for obtaining approval to manufacture or sell a new drug would require
one to one-and-a-half years for approval of clinical trials, an additional one
to three years for the completion of clinical trials, and an additional one to
one-and-a-half years for the issuance of a Drug Certificate and production
certificate.
The
effects on a company of operating within the regulatory framework described
above are significant and comprehensive. We must employ professional managers,
inspectors, receivers, verifiers, and warehouse managers, all of whom must be
appropriately trained and experienced and whose qualifications are overseen by
the SFDA; we must maintain a specialized warehouse in compliance with regulatory
standards, and we must maintain the licenses and certificates described
above.
In 2008
we began to explore sales prospects in the U.S. for BeThin Tablets, a weight
loss dietary supplement. We are currently seeking U.S. distributors for BeThin
Tablets and we have made contact with several U.S. dietary supplements stores.
Dietary supplements in the U.S. are regulated by the U.S. Food and Drug
Administration (“FDA”). Under the Dietary Supplement Health and Education Act of
1994, the dietary supplement manufacturer is responsible for ensuring that a
dietary supplement is safe before it is marketed. FDA is responsible for taking
action against any unsafe dietary supplement product after it reaches the
market. Generally, manufacturers do not need to register their products with FDA
nor get FDA approval before producing or selling dietary supplements. However,
manufacturers must make sure that product label information is truthful and not
misleading. Pursuant to its post-marketing control responsibilities, FDA's
monitors safety, e.g. voluntary dietary supplement adverse event reporting, and
product information, such as labeling, claims, package inserts, and accompanying
literature. The U.S. Federal Trade Commission regulates dietary supplement
advertising in the U.S. We are in the initial stage of setting up distribution
of BeThin Tablets in the U.S. and as a result did not incur any costs of
compliance with these regulations during fiscal 2009. This may change, as we
continue in our efforts to begin sales of this product in the U.S.
Employees
As of
December 31, 2009, we had approximately 281 employees, of whom 176 are employed
by LifeTech, 36 executive and administrative personnel, 9 are research and
development staff and 70 are marketing and sales personnel.
Risk of Loss and
Liability
The
standard contracts between Konzern and its customers do not specify risk of loss
allocation; however, the transportation company is generally responsible for
losses and damage which occur during transportation. In the event that a product
recall becomes necessary, any liability associated with the recall or use of the
product will be apportioned among the various parties involved in the production
and distribution of the product. Manufacturers are typically responsible for
problems arising from the quality of medicines, and distributors such as China
Medicine are typically responsible for problems related to incorrect packaging.
We mitigate these risks by providing for transportation insurance in our typical
delivery contracts with transportation companies.
Neither
Konzern nor LifeTech carry any product liability or other similar insurance.
While product liability lawsuits in the PRC are rare and we have never
experienced significant problems with any of our products, there can be no
assurance that we would not face liability in the event that any of our products
is found to be ineffective, harmful, unsafe, defective or tainted.
Our
subsidiary, Konzern US Holding Corporation carried general commercial liability
insurance which covered our products distributed in the U.S, until
it expired on September 1, 2009. Currently, only one of our
products, our weight-loss dietary supplement BeThin Tablets is being
distributed in the U.S.
13
ITEM
1A. RISK FACTORS
An investment in our common stock
involves a high degree of risk. You should carefully consider all of the risks
described below, together with the other information contained in this report,
before making a decision to purchase our common stock. You should only purchase
our common stock if you can afford to lose your entire investment.
Risks
Associated with Our Business
Supply
interruptions could damage our core business.
Many of the products we distribute are
derived from plant products, whose availability and price could be affected by
any of the factors that affect crop growth and availability, including weather,
fire, insects, and disease. Most of the products we distribute are produced
through complex manufacturing processes that must be designed and executed with
precision. If our suppliers are not able to acquire the raw materials or
complete the manufacturing process needed to produce the products that we
purchase from them, our business will suffer. In addition, we purchase most of
our inventories from a small number of suppliers. In 2009, our five largest
suppliers accounted for approximately 54.5% of our purchases. If any of these
suppliers were to become unable or unwilling to supply our inventories at
reasonable prices, we would be forced to look to other suppliers to meet our
demand for materials. Although we believe that alternative suppliers are
available for each of the ingredients in our major products, there is no
guarantee that all of these ingredients are or will continue to be available in
the future, or that they will be available at prices similar to those we are
accustomed to paying. Although we have not experienced any supply disruptions in
the past, there is no guarantee they will not occur in the future. As a result,
the loss of a supplier could impair our ability to operate
profitably.
Interruptions
of deliveries to customers could damage our core business.
We generate most of our revenues by
delivering products to our customers. Our performance therefore depends on the
smooth and reliable functioning of all aspects of the delivery process,
including vehicles (primarily trucks), availability of gasoline at historically
typical prices, and infrastructure, especially roads, bridges and tunnels. If we
are not able to secure trucks and delivery services at the rates to which we are
accustomed; if gasoline prices rise significantly; or if roads are damaged by
weather or earthquakes or other extraordinary events or are not repaired after
ordinary wear, our ability to make deliveries would suffer, and therefore our
ability to generate revenue, our financial results, and our competitive position
would all suffer.
Because
a significant portion of our revenue comes from a small number of customers, the
failure of one of our customers could adversely affect our financial
condition.
Our five largest customers accounted
for 45.0% of our revenue for 2009, and 37.9% of our revenue for
2008. Our customers are not required to make minimum purchases from
us or to refrain from purchasing competing products from other
companies.
Because a substantial portion of our
sales are made to a small number of customers, our accounts receivable from such
customers may represent a large percentage of our accounts receivable and
assets. Our largest account receivable as of December 31, 2009, was
approximately $5,280,444, representing approximately 23.7% of our total accounts
receivable, 7.9% of our total assets and approximately 33.3% of our working
capital. This concentration of accounts receivable represents a significant
credit risk. The failure of one or more of these customers to pay their
obligations to us in a timely manner could adversely affect our liquidity and
cash flows and could impair our ability to continue to operate profitably or at
all.
14
If
the medicines we distribute are found to cause severe side effects or other
harm, or the drug related technologies we own or develop are found to be
defective, we could suffer serious consequences.
The products we distribute may be
dangerous if taken in the wrong doses, if there are manufacturing process
defects or tampering, or if badly designed or inadequately tested prior to their
release. As the distributor and/or manufacturer of drugs and other medical
products, we may be subject to liability in the event that claims of harm
resulting from the use of our products are made. In the case of drugs that we
are developing, we could face liability not only as a distributor but also as
the designer and technology owner of the drugs. Such a claim could lead
to:
·
|
a
withdrawal or modification of government approvals of such
medicines;
|
·
|
a
government requirement that we recall or participate in the recall of one
or more of our medicines;
|
·
|
a
decline or cessation of sales of the
medicine;
|
·
|
damage
to our reputation and competitive position, and reduced success in
securing distribution rights from
manufacturers;
|
·
|
claims
against us by persons or entities claiming harm, including lawsuits
against us by persons who may have experienced severe side effects or
other harm; claims from customers that we have failed to fill orders to
specifications; claims from purchasers of our formulas that we have failed
to deliver the formulas as promised; and
claims
|
·
|
the
need for us to devote significant resources to improve a defective
technology or create a new technology for an affected medicine, to change
the way we market technology or medicine, to conduct additional clinical
trials or demand that they be conducted by a manufacturer, or to change
the labeling of a medicine or demand that labeling be changed by a
manufacturer; and
|
·
|
the
total or partial loss of the value of an affected
technology.
|
The
occurrence of any of these events would reduce our sales of the affected
medicines and substantially increase the costs of marketing these medicines, and
could have a serious adverse effect on our revenues, profitability, and
competitive position.
Because
we are dependent on our management, the loss of key executive officers could
harm our business.
Our business is largely dependent upon
the continued efforts of our chief executive officer, Senshan Yang, and our
executive vice president, Minhua Liu, whose managerial expertise would be
difficult or impossible to replace. Both Mr. Yang and Ms. Liu are also
directors. We have Employment Agreements with each of Mr. Yang and
Ms. Liu for a term that expires in June 30, 2010, these agreements will be
renewed. The loss of either of these individuals could have a material adverse
effect upon our ability to operate profitably.
We
must make significant cash payments for our product supplies long before we
generate revenue from sales of those products. We may therefore require cash
from outside sources to purchase supplies and run our business, even if our
sales increase.
Our suppliers require us to comply with
strict payment terms that are written into our supply contracts. The collection
periods for our accounts receivable typically range from three months to one
year; we are required to pay our suppliers in advance for a significant portion
of the purchase price; and we must maintain deposits with some of our suppliers.
It generally takes our supplies one to two months to deliver products once we
place a purchase order. In addition, some of our customers, especially
hospitals, require payments terms that allow them to pay for our deliveries
months after they have been made. As a result, we spend large amounts of cash
for the products we distribute long before we generate revenue from sales of
those products. Our business is therefore cash-intensive. We do not have an
accounts-receivable or inventory-based credit facility in place to provide
liquidity when it is needed. Therefore, sales of our products may not generate
sufficient cash to enable us to pay our suppliers while awaiting payment on our
receivables, and we may be forced to seek outside financing to continue
operations. Although we have consummated a financing of $69,600,000 at the end
of January 2010, $57,600,000 has been escrowed in an escrow account, the release
of which is contingent on certain conditions. Such escrowed funds are designated
for certain specified acquisitions and capital expenditures. There is no
guarantee that the escrowed funds could be disbursed according to the schedule
the management requires, if at all.
15
Acquisitions
may disrupt our operations.
An important part of our growth
strategy is to seek expansion by making strategic acquisitions. If we
make acquisitions, we could have difficulties integrating the acquired
companies' personnel and operations with our own, including:
·
|
difficulties
integrating acquired products, services, operations and rights into our
existing business;
|
·
|
potential
disruption of the ongoing businesses and distraction of our management and
the management of acquired
companies;
|
·
|
difficulties
in disposing of the excess or idle facilities of an acquired company or
business and expenses in maintaining such
facilities;
|
·
|
difficulties
in maintaining uniform standards, controls, procedures and
policies;
|
·
|
potential
impairment of relationships with employees and customers as a result of
any integration of new management
personnel;
|
·
|
potential
inability or failure to achieve additional sales and enhance our customer
base through cross-marketing of the products to new and existing
customers;
|
·
|
the
effects of any government regulations which relate to the acquired
business; and
|
·
|
potential
unknown liabilities associated with acquired businesses or product lines,
or the need to spend significant amounts to retool, reposition or modify
the marketing and sales of acquired products or the defense of any
litigation, whether of not successful, resulting from actions of the
acquired company prior to our
acquisition.
|
Our business could be severely impaired
if and to the extent that we are unable to succeed in addressing any of these
risks or other problems encountered in connection with these acquisitions, many
of which cannot be presently identified. These risks and problems could disrupt
our ongoing business, distract our management and employees, increase our
expenses and adversely affect our results of operations. Even if we manage these
difficulties, there is no guarantee that the increased revenue resulting from
the acquisition will outweigh the costs of the acquisition, the integration and
the continuing operations of our larger, consolidated company.
Our
operating results in future periods may vary from quarter to quarter and, as a
result, we may fail to meet the expectations of our investors and analysts,
which may cause our stock price to fluctuate or decline.
Our revenue and operating results have
fluctuated from quarter to quarter significantly in the past. For example, our
sales revenue for first quarter 2009 amounted to $10.1 million, about one half
of sales revenue for the fourth quarter 2009 which amounted to $20.4
million. We expect that fluctuations in both revenue and net income
will continue due to a variety of factors, many of which are outside of our
control, including the needs of our customers, competitive products offered by
others, consumer preferences, the extent of our research and development
activities, and seasonal purchasing patterns of our customers. Due to such
risks, you should not rely on period-to-period financial comparisons as an
indication of future performance.
16
New
product development in the pharmaceutical industry is time-consuming and costly
and has a low rate of successful commercialization.
Our success will depend in part on our
ability to enhance our existing products and to develop new
products. The development process for pharmaceutical products is
complex and uncertain, as well as time-consuming and
costly. Relatively few research and development programs produce a
commercial product. A product candidate that appears promising in the early
phases of development may fail to reach the market for a number of reasons, such
as:
•
|
the
failure to demonstrate safety and efficacy in preclinical and clinical
trials;
|
•
|
the
failure to obtain approvals for intended use from relevant regulatory
bodies, such as the State Food and Drug Administration (the
“SFDA”);
|
•
|
our
inability to manufacture and commercialize sufficient quantities of the
product economically; and
|
•
|
proprietary
rights, such as patent rights, held by others to our product candidates
and their refusal to sell or license such rights to us on reasonable
terms, or at all.
|
In addition, product development
requires the accurate assessment of market trends. We cannot assure you
that:
•
|
our
new product research and development efforts will be successfully and
timely completed;
|
•
|
our
clinical trials on humans for our product candidate will be
successful;
|
•
|
SFDA
or other regulatory bodies will grant necessary regulatory clearances or
approvals on a timely basis, or at all;
or
|
•
|
any
product we develop will be commercialized or achieve market
acceptance.
|
Delays in any part of the development
process or our inability to obtain regulatory approval of our products could
adversely affect our operating results by restricting or delaying our
introduction of new products. Even if we successfully commercialize new
products, these products may address markets that are currently being served by
our mature products and may result in a reduction in the sales volume of our
mature product or vice versa. Failure to develop, obtain necessary
regulatory clearances or approvals for or successfully commercialize or market
potential new products or technologies could have a material adverse effect on
our financial condition and results of operations.
Risks
Associated with Doing Business in the PRC
Changes
in the policies of the PRC government could have a significant impact upon the
business we may be able to conduct in the PRC and the profitability of that
business.
The PRC's economy is in transition from
a planned economy to a market oriented economy subject to five-year and annual
plans adopted by the government that set national economic development goals.
Policies of the PRC government can have significant effects on the economic
conditions of the PRC. The PRC government has confirmed that economic
development will follow the model of a market economy. Under this direction, we
believe that the PRC will continue to strengthen its economic and trading
relationships with foreign countries and business development in the PRC will
follow market forces. While we believe that this trend will continue, there can
be no assurance that this will be the case.
17
A change in policies by the PRC
government could adversely affect our interests by, among other factors: changes
in laws, regulations or the interpretation thereof, confiscatory taxation,
restrictions on currency conversion, imports or sources of supplies, or the
expropriation or nationalization of private enterprises. Although the PRC
government has been pursuing economic reform policies for several decades, there
can be no assurance that the government will continue to pursue such policies or
that such policies may not be significantly altered, especially in the event of
a change in leadership, social or political disruption, or other circumstances
affecting the political, economic and social situation of the PRC.
The
laws and regulations of the PRC that govern our current business operations are
sometimes vague and uncertain. Any changes in such PRC laws and regulations may
harm our business.
The PRC laws and regulations governing
our current business operations are sometimes vague and uncertain. There are
substantial uncertainties regarding the interpretation and application of PRC
laws and regulations, including the laws and regulations governing our business,
or the enforcement and performance of our arrangements with customers in the
event of the imposition of statutory liens, death, bankruptcy and criminal
proceedings. We and any future subsidiaries are considered foreign persons or
foreign funded enterprises under PRC laws, and as a result, we are required to
comply with certain PRC laws and regulations. These laws and regulations are
sometimes vague and may be subject to future changes, and their official
interpretation and enforcement involves substantial uncertainty. New laws
and regulations that affect existing and proposed future businesses may also be
applied retroactively. We cannot predict what effect the interpretation of
existing or new PRC laws or regulations may have on our businesses.
In March 2008, the National People’s
Congress of the PRC and other legislative entities began the initiative to draft
a series of policies to broaden the healthcare coverage for the population in
the rural regions. Although the details of the reform are still unclear, it is
certain that the reform will result in increased healthcare spending for the
rural population and low income families. Although the government has not
enacted any detailed policy regarding this issue, we expect that government will
provide medical insurance subsidies to rural areas and low income
families.
As a result of this healthcare reform,
government may either subsidize hospitals or healthcare institutions in rural
areas, or subsidize drug manufacturers or distributors if they can distribute
their products to rural areas with fixed profit margins. Our management cannot
guarantee that these new policies will benefit the company or help to increase
company’s revenues.
We
could be affected by recent and continuing events affecting the drug industry in
the PRC.
In July 2007, representatives of the
PRC’s leading food and drug regulatory bodies held a joint news conference to
emphasize their determination to crack down on the production and export of fake
and counterfeit food and medicine in the PRC. During the preceding several
months, the PRC’s food, drug, chemical and other industries were the subject of
many stories in the international press regarding the export of dangerous and
uncertified products from the PRC, including industrial chemicals found in pet
food in the U.S., a toxic chemical substituted for glycerin in cold medicine
sold in Panama, and lead paint found in toys made in the PRC and sold
in the U.S and Europe.
Also in
July 2007, the PRC government executed the former head of the SFDA for accepting
bribes and failing to police the marketplace. The new administrators of SFDA
have emphasized the need to impose stricter controls on pharmaceutical
manufacturing and food processing in order to regain public confidence in
PRC-made food and medicines. While we cannot know what further steps the
government will take to police the pharmaceutical market in the PRC, those steps
could include harsher sanctions for smaller violations of law, regulation, or
policy, reductions in the opportunities available to companies to defend
themselves against accusations of violations, forced closure of companies, and
broad changes to the regulatory system in which companies in the industry
operate. Any such steps could have a significant impact on our profitability or
our ability to continue operations, which impact cannot currently be predicted
or quantified.
The
pharmaceutical distribution industry consolidation may impact our profitability
and operations.
The pharmaceutical distribution
industry in the PRC is highly fragmented and lacks regulatory
oversight. The government has become more aware of the issue and started to
tighten its regulatory supervision over the pharmaceutical distribution
industry.
18
As the industry consolidates, we need
to distinguish ourselves with better products and services. We intend to achieve
this goal by focusing on distributing higher quality pharmaceutical products
with better efficacies and greater market demand. In addition, we need to
increase our efficiencies in product distribution. We cannot guarantee that we
will be able to meet this goal. However, the, successful implementation of this
strategy will provide upside potential to our profitability.
Our
subsidiaries are subject to restrictions on paying dividends and making other
payments to us.
We are a holding company incorporated
in the State of Nevada and we do not have any assets or conduct any business
operations other than our investments in our subsidiaries. As a result of our
holding company structure, we rely primarily on dividends payments from
Konzern and our other subsidiaries in the PRC. However,
PRC regulations currently permit payment of dividends only out of accumulated
profits, as determined in accordance with PRC accounting standards and
regulations. Our subsidiaries are also required to set aside a portion of its
after-tax profits according to PRC accounting standards and regulations to fund
certain reserve funds. The PRC government also imposes controls on the
conversion of RMB into foreign currencies and the remittance of currencies out
of PRC. We may experience difficulties in completing the administrative
procedures necessary to obtain and remit foreign currency. Furthermore, if any
of our subsidiaries incurs debt on its own in the future, the instruments
governing the debt may restrict its ability to pay dividends or make other
payments. If we or our subsidiaries are unable to receive all of the
revenues from our operations through these contractual or dividend arrangements,
we may be unable to pay dividends on our common stock.
Governmental
control of currency conversion may affect the value of your
investment.
The PRC government imposes controls on
the convertibility of Renminbi into foreign currencies and, in certain cases,
the remittance of currency out of the PRC. We receive substantially all of our
revenues in Renminbi, which is currently not a freely convertible currency.
Shortages in the availability of foreign currency may restrict our ability to
remit sufficient foreign currency to pay dividends, or otherwise satisfy foreign
currency dominated obligations. Under existing PRC foreign exchange regulations,
payments of current account items, including profit distributions, interest
payments and expenditures from the transaction, can be made in foreign
currencies without prior approval from the PRC State Administration of Foreign
Exchange by complying with certain procedural requirements. However, approval
from appropriate governmental authorities is required where Renminbi is to be
converted into foreign currency and remitted out of the PRC to pay
capital expenses such as the repayment of bank loans denominated in foreign
currencies.
The PRC government may also in the
future restrict access to foreign currencies for current account transactions.
If the foreign exchange control system prevents us from obtaining sufficient
foreign currency to satisfy our currency demands, we may not be able to pay
certain of our expenses as they come due.
The
fluctuation of the Renminbi may harm your investment.
The value of the Renminbi against the
U.S. dollar and other currencies may fluctuate and is affected by, among other
things, changes in the PRC's political and economic conditions. As we rely
entirely on revenues earned in the PRC, any significant revaluation of the
Renminbi may materially and adversely affect our cash flows, revenues and
financial condition. For example, to the extent that we need to convert U.S.
dollars we receive from an offering of our securities into Renminbi for our
operations, appreciation of the Renminbi against the U.S. dollar would diminish
the value of the proceeds of the offering and thereby diminish the usefulness of
the offering to us. Conversely, if we decide to convert our Renminbi into U.S.
dollars for the purpose of making payments for dividends on our common shares or
for other business purposes and the U.S. dollar appreciates against the
Renminbi, the U.S. dollar equivalent of the Renminbi we convert would be
reduced. In addition, the depreciation of significant U.S. dollar denominated
assets could result in a charge to our income statement and a reduction in the
value of these assets.
19
PRC
regulations regarding offshore financing activities by PRC residents may
increase our administrative burdens and hinder the implementation of our
acquisition strategy, and a failure by our shareholders who are PRC residents to
make filings required by such regulations could make us ineligible to distribute
profits and could expose us and our PRC-resident shareholders to liability under
PRC law.
The PRC’s State Administration of
Foreign Exchange (“SAFE”) issued a public notice in October 2005
requiring PRC residents to register with the local SAFE branch before
establishing or controlling any company outside of the PRC for the
purpose of capital financing with assets or equities of PRC companies, referred
to in the notice as an “offshore special purpose vehicle.” PRC residents that
are shareholders and/or beneficial owners of offshore special purpose companies
established before November 1, 2005 are required to register with the local
SAFE branch. In addition, any PRC resident that is a shareholder of
an offshore special purpose vehicle is required to amend its SAFE registration
with respect to that offshore special purpose company in connection with any
increase or decrease of capital, transfer of shares, merger, division, equity
investment or creation of any security interest over any assets located
in the PRC or other material changes in share capital. In May 2007,
SAFE issued relevant guidance to its local branches with respect to the
operational process for SAFE registration, which standardized more specific
and stringent supervision on the registration relating to the SAFE
notice. We have requested our current shareholders and/or beneficial
owners to disclose whether they or their shareholders or beneficial owners fall
within the ambit of the SAFE notice and urge those who are PRC residents to
register with the local SAFE branch as required under the SAFE
notice. As of the date of this report, our three PRC shareholders are
endeavoring to obtain proper SAFE registration despite of the inconsistent
interpretation raised by local SAFE bureau. However, the failure of these
shareholders to have their SAFE registrations pursuant to the SAFE notice may
subject such shareholders, and/or our PRC subsidiaries to fines and legal
sanctions and may also limit our ability to contribute additional capital into
our PRC subsidiaries, limit our PRC subsidiaries’ ability to distribute
dividends to our company or otherwise adversely affect our
business.
A
slowdown or other adverse developments in the PRC economy may harm our
customers, demand for our services and our business.
As of December 31, 2009, most of our
operations were conducted in the PRC and substantially all of our revenues were
generated from sales in the PRC. Although the PRC economy has grown
significantly in recent years, we cannot assure you that this growth will
continue. We do not know how sensitive we are to a slowdown in economic growth
or other adverse changes in the PRC economy. A slowdown in overall economic
growth, an economic downturn, a recession or other adverse economic developments
in the PRC could significantly reduce the demand for our products and harm our
business.
Because
our principal assets are located outside of the United States and nearly all of
our directors and officers reside outside of the United States, it may be
difficult for you to enforce your rights based on U.S. federal securities laws
against us and our officers and some directors in the U.S. or to enforce a
U.S. court judgment against us or them in the PRC.
Four of our six directors and all of
our officers reside outside of the United States. In addition, our operating
subsidiaries are and substantially all of our assets are located in the PRC. It
may therefore be difficult for investors in the United States to enforce their
legal rights based on the civil liability provisions of the U.S. Federal
securities laws against us in the courts of either the U.S. or the PRC and, even
if civil judgments are obtained in U.S. courts, to enforce such judgments in PRC
courts. Further, it is unclear if extradition treaties now in effect between the
United States and the PRC would permit effective enforcement against us or our
officers and directors of criminal penalties, under the U.S. Federal securities
laws or otherwise.
If
we are not able to protect our intellectual property rights, our business may be
impaired.
We have developed proprietary products,
which are based on technology and know-how developed by us, either by ourselves
or pursuant to agreements with others. The protection of intellectual property
in the PRC remains weak, and we cannot give any assurance that we will be able
to protect our intellectual property rights effectively. All of our products are
manufactured by others. Manufacturers and competitors could potentially copy or
simulate our technologies if their inherent complexity does not make such
copying unlikely. If we are not able to protect our intellectual property
rights, the value of our intellectual property, and our ability to generate
revenue from it, would be severely impaired.
20
Price
controls may affect both our revenues and net income.
The laws of the PRC provide for the
government to fix and adjust prices. To the extent that we are
subject to price control, our revenue, gross profit, gross margin and net income
will be affected since the revenue we derive from our sales will be limited and
we may face no limitation on our costs. Further, if price controls affect both
our revenue and our costs, our ability to be profitable and the extent of our
profitability will be effectively subject to determination by the applicable
regulatory authorities in the PRC.
Because
we may not be able to obtain business insurance in the PRC, we may not be
protected from risks that are customarily covered by insurance in the United
States.
Business insurance is not readily
available in the PRC, especially for intangible assets such as intellectual
property. To the extent that we suffer a loss of a type which would normally be
covered by insurance in the United States, such as product liability and general
liability insurance, we would incur significant expenses in both defending any
action and in paying any claims that result from a settlement or judgment. Since
our products are taken as medicine, any damages which we sustain could be
material to our assets and earnings. If the nature or amount of any uninsured
loss is significant, we may be unable to continue in business.
Because
our funds are held in banks which do not provide insurance, the failure of any
bank in which we deposit our funds could affect our ability to continue in
business.
Banks and other financial institutions
in the PRC do not provide insurance for funds held on deposit. As a result, in
the event of a bank failure, we may not have access to funds on deposit.
Depending upon the amount of money we maintain in a bank that fails, our
inability to have access to our cash could impair our operations, and, if we are
not able to access funds to pay our suppliers, employees and other creditors, we
may be unable to continue in business.
Failure
to comply with the United States Foreign Corrupt Practices Act could subject us
to penalties and other adverse consequences.
We are subject to the United States
Foreign Corrupt Practices Act, which generally prohibits United States companies
from engaging in bribery or other prohibited payments to foreign officials for
the purpose of obtaining or retaining business. Foreign companies, including
some that may compete with us, are not subject to these prohibitions.
Corruption, extortion, bribery, pay-offs, theft and other fraudulent practices
occur from time-to-time in the PRC. We can make no assurance, however, that our
employees or other agents will not engage in such conduct for which we might be
held responsible. If our employees or other agents are found to have engaged in
such practices, we could suffer severe penalties and other consequences that may
have a material adverse effect on our business, financial condition and results
of operations.
Any
recurrence of a widespread public health problem, such as bird flu, could
adversely affect our business.
Any widespread public health problem,
including bird flu, in the PRC, where a substantial proportion of our revenues
are derived, could have a negative effect on both our revenues and our
operations. Our operations may be impacted by a number of
health-related factors, including the following:
·
|
quarantines
or closures of some of our offices which would severely disrupt our
operations,
|
·
|
the
sickness or death of our key officers and employees,
and
|
·
|
a
general slowdown in the economy of the
PRC.
|
21
Any of
the foregoing events or other unforeseen consequences of public health problems
could adversely affect our business and results of operations.
Risks
Associated with Our Common Stock
There
is a limited trading market for our common stock.
While, our common stock is currently
listed on the FINRA Over-the-Counter Bulletin Board ("OTCBB"), there is
currently a very limited trading market for our common stock. The Financial
Industry Regulatory Authority has enacted changes that limit quotations on the
OTCBB to securities of issuers that are current in their reports filed with the
Securities and Exchange Commission. The effect on the OTCBB of these rule
changes and other proposed changes cannot be determined at this time. The OTCBB
is an inter-dealer, over-the-counter market that provides significantly less
liquidity than the NASDAQ market (the "NASDAQ Market"). Quotes for stocks
included on the OTCBB are not listed in the financial sections of newspapers as
are those for the NASDAQ Market. Therefore, prices for securities traded solely
on the OTCBB may be difficult to obtain and holders of common stock may be
unable to resell their securities at or near their original offering price or at
any price.
Although
we have submitted an application to have our common stock listed on the NASDAQ
Market, there is no guarantee that such submission will result in the ultimate
approval. We cannot assure you there will ever be a broader market for our
common stock or that if such a market develops, that it will continue. Our stock
price may fluctuate dramatically in the future in response to any of the
following factors, some of which are beyond our control:
·
|
variations in our quarterly
operating results;
|
·
|
announcements that our revenue or
income are below analysts'
expectations;
|
·
|
general economic
slowdowns;
|
·
|
matters affecting the economy of
the PRC and the relationship between the United States and the
PRC;
|
·
|
changes in market valuations of
both similar companies and companies whose business is primarily or
exclusively in the PRC;
|
·
|
sales of large blocks of our
common stock; and
|
·
|
announcements by us or our
competitors of significant contracts, acquisitions, strategic
partnerships, joint ventures or capital
commitments.
|
The
rights of the holders of common stock may be impaired by the potential issuance
of preferred stock.
Our certificate of incorporation gives
our board of directors the right to create new series of preferred stock. As a
result, the board of directors has and in the future may, without stockholder
approval, issue preferred stock with voting, dividend, conversion, liquidation
or other rights which could adversely affect the voting power and equity
interest of the holders of common stock. Preferred stock, which could be issued
with the right to more than one vote per share, could be utilized as a method of
discouraging, delaying or preventing a change of control. The possible impact of
such preferred stock on takeover attempts could adversely affect the price of
our common stock. Although we have no present intention to issue any additional
shares of preferred stock or to create any new series of preferred stock, we may
issue such shares in the future.
23
Investors could
lose confidence in our financial reports, and our business and stock price may
be adversely affected, because our internal control over financial reporting is
not adequate or if we disclose significant existing or potential deficiencies or
material weaknesses in those controls.
Section 404 of the Sarbanes-Oxley Act
of 2002 requires us to include a report on our internal control over financial
reporting in our Annual Report on Form 10-K. That report includes
management’s assessment of the effectiveness of our internal control over
financial reporting as of the end the fiscal year. Additionally, beginning with
our Annual Report on Form 10-k for the year ending December 31, 2010 our
independent registered public accounting firm will be required to issue a report
on their evaluation of the operating effectiveness of our internal control over
financial reporting.
We continue to evaluate our existing
internal controls against the standards adopted by the Public Company Accounting
Oversight Board, or PCAOB. During the course of our ongoing
evaluation of our internal controls for the year ended December 31, 2009, we
have identified, and may in the future continue to identify, material weaknesses
and areas requiring improvement, and may have to design enhanced processes and
controls to address issues identified through this review. Remedying
any significant deficiencies or material weaknesses that we or our independent
registered public accounting firm may identify could require us to incur
significant costs and expend significant time and management resources. We
cannot assure you that any of the measures we may implement to remedy any such
deficiencies will effectively mitigate or remedy such deficiencies. Further, if
we are not able to complete the assessment under Section 404 in a timely manner
or to remedy any identified material weaknesses, we and when applicable, our
independent registered public accounting firm would be unable to conclude that
our internal control over financial reporting is effective at the required
reporting deadlines. If our internal control over financial reporting is found
by management or by our independent registered public accountant to not be
adequate or if we disclose significant existing or potential deficiencies or
material weaknesses in those controls, investors could lose confidence in our
financial reports, we could be subject to sanctions or investigations by the
Securities and Exchange Commission or other regulatory authorities and our stock
price could be adversely affected.
A determination that there is a
significant deficiency or material weakness in the effectiveness of our internal
control over financial reporting could also reduce our ability to obtain
financing or could increase the cost of any financing we obtain and require
additional expenditures to comply with applicable requirements.
We
do not foresee paying cash dividends in the foreseeable future and, as a result,
our investors' sole source of gain, if any, will depend on capital appreciation,
if any.
We do not plan to declare or pay any
cash dividends on our shares of common stock in the foreseeable future and we
currently intend to retain any earnings to finance the growth of our business.
As a result, investors should not rely on an investment in our securities if
they require the investment to produce dividend income. Capital appreciation, if
any, of our shares may be investors' sole source of gain for the foreseeable
future. Moreover, investors may not be able to resell their shares of our common
stock at or above the price they paid for them.
Because
the holders of our warrants have cashless exercise rights, we may not receive
proceeds from the exercise of the outstanding warrants if the underlying shares
are not registered.
The holders of our warrants have
cashless exercise rights, which provide them with the ability to receive common
stock with a value equal to the appreciation in the stock price over the
exercise price of the warrants being exercised. This right with
respect to the Series A and Series B warrants was not exercisable during the
first twelve months that the warrants were outstanding and thereafter if the
underlying shares are subject to an effective registration statement. To the
extent that the holders of the warrants exercise this right, we will not receive
proceeds from such exercise.
24
After
our financing, our new principal stockholder will have substantial control over
us.
Upon the consummation of the January
2010 private placement, the investor in the private placement now owns
approximately 54 % of the total issued and outstanding shares of common stock on
a fully diluted basis. As a consequence, the investor will be able to
exert a significant degree of influence or actual control over our management
and affairs and will control matters requiring stockholder approval, including
the election of directors, a merger, consolidation or sale of all or
substantially all of our assets, and any other significant
transaction. Specifically, pursuant to the Subscription Agreement, the
investor has the right to nominate one non-independent director and four
independent directors, reasonably acceptable to Senshan Yang. The interests of
this stockholder may not always coincide with your interests or the interests of
our other stockholders. For instance, this concentration of ownership
may have the effect of delaying or preventing a change in control of the Company
otherwise favored by our other stockholders.
The
Redeemable Convertible Preferred Stock issued to the investor in our2010 private
placement is subject to redemption upon the occurrence of certain events
including events which may have material adverse effect on our business or
operations.
At the
closing of our 2010 private placement, we deposited $57,600,000 in an escrow
account for a period of up to twenty-eight months until disbursed to us in
accordance with the instructions of our board of directors and/or the joint
instructions of our board of directors and the investor. Upon the
occurrence of certain events, including events which may have a material adverse
effect on our business or operations, the failure by certain of our shareholders
(who are also members of our senior management) to obtain certain regulatory
confirmations, or our failure to identify suitable uses for the proceeds of the
private placement, the investor has the right to require us to redeem the
Redeemable Convertible Preferred Stock. In the event the investor
submits all or any of its Redeemable Convertible Preferred Stock to us for
redemption, the funds deposited with the escrow agent at the closing will be
used to fund the redemption amount, which will consequently result in the
aggregate amount of the escrowed proceeds being proportionately
reduced. Additionally, in the event of such a redemption our
liquidity may be adversely affected and the market value of our common stock may
decline.
ITEM
1B. UNRESOLVED STAFF COMMENTS
Not
applicable.
ITEM 2. PROPERTIES
Konzern
renewed its lease of approximately 418 square meters of office space at Room 702
Guangri Mansion No. 9, South Wuyang Xin Chengsi, Guangzhou, PRC from
Guangzhou Carpentry Company, the new lease will be expire on April 30,
2011, and the rent is approximately $22,964 annually.
Konzern
renewed the lease of approximately 338 square meters for Room 701 Guangri
Mansion No. 9, South Wuyang Xin Chengsi, Guangzhou, China from Guangzhou
Carpentry Company. The lease will expire on April 30, 2011, and
the rent is approximately $28,400 annually.
Konzern
leased a new office in the 2nd floor
Guangri Mansion No. 9, South Wuyang Xin Chengsi, Guangzhou, China, which will be
in effect from March 1, 2009 to Feburary 28, 2012 for the total rent of
approximately $156,324.
Konzern
renewed its one-year lease of approximately 700 square meters of warehouse space
at 67 Shahe Road, Tianhe District, Guangzhou City, for which we pay annual rent
of approximately $30,807.
Co-Win
leased Room 901 Guangri Mansion No. 9, South Wuyang Xin Chengsi, Guangzhou,
China from Guangzhou Carpentry Company for thirty-two months from August 1, 2008
to April 30, 2011. The total rent is approximately $77,458.
Co-Win
also leased an office space of approximately 30 square meters from January 1,
2009 to November 30, 2013 for a total of $6,751.
Co-Win
entered into a lease agreement with Guangzhou Municipal Microbe Research
Institute (the “Research Institute”), pursuant to which Co-Win has an entire
floor in a industrial building located at No.1 Jiantashan Road, Luogang District
in Guangzhou with a total area of approximately 800 square meters for the term
of five years from December 1, 2008 to November 30, 2013 for no consideration as
part of an arrangement relating to cooperation between the parties in
development of rADTZ. This cooperation is carried out pursuant to a technology
development entrustment agreement described in more detail under Item 1
“Business”.
After the
acquisition of LifeTech, its properties and land-use rights in Conghua,
Guangzhou we have realized our objective of being a manufacturer. According to
the land record, LifeTech holds the land-use rights for 68,339 square meters and
for property of 20,830.52 square meters, including 19 buildings for
manufacturing and offices, seven buildings for apartments and the mass hall of
the workers.
We
believe that our facilities are adequate for the conduct of our business for the
foreseeable future.
ITEM 3. LEGAL PROCEEDINGS
Neither
the Company nor any of its subsidiaries is currently a party to any pending or
threatened legal proceeding and we are not aware of any pending legal proceeding
to which any of our officers, directors, or any beneficial holders of 5% or more
of our voting securities are adverse to us or have a material interest adverse
to us.
25
ITEM 4. [REMOVED AND
RESERVED]
PART II
ITEM 5. MARKET FOR REGISTRANT’S COMMON
EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY
SECURITIES
Market
for Our Common Stock
There is a limited market for our
common stock. Our common stock is traded on the over-the-counter
market and quotations are reported on the Over-the-Counter Bulletin Board
overseen by FINRA under the symbol CHME. The table below sets forth the high and
low bid price for each quarter during the past two years, as reported by the
Yahoo Finance website at http://finance.yahoo.com/q?s=CHME.OB.
These
quotations reflect inter-dealer prices, without retail mark-up, mark-down or
commission and may not represent actual transactions.
High
|
Low
|
|||||||
Fourth
Quarter 2009
|
$
|
4.37
|
$
|
1.70
|
||||
Third
Quarter 2009
|
$
|
2.49
|
$
|
1.56
|
||||
Second
Quarter 2009
|
$
|
2.16
|
$
|
1.10
|
||||
First
Quarter 2009
|
$
|
1.27
|
$
|
0.57
|
||||
Fourth
Quarter 2008
|
$
|
1.70
|
$
|
0.66
|
||||
Third
Quarter 2008
|
$
|
2.65
|
$
|
1.55
|
||||
Second
Quarter 2008
|
$
|
3.05
|
$
|
1.81
|
||||
First
Quarter 2008
|
$
|
2.90
|
$
|
1.55
|
As of March 26, 2010, there are
approximately 40 holders of record of our common stock.
Dividends
We did not pay any dividends on our
common stock during the years ended December 31, 2009 and 2008. We
plan to retain future earnings, if any, for use in our business, and do not
anticipate paying dividends on our common stock in the foreseeable
future.
PRC regulations currently permit
payment of dividends only out of accumulated profits, if any, as determined in
accordance with PRC accounting standards and regulations. Konzern,
LifeTech, Co-win and our other PRC subsidiaries are also required to set aside a
portion of their after-tax profits according to PRC accounting standards
and regulations to fund certain reserve funds.
Securities
Authorized for Issuance under Equity Compensation Plan
The following table summarizes the
equity compensation plans under which our securities may be issued as of the
date of this report.
Plan Category
|
Number of
securities to be
issued upon
exercise of
outstanding
options,
warrants and
rights
|
|
Weighted-
average exercise
price of
outstanding
options, warrants
and rights
|
|
Number of
securities remaining
available for future
issuance under
equity
compensation plans
(excluding
securities reflected
in column (a))
|
||
Equity
compensation
plans
approved by security
holders
|
355,000
|
$ |
1.39
|
610,000
|
|||
Equity
compensation plan not approved by security holders
|
—
|
—
|
—
|
||||
Total
|
355,000
|
610,000
|
26
A 2006
long-term incentive plan and the outstanding options were approved by our board
of directors and stockholders.
Recent
Sales of Unregistered Securities
On May 27, 2009, we granted 70,000
Series C warrants with an exercise price of $0.85 to a third party in exchange
for investor relations services. This transaction was exempt from
registration pursuant to Section 4(2) of the Securities Act.
In September 2009, we issued 53,397
shares of common stock to Steve Mazur upon the cashless exercise of 179,474
Class A warrants. This transaction was exempt from registration pursuant to
Section 3(a)(9) of the Securities Act.
On December 15, 2009, we issued 130,966
shares of common stock to Ray and Amy Rivers, as joint tenants with right of
survivorship, upon the cashless exercise of 179,474 Series A warrants and
126,474 Series B warrants. These transaction were exempt from
registration pursuant to Section 3(a)(9) of the Securities Act.
On January 13, 2010, we issued 225,001
shares of common stock to Barron Partners LP upon the cash exercise of 225,001
Class B warrants. This transaction was exempt from registration pursuant to
Section 3(a)(9) of the Securities Act.
On January 21, 2010, we issued 42,143
shares of common stock to William Denkin and 53,299 shares of common stock to
Steve Mazur upon the cashless exercise of 100,000 and 126,474 Series B warrants,
respectively. These transaction were exempt from registration pursuant to
Section 3(a)(9) of the Securities Act.
On January 15 and January 25, 2010, we
issued total 80,000 shares of common stock to JMG Triton Offshore Fund and JMG
Capital Partners upon the cash exercise of Class B warrants. This transaction
was exempt from registration pursuant to Section 3(a)(9) of the Securities
Act.
On January 25, 2010, we issued 390,737
shares of common stock to Barron Partners LP upon the cashless exercise of
800,000 Class B warrants. This transaction was exempt from registration pursuant
to Section 3(a)(9) of the Securities Act.
On January 29, 2010, we issued
4,000,000 shares of common stock and 1,920,000 shares of redeemable convertible
preferred stock to OEP CHME Holdings, LLC pursuant to the Subscription
Agreement. This transaction was exempt from registration pursuant to Section
4(2) of the Securities Act.
On March
13, 2010, we issued 53,380 shares of common stock to CCG Investor Relations upon
the cashless exercise of 70,000 Class C warrants. This transaction was exempt
from registration pursuant to Section 3(a)(9) of the Securities
Act.
On March
12 and March 18, 2010, we issued an aggregate 109,000 shares of common stock to
JMG Triton Offshore Fund and JMG Capital Partners upon the cash exercise of
Class B warrants. These transactions were exempt from registration pursuant to
Section 3(a)(9) of the Securities Act.
On March
18, 2010, we issued 26,474 shares of common stock to Mr. William M.
Denkin upon the cash exercise of Class B warrants. This transaction
was exempt from registration pursuant to Section 3(a)(9) of the Securities
Act.
27
Transfer
Agent
The Company's stock transfer agent is
Continental Stock Transfer & Trust Company, located at 17 Battery Place, New
York, New York 10004. Their telephone number is 212-509-4000, and their
facsimile is 212-509-5150.
ITEM
6. SELECTED FINANCIAL DATA
Not Applicable.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
The following discussion and analysis
of our financial condition and results of operations should be read in
conjunction with the financial statements and accompanying notes and the other
financial information appearing in Part I, Item 1 and elsewhere in this
report.
This discussion also contains
forward-looking statements reflecting our current expectations for the
Company. These statements are subject to the risks and uncertainties
described in the “Risk Factors” and “Predictive Statements and Associated Risk”
sections of this report.
Overview
China Medicine Corporation (“we,” “us”
or the “Company”), operating through Guangzhou Konzern Medicine Co., Ltd.
(“Konzern”), our wholly owned subsidiary organized under the laws of the
People’s Republic of China (the “PRC” or “China”), is a distributor of
approximately 2,100 pharmaceutical products in China. Through
Guangzhou LifeTech Pharmaceutical Co., Ltd (“LifeTech”), a wholly owned
subsidiary of Konzern under the laws of PRC the Company is also a manufacturer
of Traditional Chinese Medicines and dry powder for injection in
China. Through Guangzhou Co-win Bioengineering Co., Ltd., another
subsidiary organized under the laws of PRC in which Konzern owns 70% of the
equity, the Company is a developer and manufacturer of Aflatoxin Detoxifizyme
(“rADTZ”).
Also as a developer and manufacturer of
innovative pharmaceutical products, currently the Company has fourteen patents
registered with the State Food and Drug Administration of PRC (“SFDA”), and has
eleven others pending for approval, and the Company has five patents registered
and eleven others pending for approval overseas.
Most of our revenues have been derived
from three sources, the resale of pharmaceutical products purchased from
suppliers (“distributed products”), manufacture, distribution and sale of
products (including Bumetanide injection, Ozagrel Dried powder injection,
Levocarnitine dried powder injection) of the Company’s own products under its
own brand names (“owned products”) and research and development of new or
improved drug formulas and production techniques, some of which are licensed to
other in exchange for royalties. In particular, for the year ended
December 31, 2009, the revenue from sales of owned products amounted to
$3,600,114, an increase of $710,808 from $2,889,306 for 2008.
The pharmaceutical products we
distribute, include prescription and over-the-counter drugs, Chinese herbs,
Traditional Chinese Medicines made from Chinese herbs, nutritional supplements,
dietary supplements and medical instruments.
Although we are competing with large
state-owned medicine distributors that are better capitalized than we are, we
believe that our competitive advantages include our ownership of good research
and development facilities, our excellent after-sale customer service, and our
exclusive rights for the nationwide or region-wide distribution of certain
medical products. Our competitive pricing and our ability to provide timely
delivery are also important factors to attract and retain our
customers.
In 2009, we acquired LifeTech and its
manufacturing capacity which has enabled us to manufacture products
ourselves. We expect that this capability should substantially
increase our gross margin on certain products by reducing the cost of
supplies.
28
The Chinese government has recently
begun an initiative to draft a series of policies to broaden the healthcare
coverage for residents in rural regions. Although the details of the
reform are still unclear, it is expected that the reforms will result in
increased healthcare spending by the rural residents and low income
families.
The government may either subsidize
hospitals or healthcare institutions in rural areas, or subsidize medicine
manufacturers or distributors that distribute their products to rural
areas. At the same time, increase in the disposable income in these
areas, and the aging of the rural population, will increase the demand for
healthcare products in the years to come. In 2009, Konzern expanded
its marketing and promotion in the rural areas to take advantage of the policy
reforms, and we expect these expenditures to increase revenues in the new fiscal
year. With the acquisition of LifeTech, the number of our owned products has
increased to more than forty; and we believe that at least half of our owned
products are particularly attractive to populations in rural areas.
Our distribution business depends
heavily on our ability both to obtain supplies of our products and to distribute
them in the Chinese market. Typically, we would expect that exclusive
distribution rights, either nationwide or in specific regions, would contribute
to higher profit margins than non-exclusive distribution rights. We
currently have exclusive rights to nationwide distribution of 46 products,
including 39 products manufactured by LifeTech, we have distribution rights
throughout Guangdong Province for 661 products obtained from our
suppliers.
The seven distributed products for
which we have exclusive national distribution rights accounted for approximately
22.7% of our sales in fiscal year 2009 and 29.4% of our sales in fiscal year
2008. The most significant of these products is Iopamidol Injection, a
prescription medicine that is used for angiography & CT scanning. For the
years ended December 31, 2009 and 2008, our total revenue from sales of this
product amounted to $8,899,226 and $6,119,551, respectively, which were 13.7%
and 11.4% of our annual sales for the years ended December 31, 2009 and 2008,
respectively.
Beginning in 2007, in an effort to help
consolidate the provincial medicine acquisition market and promote a transparent
bidding process, the provincial government of Guangdong Province established an
on-line bidding system called the “Guangdong Sunshine Medicine Public Internet
Bidding System,” referred to herein as the Bidding System. We believe
the new Bidding System provides us with greater opportunities to compete for
distribution rights in Guangdong Province. Prior to the institution
of the Bidding System, it was difficult for the non-state-owned medicine
companies to do business with hospitals, which generally were owned by the
state.
During 2009, we had an important
breakthrough in regional exclusive distribution. Prior to 2007, we
did not have any exclusive regional sales rights with our suppliers. In part due
to the Bidding System mentioned above, we successfully obtained exclusive
regional sales rights for 661 products in 2009, an increase of 144, from 516
products in 2008.
Revenue
from sales generated from exclusive regional rights obtained through the Bidding
System is significant, amounting to $16,715,099 or 25.8% of our total revenue
during the year ended December 31, 2009, and $17,466,987 or 32.6% of our total
revenue during the year ended December 31, 2008.
In accordance with the Bidding System’s
policy, we retain possession of the aforesaid distribution rights through 2010.
We expect that increased sales pursuant to these rights will become an important
driver of our growth in 2010.
During the fiscal year 2009, our
reliance on certain suppliers has increased. Our five largest suppliers
accounted for 54.5% of our total purchases for the year ended December 31, 2009,
compared to 47.2% for the year ended December 31, 2008.
In addition, it generally takes one to
two months to receive products from our suppliers after we place an order. In
some cases, we must maintain funds on deposit with a supplier. These factors
require us to use significant cash in our operations. We are
frequently required to make significant down payments when we place orders, in
order to secure the lowest possible purchase price and the broadest possible
distribution area. These down payments are made pursuant to contracts with the
suppliers, and to the extent that our sales exceed the contract amount, we will
receive a credit from the supplier. As of December 31, 2009, we had a total
balance of such advances to suppliers of $2,518,396.
29
During the fiscal year 2009, our five
largest customers accounted for 45.0% of total sales for the year ended December
31, 2009, compared to 37.9% for the corresponding period of 2008. Currently we
have approximately 800 customers, which was virtually the same as
2008.
Our customers are typically wholesale
medical product supply companies, hospitals and retail drug stores. Our
contracts with our customers do not provide for minimum purchases, and our
customers are not restricted from purchasing competitive products from
others. Our collection period ranges from three months to one
year.
Because a substantial portion of our
sales were made to a small number of customers, our accounts receivable from a
small number of customers represented a large percentage of our total accounts
receivable and assets. Our largest account receivable as of December 31, 2009,
was approximately $5,280,444, representing approximately 23.7% of our total
accounts receivable, 7.9% of our total assets, 8.2% of total sales and
approximately 33.3% of our working capital. Our three largest accounts
receivable totaled approximately $8,096,488, representing approximately 36.3 %
of our total accounts receivable, or approximately 12.1% of our total assets,
12.6% of our total sales and approximately 51.1% of our working capital. This
concentration of accounts receivable represents a credit risk, although the
credit risk has been alleviated to a certain extent by the
management.
In 2009, the revenue from sales of our
core distribution products, including Iopanmidol injection, Fengduoxin
Cefamandolenafate injection, Xue Shuan Tong and Hongjin Xiaojie Capsule,
contributed the majority of the gross margin. We continued to extend our
distribution network and product mix. LifeTech’s products should contribute
higher gross margin, and we expect to add at least one national product
distribution arrangement in the coming year. Meanwhile, we are in the
process of launching a series of our owned products such as BeThin Tablets, a
multivitamin pack and three types of herbal tea within the territory of China
and the US. In this regard, we will allocate more resources to the promotion of
owned products such as the multivitamin pack and three types of herbal tea in
2010.
To distinguish ourselves from peers, we
have been striving to build our reputation as a high-quality supplier that
provides excellent service. We have been aiming at distributing those
pharmaceutical products which are more effective, more consistent in quality,
and enjoy higher market demand.
Although the distribution of our
suppliers’ pharmaceutical products has been the major source of revenues,
amounting to 93.2% and 92.1% of our total revenues in 2009 and 2008
respectively, management is strongly committed to our long term strategy which
is to distribute our own pharmaceutical products manufactured by LifeTech, and
to engage in more research and development of intellectual property, including
drug formulas and production techniques.
With the acquisition of LifeTech, we
have diversified from being a pharmaceutical distributor to an enterprise with a
research and development force and manufacturing facilities. We also
expanded our sales channels and distribution network. Specifically, the
acquisition of LifeTech enhanced our product line with high margin
pharmaceuticals and improved our manufacturing capabilities for existing owned
products. In the next three to five years we expect an increasing portion of our
revenue will be from the sale of self-owned pharmaceuticals.
Because most of our business is
conducted in the PRC, our transactions are predominantly accounted for in
Chinese Renminbi (RMB). Our financial condition and the results of our
operations, expressed in terms of United States dollars (USD), is dependent upon
the applicable currency exchange rate, which can change significantly from
period to period and may be affected by the relationship between the United
States and the PRC. During fiscal 2007, US dollars depreciated versus the
Chinese Yuan, but the exchange rate of USD versus RMB was stable at 0.1467
during 2008 and 2009. As a result, we incurred a translation gain of $9,800,
which is recognized as other comprehensive income.
30
Results
of Operations
The
following table sets forth our statements of operations for the year ended
December 31, 2009 and 2008, in U.S. dollars:
|
Year Ended December 31,
|
|||||||
2009
|
2008
|
|||||||
Revenue
|
64,751,018 | 53,647,806 | ||||||
Product
sales
|
64,120,538 | 52,307,211 | ||||||
Medical
technology sales
|
630,480 | 1,340,595 | ||||||
Costs
of goods sold
|
45,766,628 | 38,074,919 | ||||||
Gross
profit
|
18,984,390 | 15,572,887 | ||||||
R&D
expenses
|
1,454,402 | 992,497 | ||||||
Selling,
general and administrative costs
|
5,263,697 | 3,652,525 | ||||||
Income
from operations
|
12,266,291 | 10,927,865 | ||||||
Other
income (expense), net
|
(82,077 | ) | 85,622 | |||||
Change
in fair value of warrant liabilities
|
(7,232,388 | ) | ||||||
Income
before income taxes & Noncontrolling interests
|
4,951,826 | 11,013,487 | ||||||
Provision
for income taxes
|
3,549,680 | 2,006,137 | ||||||
Income
before noncontrolling interests
|
1,402,146 | 9,007,350 | ||||||
Minority
interest
|
315,531 | 118,266 | ||||||
Net
income
|
1,717,677 | 9,125,616 | ||||||
Other
comprehensive income
|
||||||||
Foreign
currency translation adjustment
|
9, 800 | 2,305,499 | ||||||
Foreign
currency translation attributable to noncontrolling
interests
|
(194 | ) | 60,461 | |||||
Comprehensive
income
|
1,727,283 | 11,491,576 |
Our
revenue is derived primarily from the sale of prescription and over-the-counter
medicines, Chinese herbs, traditional Chinese medicines derived from Chinese
herbs, dietary supplements, and medical instruments (collectively “product
sales”) and the sale of medical technology (“medical technology sales”). The
following table sets forth the revenues and percentage of revenues derived from
each of these types of products.
Years Ended December 31,
|
||||||||||||||||
2009
|
2008
|
|||||||||||||||
Medicines
|
$ | 61,434,749 | 94.88 | % | $ | 50,924,777 | 94.92 | % | ||||||||
Dietary
Supplements
|
993,029 | 1.53 | % | 450,776 | 0.84 | % | ||||||||||
Medical
Equipment
|
1,224,385 | 1.89 | % | 878,904 | 1.64 | % | ||||||||||
Medical
Technology
|
630,480 | 0.97 | % | 1,340,595 | 2.50 | % | ||||||||||
Others
|
468,375 | 0.73 | % | 52,754 | 0.10 | % | ||||||||||
Total
|
$ | 64,751,018 | 100 | % | 53,647,806 | 100 | % |
31
|
Years Ended December 31,
|
|||||||||||||||
2009
|
2008
|
|||||||||||||||
Western
Prescription Products
|
$
|
33,204,453
|
51.28
|
%
|
$
|
31,775,939
|
59.23
|
%
|
||||||||
|
||||||||||||||||
Western
Over-the-Counter Products
|
5,742,006
|
8.87
|
%
|
3,153,503
|
5.88
|
%
|
||||||||||
TCM
Prescription Products
|
13,262,752
|
20.48
|
%
|
11,024,481
|
20.55
|
%
|
||||||||||
TCM
Over-the-Counter Products
|
9,225,538
|
14.25
|
%
|
4,970,854
|
9.27
|
%
|
||||||||||
Total
Medicines
|
$
|
61,434,749
|
94.88
|
%
|
$
|
50,924,777
|
94.92
|
%
|
Revenue
Total
revenue for the year ended December 31, 2009 was $64,751,018, an increase of
$11,103,212, or 20.7%, from total revenue of $53,647,806 for the year ended
December 31, 2008.
Revenue from product sales for the year
ended December 31, 2009 was $64,120,538, an increase of $11,813,327, or 22.6%,
from revenue of $52,307,211 for the year ended December 31, 2008.
Revenue from exclusive national
distribution of seven products as of December 31, 2009 decreased by $1,092,337
to $13,270,992 compared with $15,771,912 in 2008.
Revenue from products obtained through
the Bidding System as of December 31, 2009 was $16,715,099, representing 25.81%
of total revenue. In addition, an earlier Chinese New Year resulted in many
orders having been booked prior to December 31, 2009 which contributed to the
sales growth.
Sales of technology and know-how
relating to the production of medicines were $630,480 or 0.97% of total sales,
and $1,340,595 or 2.5% of total sales, for the years ended December 31, 2009 and
2008, respectively. We initially acquired the technology in an undeveloped state
from other companies, undertook research and development to make improvements to
the technology, and sold the improved technology to drug manufacturers. The
primary reason for the decrease in technology sales is that fewer new customers
have signed contracts to acquire technology sales in 2009. We believe this is
due to regulatory action by the State Food and Drug Administration (“SFDA”),
which must approve every transfer of ownership of technology in the PRC, and
which recently enhanced its approval procedures by setting higher application
criteria which requires more time for review.
Due to
the change in market demand and regulatory environment, technology sales have
decreased in the past two years. However, we expect that the international
transfer of rADTZ patent rights will be a considerable growth factor in the near
future and therefore will boost the revenue generated by technology
sales.
Cost
of revenue
Cost of revenue for the year ended
December 31, 2009 was $45,766,628, or 70.68% of total revenue, compared to
$38,074,919, or 70.97% of total revenue in 2008.
Gross
Profit and Gross Margin
Gross profit for the year ended
December 31, 2009 was $18,984,390, an increase of $3,411,503, or 21.91%, from
$15,572,887 for the year ended December 31, 2008. Our gross margin for the year
ended December 31, 2009 was 29.32%, as compared with 29.03% for the year ended
December 31, 2008.
32
Because we intend to enlarge the
percentage of LifeTech’s products in our product portfolio in the future, and
despite the fact that we expect sales volume in 2010 to remain relatively
stable, we do expect profit margins will improve.
Research
and Development Expenses
Research and development expenses were
$1,454,402 for the year ended December 31, 2009, compared with $992,497 for the
year ended December 31, 2008.
In the fourth quarter of 2008, we added approximately $2.5M of new fixed
assets for research purposes; related depreciation attributed to approximately
$430,000 of the difference in 2009. Under the regulations on new drug
registration, experimental data in some application materials must be performed
by the cooperative laboratory, which is located in Nanhua University of Hunan
province. As a result, additional experiments were required which
increased our research and development expense. Management is committed to
establishing a long term strategy in research and development subject to our
cash availability, the proportions of this expenditure to total revenues and net
income, as well as the potential contributions to our business.
Selling,
General and Administrative Expenses
Selling, general and administrative
expenses were $5,263,697 for the year ended December 31, 2009, an increase of
$1,611,172 from $3,652,525 for the year ended December 31, 2008. The increase
was mainly due to: (i) increased officer salaries, (ii) increased freight, and
(iii) an increase in professional consulting expenses on the acquisition and the
financing. More managers were recruited joining our team for expansion and
growth in 2009. Salaries increased from $302,828 in 2008 to $976,741
in 2009. Freight expenses for the year ended December 31, 2009 were
$706,211 from $491,213 for 2008.
Income
Taxes
Provision for income taxes was
$3,549,680 for the year ended December 31, 2009, compared with $2,006,137 for
the year ended December 31, 2008. The increase was due to the growth of sales
revenue and operating income, and the income tax rate change from 12.5% to 25%
based on the tax law of PRC.
Net
Income
Net income for the year ended December
31, 2009 was $1,717,677, a decrease of $7,407,939, or 81.18% from $9,125,616 for
the year ended December 31, 2008. The decrease was mainly due to the change in
the fair value of warrant liabilities, which did not occur in 2008.
We use
non-GAAP adjusted net earnings to measure the performance of our business
internally by excluding non-cash charges related to the warrants. We believe
that the non-GAAP adjusted financial measure allow us to focus on managing
business operating performance because the measure reflects our essential
operating activities and provides a consistent method of comparison to
historical periods. We believe that providing the non-GAAP measures that we use
internally to its investors is useful to investors for a number of reasons. The
non-GAAP measure provides a consistent basis for investors to understand our
financial performance in comparison to historical periods without variation of
non-recurring items and non-operating related charges. In addition,
it allows investors to evaluate our performance using the same methodology and
information as that used by our management. Non-GAAP measures are
subject to inherent limitations because they do not include all of the expenses
included under GAAP and because they involve the exercise of judgment of which
charges are excluded from the non-GAAP financial measure. However, we compensate
for these limitations by providing the relevant disclosure of the items
excluded.
The
following table provides a non-GAAP financial measure and a reconciliation of
that non-GAAP measure to the GAAP net income:
33
Year Ended
|
||||||||
|
|
December 31
|
|
|||||
2009
|
2008
|
|||||||
Net
Income (Loss)
|
$
|
1,717,677
|
$
|
9,125,616
|
||||
Add
back (Deduct):
|
||||||||
Change
in fair value of warrant
|
7,232,388
|
-
|
||||||
Adjusted
Net Income
|
$
|
8,950,065
|
$
|
9,125,616
|
||||
Diluted
EPS
|
$
|
0.11
|
$
|
0.60
|
||||
Add
back (Deduct):
|
||||||||
Change
in fair value of warrant
|
0.47
|
0.00
|
||||||
Adjusted
EPS
|
$
|
0.58
|
$
|
0.60
|
Excluding
this non-cash expense, adjusted net income of 2009 was approximately $9.0
million, or $0.58 per fully diluted share. Earnings per share were calculated
using a diluted weighted share count of 15.4 million shares for the end of 2009
and 15.3 million shares for the end of 2008.
Liquidity
and Capital Resources
As of
December 31, 2009, we had $2.2 million in cash and cash equivalents, which
included the restricted cash. We have historically funded our working capital
needs from operations, advance payments from customers, bank borrowings, and
capital from shareholders. Our working capital requirements are influenced by
the level of our operations, the numerical and dollar volume of our contracts,
the progress of our contract execution, and the timing of accounts receivable
collections.
On December 31, 2009, the Company
entered into a Stock Subscription Agreement for an equity private placement (the
"Subscription Agreement") with One Equity Partners ("OEP"), the global private
equity investment arm of JPMorgan Chase & Co.
Subject to certain closing conditions,
OEP agreed to purchase 4,000,000 of the Company's common shares at $3.00 per
share and 1,920,000 of the Company's redeemable convertible preferred shares at
$30 per share, for an aggregate purchase price of $69.6 million. Each redeemable
convertible preferred share is initially convertible into ten common
shares.
On January 29, 2010, the Company closed
the equity private placement contemplated in the Subscription Agreement. At such
time, $8,900,000 of net proceeds was deposited in our bank account and
$57,600,000 was placed in the escrow account. We expect to use the net proceeds
of the financing for capital expenditures relating to its recent acquisition of
LifeTech, for working capital purposes, and for future expansion and/or
acquisition projects subject to approval from OEP and the Company's board of
directors.
Operating
Activities
Net cash
provided by operating activities was $16,959,384 for the year ended December 31,
2009, an increase of $12,750,300 from net cash of $4,209,084 used in our
operations for the year ended December 31, 2008. The increase in net cash
provided by operating activities was largely due to the increase in operating
income because of the increased sales, and the decrease in inventories and
advances to suppliers.
Investing
Activities
Net cash used in investing activities
was $13,536,094 during the fiscal year ended December 31, 2009, an increase of
$5,672,827 or 72.1%, from net cash of $7,863,267 used in investing activities
during the fiscal year ended December 31, 2008. Net cash used in investing
activities consisted primarily of payments for the acquisition of rADTZ
equipment and the acquisition of LifeTech.
34
Financing
Activities
Net cash
used in financing activities was $5,749,289 during the fiscal year ended
December 31, 2009, a cash decrease of $6,111,789 from $362,500 provided by
financing activities during the fiscal year ended December 31,
2008. The increase in net cash used in financing activities was
largely due to: i) financing activities with the Bank of China and ii) repayment
of LifeTech’s bank loans in accordance with the acquisition terms. In
July 2009, we received a $2.9M loan from the Bank of China. We
subsequently repaid the full principal and re-borrowed $3.6M from the Bank of
China, which translated to a net impact on cash inflow of $0.6M. In
accordance with the acquisition terms, we also paid down approximately $7.3M of
LifeTech’s bank loans.
As of
December 31, 2009, we had working capital of $15,844,307, a decrease of
$16,733,362 or 51.4%, from $32,577,669 as of December 31, 2008.
The
following table sets forth the changes in certain balance sheet items, in U.S.
dollars and percentages, from December 31, 2008 to 2009.
Balance Sheet Caption
|
Change in US dollars
12/31/08 to 12/31/09
|
|
Percentage Change
12/31/08 to 12/31/09
|
|||
Accounts receivable
|
2,278,004
|
|
11.8
|
% | ||
Inventories
|
(3,369,333
|
) |
(71.3
|
)% | ||
Advances
to suppliers
|
(3,614,990
|
) |
(59.0
|
)% | ||
Accounts
payable
|
608,589
|
993.7
|
% | |||
Customer
deposits
|
331,850
|
219.1
|
% |
Because
the balance sheet on December 31, 2009 is consolidated and also includes
the figures attributable to LifeTech, the changes from December 31, 2008 to
December 31, 2009 appear very large.
The
change in these balance sheet captions reflects the nature of the cash
requirements of our business. Because it takes one to two months to receive
products we order, we have been decreasing our inventories to increase inventory
turnover. From December 31, 2008 to December 31, 2009, our
inventories decreased 71.3%.
In the
course of our business, we must make significant deposits to our suppliers when
we place an order. Our advances to suppliers decreased 59.0% from December 31,
2008 to December 31, 2009 because of a decrease in our arrangement of cash
control and our payment policies, whereby we try to pay our suppliers (other
than required down payments) once or twice a year. As of December 31, 2009, our
advance payments to our suppliers totaled approximately $2,518,396.
In
addition, our customer deposits increased 993.7% from December 31, 2008 to
December 31, 2009, which reflects that LifeTech’s cash advantage as a
manufacturer. We require our customers to pay a certain percentage of the sales
price as a deposit before we ship products to them, such as Konzern has to pay
deposits to other manufacturers.
During
2009, we purchased additional equipment to commercialize rADTZ for a total
purchase price of approximate $3.8 million.
We
believe that our available funds will provide us with sufficient capital for at
least the next twelve months; however, we may acquire one or two additional
production facilities to manufacture our own products. We believe that the
proceeds from our recent private placement should provide us with sufficient
capital to make acquisitions, establish additional production facilities and
operate the combined companies.
Critical
Accounting Policies and Estimates
Management's
discussion and analysis of its financial condition and results of operations are
based upon our consolidated financial statements, which have been prepared in
accordance with accounting principles generally accepted in the United States.
Our financial statements reflect the selection and application of accounting
policies which require management to make significant estimates and judgments.
See note 2 to our consolidated financial statements, "Summary of Significant
Accounting Policies." Management bases its estimates on historical experience
and on various other assumptions that are believed to be reasonable under the
circumstances. Actual results may differ from these estimates under different
assumptions or conditions. We believe that the following reflect the more
critical accounting policies that currently affect our financial condition and
results of operations.
35
Revenue
recognition
We
recognize revenue when all four of the following criteria are met: (1)
persuasive evidence has been received that an arrangement exists; (2) delivery
of the products and/or services has occurred; (3) the selling price is fixed or
determinable; and (4) collectibility is reasonably assured. We follow the
provisions of the SEC’s Staff Accounting Bulleting No. 104, which sets forth
guidelines for the timing of revenue recognition based upon factors such as
passage of title, installation, payments and customer acceptance. Any amounts
received prior to satisfying our revenue recognition criteria are recorded as
deferred revenue.
Sales
revenue represents the invoiced value of goods, net of a value-added tax (VAT).
All of the Company’s products, which are sold exclusively in the PRC, are
subject to a Chinese value-added tax at a rate of 13% to 17% of the gross sales
price. This VAT may be offset by VAT paid by the Company on raw materials and
other materials included in the cost of producing their finished
product.
Research
and development costs
Research
and development costs are expensed as incurred. To the extent that research and
development services are performed for us by third parties, these costs are
expensed when the services are performed by the third party. The costs of
material and equipment that are acquired or constructed for research and
development activities, and have alternative future uses, either in research and
development, marketing, or sales, are classified as property and equipment or
depreciated over their estimated useful lives.
Use
of estimates
The
preparation of financial statements in conformity with generally accepted
accounting principles of the United States of America requires management to
make estimates and assumptions that affect the amounts reported in the combined
financial statements and accompanying notes. Management believes that the
estimates utilized in preparing its financial statements are reasonable and
prudent. Actual results could differ from these estimates.
Inventories
We record
reserves against our inventory in our warehouse to provide for estimated
obsolete or unsalable inventory based on assumptions about future demand for our
products and market conditions. If future demand and market conditions are less
favorable than management's assumptions, additional reserve could be required.
Likewise, favorable future demand and market conditions could positively impact
future operating results if previously reserved inventory is sold.
ITEM
7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK
Not applicable.
36
ITEM 8. FINANCIAL STATEMENTS AND
SUPPLEMENTARY DATA
INDEX TO
CONSOLIDATED FINANCIAL STATEMENTS
Page
|
||
Report
of Independent Registered Public Accounting Firm
|
F-2
|
|
Consolidated
Balance Sheets at December 31, 2009 and 2008
|
F-3
|
|
Consolidated
Statements of Income and Other Comprehensive Income for the years ended
December 31, 2009 and 2008
|
F-4
|
|
Consolidated
Statement of Changes in Equity for the years ended December 31,
2009 and 2008
|
F-5
|
|
Consolidated
Statements of Cash Flows for the years ended December 31, 2009 and
2008
|
F-6
|
|
Notes
to Consolidated Financial Statements
|
F-7
|
F-1
REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the
Board of Directors and Stockholders of
China
Medicine Corporation
We have
audited the accompanying consolidated balance sheets of China Medicine
Corporation and subsidiaries as of December 31, 2009 and 2008, and the related
consolidated statements of income and other comprehensive income, changes in
equity, and cash flows for each of the years in the two-year period ended
December 31, 2009. China Medicine Corporation’s management is responsible for
these financial statements. Our responsibility is to express an opinion on these
financial statements based on our audits.
We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. The company is not required to
have, nor were we engaged to perform, an audit of its internal control over
financial reporting. Our audit included consideration of internal control over
financial reporting as a basis for designing audit procedures that are
appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of the company’s internal control over financial
reporting. Accordingly, we express no such opinion. An audit also includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements, assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our
opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the financial position of China Medicine Corporation
and subsidiaries as of December 31, 2009 and 2008, and the results of its
operations and its cash flows for each of the years in the two-year period ended
December 31, 2009 in conformity with accounting principles generally accepted in
the United States of America.
___
Frazer Frost, LLP (Successor Entity of Moore Stephens Wurth Frazer and Torbet,
LLP, see Form 8-K filed on January 7, 2010)
Brea,
California
March 28,
2010
135 South
State College Boulevard, Suite 300 | Brea, California 92821 | 714.990.1040 |
frazerfrost.com
Los
Angeles and Visalia, CA | Little Rock and Fayetteville, AR | Raleigh, NC
FRAZER FROST, LLP is an
independent firm associated with Moore Stephens International
Limited.
F-2
CHINA
MEDICINE CORPORATION AND SUBSIDIARIES
CONSOLIDATED
BALANCE SHEETS
December
31,
|
December
31,
|
|||||||
2009
|
2008
|
|||||||
ASSETS
|
||||||||
CURRENT
ASSETS
|
||||||||
Cash
|
$ | 471,769 | $ | 2,791,814 | ||||
Restricted
Cash
|
1,760,400 | - | ||||||
Notes
receivables
|
4,401 | 600,911 | ||||||
Accounts
receivable, trade, net of allowance for doubtful accounts of $157,083 and
$96,609 as of December 31, 2009 and 2008,
respectively
|
22,314,660 | 19,225,091 | ||||||
Inventories
|
2,731,097 | 4,725,322 | ||||||
Advances
to suppliers
|
2,518,396 | 6,121,974 | ||||||
Other
current assets
|
461,006 | 192,080 | ||||||
Total
current assets
|
30,261,729 | 33,657,192 | ||||||
Plant
and Equipment, Net
|
12,000,687 | 3,761,637 | ||||||
OTHER
ASSETS
|
||||||||
Long
term prepayments
|
7,900,212 | 6,014,920 | ||||||
Intangible
assets, net
|
16,681,854 | 1,247,567 | ||||||
Total
other assets
|
24,582,066 | 7,262,487 | ||||||
Total
assets
|
$ | 66,844,482 | $ | 44,681,316 | ||||
LIABILITIES AND SHAREHOLDERS'
EQUITY
|
||||||||
CURRENT
LIABILITIES
|
||||||||
Short
term Loans
|
$ | 9,506,160 | $ | - | ||||
Accounts
payable, trade
|
1,324,269 | 61,243 | ||||||
Other
payables and accrued liabilities
|
939,887 | 50,559 | ||||||
Customer
deposits
|
483,358 | 151,429 | ||||||
Taxes
payable
|
2,119,745 | 772,289 | ||||||
Liquidated
damages payable
|
44,003 | 44,003 | ||||||
Total
current liabilities
|
14,417,422 | 1,079,523 | ||||||
Fair
value of warrant liabilities
|
6,918,068 | - | ||||||
Total
liabilities
|
21,335,490 | 1,079,523 | ||||||
Commitments
and contingencies
|
||||||||
SHAREHOLDERS'
EQUITY
|
||||||||
Preferred
stock, $0.0001 par value; 10,000,000 shares authorized, no shares issued
and outstanding
|
- | - | ||||||
Common
stock, $0.0001 par value; 90,000,000 shares authorized, 15,451,105 and
15,226,742 shares issued and outstanding at December 31, 2009 and 2008,
respectively
|
1,544 | 1,522 | ||||||
Paid-in
capital
|
13,380,444 | 13,011,012 | ||||||
Statutory
reserves
|
4,293,116 | 3,178,861 | ||||||
Retained
earnings
|
22,875,987 | 22,146,572 | ||||||
Accumulated
other comprehensive income
|
4,438,094 | 4,428,294 | ||||||
Total
shareholders' equity
|
44,989,185 | 42,766,261 | ||||||
NONCONTROLLING
INTERESTS
|
519,807 | 835,532 | ||||||
Total
equity
|
45,508,992 | 43,601,793 | ||||||
Total
liabilities and equity
|
$ | 66,844,482 | $ | 44,681,316 |
See
report of independent registered public accounting firm.
The
accompanying notes are an integral part of these consolidated
statements.
F-3
CHINA
MEDICINE CORPORATION AND SUBSIDIARIES
CONSOLIDATED
STATEMENTS OF INCOME AND OTHER COMPREHENSIVE INCOME
Years ended December 31,
|
||||||||
2009
|
2008
|
|||||||
REVENUES
|
||||||||
Product
sales
|
$ | 64,120,538 | $ | 52,307,211 | ||||
Medical
formula sales
|
630,480 | 1,340,595 | ||||||
Total
revenues
|
64,751,018 | 53,647,806 | ||||||
COST
OF REVENUES
|
45,766,628 | 38,074,919 | ||||||
GROSS
PROFIT
|
18,984,390 | 15,572,887 | ||||||
OPERATING
EXPENSES
|
||||||||
Research
and development
|
1,454,402 | 992,497 | ||||||
Selling,
general and administrative
|
5,263,697 | 3,652,525 | ||||||
Total
operating expenses
|
6,718,099 | 4,645,022 | ||||||
INCOME FROM
OPERATIONS
|
12,266,291 | 10,927,865 | ||||||
OTHER
(EXPENSE) INCOME :
|
||||||||
Other
(expense) income , net
|
(82,077 | ) | 85,622 | |||||
Change
in fair value of warrant liabilities
|
(7,232,388 | ) | - | |||||
INCOME
BEFORE INCOME TAXES AND NONCONTROLLING INTERESTS
|
4,951,826 | 11,013,487 | ||||||
PROVISION
FOR INCOME TAXES
|
3,549,680 | 2,006,137 | ||||||
NET
INCOME (CHINA MEDICINE CORPORATION AND NONCONTROLLING
INTERESTS)
|
1,402,146 | 9,007,350 | ||||||
Add:
Net loss attributable to noncontrolling interests
|
315,531 | 118,266 | ||||||
NET
INCOME ATTRIBUTABLE TO CHINA MEDICINE CORPORATION
|
1,717,677 | 9,125,616 | ||||||
OTHER
COMPREHENSIVE INCOME (LOSS)
|
||||||||
Foreign
currency translation adjustment
|
9,800 | 2,305,499 | ||||||
Foreign
currency translation attributable to noncontrolling
interests
|
(194 | ) | 60,461 | |||||
COMPREHENSIVE
INCOME
|
$ | 1,727,283 | $ | 11,491,576 | ||||
EARNINGS
PER SHARE
|
||||||||
Basic
|
$ | 0.11 | $ | 0.60 | ||||
Diluted
|
$ | 0.11 | $ | 0.60 | ||||
WEIGHTED
AVERAGE SHARES OUTSTANDING
|
||||||||
Basic
|
15,267,512 | 15,173,113 | ||||||
Diluted
|
15,411,144 | 15,308,529 |
See
report of independent registered public accounting firm.
The
accompanying notes are an integral part of these consolidated
statements.
F-4
CHINA
MEDICINE CORPORATION AND SUBSIDIARIES
CONSOLIDATED
STATEMENT OF CHANGES IN EQUITY
Accumulated
|
||||||||||||||||||||||||||||||||||||||||
Retained Earnings
|
other
|
|||||||||||||||||||||||||||||||||||||||
Preferred Stock
|
Common Stock
|
Paid-in
|
Statutory
|
comprehensive
|
Noncontrolling
|
|||||||||||||||||||||||||||||||||||
Shares
|
Par
Value
|
Shares
|
Par
Value
|
capital
|
reserves
|
Unrestricted
|
income
|
Interests
|
Totals
|
|||||||||||||||||||||||||||||||
BALANCE,
January 1, 2008
|
111,649 | $ | 11 | 14,821,641 | $ | 1,482 | $ | 12,560,078 | $ | 2,191,230 | $ | 14,008,587 | $ | 2,122,795 | $ | 893,337 | 31,777,520 | |||||||||||||||||||||||
Net
income (loss)
|
9,125,616 | (118,266 | ) | 9,007,350 | ||||||||||||||||||||||||||||||||||||
Adjustment
of statutory reserve
|
987,631 | (987,631 | ) | - | ||||||||||||||||||||||||||||||||||||
Preferred
stock converted to common stock
|
(111,649 | ) | (11 | ) | 115,101 | 11 | - | |||||||||||||||||||||||||||||||||
Stock
options exercised
|
290,000 | 29 | 362,471 | 362,500 | ||||||||||||||||||||||||||||||||||||
Stock
option and warrant compensation
|
88,463 | 88,463 | ||||||||||||||||||||||||||||||||||||||
Foreign
currency translation adjustments
|
2,305,499 | 60,461 | 2,365,960 | |||||||||||||||||||||||||||||||||||||
BALANCE,
December 31, 2008
|
- | - | 15,226,742 | 1,522 | 13,011,012 | 3,178,861 | 22,146,572 | 4,428,294 | 835,532 | 43,601,793 | ||||||||||||||||||||||||||||||
Cumulative
effect of reclassification of warrants
|
(541,535 | ) | 125,993 | (415,542 | ) | |||||||||||||||||||||||||||||||||||
BALANCE,
January 1, 2009, as adjusted
|
- | - | 15,226,742 | 1,522 | 12,469,477 | 3,178,861 | 22,272,565 | 4,428,294 | 835,532 | 43,186,251 | ||||||||||||||||||||||||||||||
Net
income (loss)
|
1,717,677 | (315,531 | ) | 1,402,146 | ||||||||||||||||||||||||||||||||||||
Adjustment
of statutory reserve
|
1,114,255 | (1,114,255 | ) | - | ||||||||||||||||||||||||||||||||||||
Stock
options exercised
|
40,000 | 4 | 49,996 | 50,000 | ||||||||||||||||||||||||||||||||||||
Warrants
exercised in a cashless manner
|
184,363 | 18 | 729,844 | - | 729,862 | |||||||||||||||||||||||||||||||||||
Stock-based
compensation
|
131,127 | 131,127 | ||||||||||||||||||||||||||||||||||||||
Foreign
currency translation adjustments
|
9,800 | (194 | ) | 9,606 | ||||||||||||||||||||||||||||||||||||
BALANCE,
December 31, 2009
|
- | $ | - | 15,451,105 | $ | 1,544 | $ | 13,380,444 | $ | 4,293,116 | $ | 22,875,987 | $ | 4,438,094 | $ | 519,807 | $ | 45,508,992 |
See
report of independent registered public accounting firm.
The
accompanying notes are an integral part of these consolidated
statements.
F-5
CONSOLIDATED
STATEMENTS OF CASH FLOWS
Years
ended December 31,
|
||||||||
2009
|
2008
|
|||||||
CASH
FLOWS FROM OPERATING ACTIVITIES:
|
||||||||
Net
income attributable to China Medicine Corporation
|
$ | 1,717,677 | $ | 9,125,616 | ||||
Net
loss attributable to noncontrolling interests
|
(315,531 | ) | (118,266 | ) | ||||
Net
income
|
1,402,146 | 9,007,350 | ||||||
Adjustments
to reconcile net income to cash
|
||||||||
provided
by operating activities:
|
||||||||
Depreciation
and amortization
|
1,012,149 | 420,769 | ||||||
Bad
debt expense
|
45,938 | 36,428 | ||||||
Loss
on sale of assets
|
21,241 | 9,416 | ||||||
Stock-based
compensation
|
131,127 | 88,463 | ||||||
Change
in fair value of warrants liabilities
|
7,232,388 | - | ||||||
Change
in operating assets and liabilities:
|
||||||||
Notes
receivables
|
596,143 | (590,466 | ) | |||||
Accounts
receivable, trade
|
(2,278,004 | ) | (4,786,654 | ) | ||||
Inventories
|
3,369,333 | (491,874 | ) | |||||
Advances
to suppliers
|
3,614,991 | 461,695 | ||||||
Other
current assets
|
(213,245 | ) | (105,081 | ) | ||||
Accounts
payable, trade
|
608,589 | (20,683 | ) | |||||
Other
payables and accrued liabilities
|
638,074 | (21,947 | ) | |||||
Customer
deposits
|
331,850 | (64,938 | ) | |||||
Taxes
payable
|
446,664 | 266,606 | ||||||
Net
cash provided by operating activities
|
16,959,384 | 4,209,084 | ||||||
CASH
FLOWS FROM INVESTING ACTIVITIES:
|
||||||||
Purchase
of intangible assets
|
(234,576 | ) | - | |||||
Purchase
of building improvement and equipment
|
(3,438,924 | ) | (2,666,014 | ) | ||||
Cash
proceeds from disposition of fixed assets
|
21,992 | - | ||||||
Long
term prepayments
|
(1,884,135 | ) | (5,197,253 | ) | ||||
Cash
paid out for acquiring new subsidiaries
|
(8,176,871 | ) | - | |||||
Cash
received from newly acquired subsidiaries
|
176,421 | - | ||||||
Net
cash used in investing activities
|
(13,536,093 | ) | (7,863,267 | ) | ||||
CASH
FLOWS FROM FINANCING ACTIVITIES:
|
||||||||
Proceeds
from exercise of warrants and options
|
50,000 | 362,500 | ||||||
Loan
proceeds
|
6,597,450 | - | ||||||
Loan
payments
|
(10,637,419 | ) | - | |||||
Increase
in restricted cash
|
(1,759,320 | ) | - | |||||
Net
cash (used in) provided by financing activities
|
(5,749,289 | ) | 362,500 | |||||
EFFECT
OF EXCHANGE RATE ON CASH
|
5,953 | 315,723 | ||||||
DECREASE
IN CASH
|
(2,320,045 | ) | (2,975,960 | ) | ||||
CASH,
beginning of year
|
2,791,814 | 5,767,774 | ||||||
CASH,
end of year
|
$ | 471,769 | $ | 2,791,814 | ||||
Supplemental
disclosure of cash flows:
|
||||||||
Cash
paid interest
|
$ | 75,765 | $ | - | ||||
Cash
paid income tax
|
$ | 3,219,733 | $ | 2,059,396 | ||||
Non-cash
transactions:
|
||||||||
For
the year ended December 31, 2009, holders of Class A warrants and Class B
warrants cashlessly exercised
|
||||||||
458,422
warrants for 184,363 shares of common stock
|
||||||||
For
the year ended December 31, 2008, holders of Series A convertible
preferred stock converted 111,649 shares
|
||||||||
of
Series A preferred stock into 115,101 shares of common
stock
|
See
report of independent registered public accounting firm.
The
accompanying notes are an integral part of these consolidated
statements.
F-6
CHINA
MEDICINE CORPORATION AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
December
31, 2009
Note
1 - Organization
Principal
activities
China
Medicine Corporation (“CMC” or the "Company") was incorporated on February 10,
2005. The Company, through its subsidiaries in the People’s Republic
of China (“PRC” or “China”), engages in the research and development,
manufacture, and wholesale distribution of prescription and over the counter
medicines, traditional Chinese medicines, which are medicines derived from
Chinese herbs, dietary supplements, medical instruments and the sale of medical
formula in the PRC. The Company primarily operates through its wholly-owned
subsidiaries, Guangzhou Konzern Medicine Co., Ltd. (“Konzern”) and Guangzhou
LifeTech Pharmaceutical Co., Ltd (“LifeTech”). Both companies are
organized under the laws of the PRC. All other subsidiaries were
still in the development stage and either had not undertaken significant
operating activities or had no activities as of December 31, 2009.
Current
development
On May
20, 2009, Guangzhou Konzern Bio-Tech Co., Ltd. ("Konzern Bio-Tech") was
incorporated with the registered capital of RMB 500,000. Konzern Bio-Tech was
established for the purpose of engaging in research and development and
utilizing the supports from the Chinese Government for domestic Hi-Tech
companies. Konzern has 100% ownership of Konzern Bio-Tech. Konzern Bio-Tech is
still in development and has not undertaken significant operating
activities.
On June
10, 2009, the Company completed its reincorporation in Nevada. The
reincorporation effected a change in the Company’s legal domicile from Delaware
to Nevada. The Company’s business, assets, liabilities, and headquarters were
unchanged as a result of the reincorporation and the directors and officers of
the Company prior to the reincorporation continued to serve the Company after
the reincorporation.
On
October 26, 2009, Konzern entered into an Equity Ownership Transfer
Agreement with Sinoform Limited (“Sinoform”) to acquire 100% of Sinoform’s
equity interests in LifeTech. LifeTech was founded in 1992 and is a
developer and manufacturer of pharmaceutical products with a focus on vascular
medicines, anti-inflammatory medicines, women’s health and other general health
traditional Chinese medicines. Concurrently, Konzern entered into a
separate agreement with Mcwalts Investment Holdings Limited (“Mcwalts”) to
acquire 100% of Mcwalts ownership in LifeTech Medicine Technologies Co., Ltd.
(“Technology”). Technology was in the development stage and had
no operations as of December 31, 2009. LifeTech and Technology were
under common control and ownership of Mcwalts. The two acquisitions
were considered as one acquisition and are referred to as the “Acquisition”
below. Konzern gained control of LifeTech and Technology on October
26, 2009. See Note 15 for further discussion.
F-7
CHINA
MEDICINE CORPORATION AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
December
31, 2009
Note
2 - Summary of significant accounting policies
Basis of
presentation
The
consolidated financial statements of the Company reflect its subsidiaries,
Konzern, Konzern US Holdings (“Konzern Holding”), Konzern Bio-Tech, LifeTech,
and Technology, all of which are 100% owned subsidiaries, and Guangzhou Co-Win
Bioengineering Co., Ltd. (“Co-Win”), its 70% owned subsidiary. The accompanying
consolidated financial statements have been prepared in accordance with
accounting principles generally accepted in the United States of America. All
material inter-company transactions and balances have been eliminated in
consolidation.
Since
LifeTech and Technology were acquired on October 26, 2009, their operating
results for the period between October 26, 2009 to December 31, 2009 were
included in the consolidated financial statements as of December 31,
2009.
Use of
estimates
In
preparing financial statements in conformity with generally accepted accounting
principles, management is required to make estimates and assumptions that affect
the reported amounts of assets and liabilities, and the disclosure of contingent
assets and liabilities at the date of the financial statements, and revenues and
expenses during the reported period. For example, management estimates the fair
value of its options and warrants as well as the amount of potentially
uncollectible accounts. Management believes that the estimates
utilized in preparing its consolidated financial statements are reasonable and
prudent. Actual results could differ from those estimates.
Cash and Cash
Equivalents
For
purposes of the cash flow statements, the Company considers all highly liquid
investments with original maturities of three months or less at the time of
purchase to be cash equivalents. Cash includes cash on hand and demand deposits
in accounts maintained with banks in China.
Restricted
Cash
As part
of its loan agreement with a bank, the Company is expected to maintain certain
compensating cash balances at the bank’s desires.
F-8
CHINA
MEDICINE CORPORATION AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
December
31, 2009
Concentrations and
Risks
Financial
instruments, which subject the Company to concentration of credit risk, consist
of cash. The Company maintains balances at financial institutions or state-owned
banks within China which, from time to time, may exceed Federal Deposit
Insurance Corporation insured limits for banks that are located in the Unites
States. No deposits within the PRC are covered by insurance. As of December 31,
2009 and December 31, 2008, the Company had deposits in excess of federally
insured limits total of $2,232,169 and $2,613,220, respectively. The Company has
not experienced any losses in such accounts and believes it is not exposed to
any significant risks on its cash in bank accounts.
The
Company's operations may be adversely affected by significant political,
economic and social uncertainties in China. Although the Chinese government has
pursued economic reform policies in the past, there is no assurance that the
Chinese government will continue to pursue such policies or that such policies
may not be significantly altered, especially in the event of a change in
leadership, social or political disruption or unforeseen circumstances affect
China's political, economic and social conditions. There is also no guarantee
that the Chinese government's pursuit of economic reforms will be consistent or
effective.
For the
year ended December 31, 2009, two suppliers accounted for approximately 40% of
the Company’s total purchases, individually accounted for 22% and 18%,
respectively. Payables due to those two suppliers amounted to $37,308 at
December 31, 2009. Five suppliers accounted for approximately 47% of the
Company’s purchases for the years ended December 31, 2008. Advances to those
five suppliers represented 22% of the Company’s total advances to suppliers as
of December 31, 2008, and there were no accounts payables due to those suppliers
at December 31, 2008.
One major
customer accounted for approximately 25% and 15% of the Company's total sales
for the years ended December 31, 2009 and 2008, respectively. The accounts
receivable balance of this customer amounted to $5,280,444, representing 24% of
the total accounts receivable as of December 31, 2009, and $4,343,277,
representing 23% of the total accounts receivable as of December 31,
2008.
The top
three products accounted for approximately 20% and 16% of the Company’s total
sales for the years ended December 31, 2009 and 2008, respectively.
Notes
receivables
Notes
receivables represent trade accounts receivable due from various customers where
the customers’ banks have guaranteed the payment of the receivables. This amount
is non-interest bearing and is normally paid within three to six months. The
Company has the ability to submit a request for payment to the customer’s bank
earlier than the scheduled payment date, but will incur an interest charge and a
processing fee when it submits the early payment request.
F-9
CHINA
MEDICINE CORPORATION AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
December
31, 2009
Accounts receivable,
trade
The
Company extends unsecured credit to its customers in the ordinary course of
business. Management reviews the composition of accounts receivable
and analyzes historical bad debts, customer concentrations, customer credit
worthiness, current economic trends and changes in customer payment patterns to
determine if the allowance for doubtful accounts is adequate. An
estimate for doubtful accounts is made when collection of the full amount is no
longer probable. Account balances are written-off after management has exhausted
all collection efforts.
Inventories
Inventories
are stated at the lower of cost or market value. Cost is determined using the
weighted average method. Management reviews inventories for obsolescence or cost
in excess of net realizable value periodically and records an inventory
write-down and additional cost of goods sold when the carrying value exceeds net
realizable value.
Advances to
suppliers
Advances
on inventory purchases are down payments or deposits for inventory
purchases. The inventory is normally delivered within one to two
months after the payments have been made except for vendors who have an agency
relationship with the Company. This amount is refundable and bears no
interest. The Company has legally binding contracts with its vendors, which
require the payments to be returned to the Company when the contract
ends.
Plant and
equipment
Plant and
equipment are stated at the actual cost of acquisition less accumulated
depreciation. Major additions and betterments are capitalized. Expenditures for
maintenance and repairs are charged to earnings as incurred. When assets are
retired or otherwise disposed of, the related cost and accumulated depreciation
are removed from the respective accounts, and any gain or loss is included in
operations. Depreciation is provided in amounts sufficient to relate the costs
of depreciation of assets to operations principally using the straight-line
method for substantially all assets with a residual value of 5% of the actual
cost and estimated lives as follows:
Buildings
and improvements
|
50
years
|
Leasehold
improvements
|
5
years
|
Production
equipment
|
10
-12 years
|
Furniture,
fixture and office equipment
|
5
years
|
Motor
vehicles
|
5 -
10 years
|
F-10
CHINA
MEDICINE CORPORATION AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
December
31, 2009
A
majority of the construction in progress represents the costs incurred in
connection with the construction of equipment for manufacturing
aflatonix-detoxifizyme (“rADTZ”). No depreciation is provided for
construction in progress until such time as the assets are completed and placed
into service.
Long term
prepayments
Long term
prepayment mostly represents partial payments or deposits on acquiring
technology and exclusive distribution rights; these payments and deposits are
refundable.
Intangible
assets
Intangible
assets mainly include land use rights and patents. Intangible assets
are stated at cost (actual costs or estimated fair value upon acquisition), less
accumulated amortization. Amortization expense is recognized on the
straight-line basis over the estimated useful lives of the assets as
follows:
Intangible
assets
|
Weighted
average
estimated
useful
lives
|
|
Land
use rights
|
41-46
years
|
|
Manufacturing
patents
|
16
years
|
|
rADTZ
patent
|
11
years
|
All land
in the PRC is government owned. However, the government grants “land
use rights.” Lifetech acquired land use rights in 2002 and 2007 and
has the right to use the land for 50 years. The rights are amortized
on a straight line basis over the weighted average useful lives.
The
Company acquired manufacturing patents through the acquisition of LifeTech and
Technology. Acquired patents were measured based on their fair
values. Manufacturing patents are being amortized on a straight-line
basis over a period of 20 years from the application date. The
weighted average remaining life of the acquired patents was 16 years on the date
of the acquisition.
Beginning
in 2007, the Company acquired technology to manufacture rADTZ. The
major costs of intangibles includes patent and technology acquired and related
final experiment costs required by the government. The Company will begin
amortizing costs once manufacturing begins. As of December 31, 2009, the Company
has started trial production to meet government requirements and is in the
process of applying the government permit to allow the Company to manufacture
rADTZ. The Company expects to obtain the permit in 2010.
F-11
CHINA
MEDICINE CORPORATION AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
December
31, 2009
Under the
FASB’s accounting standard of goodwill and other intangible assets, all goodwill
and certain intangible assets determined to have indefinite lives will not be
amortized but will be tested for impairment at least annually. Intangible assets
other than goodwill will be amortized over their useful lives and reviewed for
impairment at least annually or more often whenever there is an indication that
the carrying amount may not be recovered.
Impairment of long-lived
assets
Per
FASB’s accounting standards, long-lived assets are analyzed for impairment. The
Company tests for impairment of long-lived assets at least annually or more
often whenever there is an indication that the carrying amount of the asset may
not be recovered. Recoverability of these assets is determined by comparing the
forecasted undiscounted cash flows generated by those assets to the assets' net
carrying value. The amount of impairment loss, if any, is measured as the
difference between the net book value of the assets and the estimated fair value
of the related assets.
Management
evaluates the recoverability of long-lived assets by measuring the carrying
amount of the assets against the estimated undiscounted future cash flows
associated with them. At the time such flows of certain long-lived assets are
not sufficient to recover the carrying value of such assets, the assets are
adjusted to their fair values. As of December 31, 2009, the Company believes
that there were no impairments of long-lived assets.
Fair value of financial
instruments
The
accounting standards regarding fair value of financial instruments and related
fair value measurements defines financial instruments and requires fair value
disclosures of those financial instruments. The fair value measurement
accounting standard defines fair value, establishes a three-level valuation
hierarchy for disclosures of fair value measurement and enhances disclosure
requirements for fair value measures. The carrying amounts reported in the
balance sheets for current assets and current liabilities qualifying as
financial instruments are a reasonable estimate of fair value because of the
short period of time between the origination of such instruments and their
expected realization and their current market rate of interest. The
three levels are defined as follow:
·
|
Level
1 inputs to the valuation methodology are quoted prices (unadjusted) for
identical assets or liabilities in active
markets.
|
F-12
CHINA
MEDICINE CORPORATION AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
December
31, 2009
·
|
Level
2 inputs to the valuation methodology include quoted prices for similar
assets and liabilities in active markets, and inputs that are observable
for the asset or liability, either directly or indirectly, for
substantially the full term of the financial
instrument.
|
·
|
Level
3 inputs to the valuation methodology are unobservable and significant to
the fair value measurement.
|
Determining
which category an asset or liability falls within the hierarchy requires
significant judgment. The Company evaluates the hierarchy disclosures each
quarter. Liabilities measured at fair value on a recurring basis are summarized
as follows:
Carrying Value as
of
December 31, 2009
|
Fair Value Measurements at December 31, 2009
Using Fair Value Hierarchy
|
|||||||||
Level
1
|
Level
2
|
Level
3
|
||||||||
Warrant
liabilities
|
$
|
6,918,068
|
$
|
6,918,068
|
A
discussion of the valuation techniques used to measure fair value for the
liabilities listed above and activity for these liabilities for the year ended
December 31, 2009, is provided elsewhere in the footnotes.
In
addition to assets and liabilities that are recorded at fair value on a
recurring basis, the Company is required to record assets and liabilities at
fair value on a non-recurring basis. Generally, assets are recorded
at fair value on a non-recurring basis as a result of impairment charges. For
year ended December 31, 2009, there were no impairment charges.
Noncontrolling
interest
Noncontrolling
interest consists of the 30% interest of noncontrolling shareholders in Co-Win.
Effective on January 1, 2009, the Company adopted the FASB’s standard
regarding noncontrolling interests in consolidated financial
statements. Certain provisions of this statement are required to be
adopted retrospectively for all periods presented. Such provisions include a
requirement that the carrying value of noncontrolling interests (previously
referred to as minority interests) be removed from the mezzanine section of the
balance sheet and reclassified as equity; and consolidated net income to be
recast to include net income attributable to the noncontrolling interest. As a
result of this adoption, the Company reclassified noncontrolling interests in
the amounts of $519,807 and $835,532 from the mezzanine section to equity at
December 31, 2009 and 2008, respectively.
F-13
CHINA
MEDICINE CORPORATION AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
December
31, 2009
Revenue
recognition
The
Company recognizes revenue when all four of the following criteria are met: (1)
persuasive evidence has been received that an arrangement exists; (2) delivery
of the products and/or services has occurred; (3) the selling price is fixed or
determinable; and (4) collectability is reasonably assured. The Company follows
the accounting standard regarding revenue recognition which sets forth
guidelines in the timing of revenue recognition based upon factors such as
passage of title, installation, payments and customer acceptance. Any amounts
received prior to satisfying the Company's revenue recognition criteria is
recorded as deferred revenue. The Company requires its customers to deposit
monies with the Company when they place an order. The Company does not pay
interest on these amounts.
Sales
revenue represents the invoiced value of goods, net of a value-added tax (VAT).
All of the Company's products that are sold in the PRC are subject to a Chinese
VAT at a rate of 17% of the gross sales price. This VAT may be offset by VAT
paid by the Company on raw materials and other materials included in the cost of
producing their finished product.
Output
VAT on sales and input VAT on purchases amounted to $10,926,933 and $7,196,791,
respectively, for the year ended December 31, 2009, $9,048,561 and $6,740,512,
respectively, for the year ended December 31, 2008. Sales and purchases are
recorded net of VAT collected and paid as the Company acts as an agent for the
government. VAT taxes are not impacted by the income tax holiday.
Research and development
costs
Research
and development costs are expensed as incurred. The costs of material and
equipment that are acquired or constructed for research and development
activities, and have alternative future uses, either in research and development
or sales and marketing, are classified as equipment and depreciated over their
estimated useful lives.
Shipping and handling
costs
Shipping
and handling costs related to costs of goods sold are included in selling,
general and administrative costs and totaled $706,211 and $491,213 for the years
ended December 31, 2009 and 2008.
Advertising
costs
The
Company expenses the cost of advertising as incurred in selling, general and
administrative costs. For the years ended December 31, 2009 and 2008,
advertising expenses amounted to $555,733 and $536,674,
respectively.
F-14
CHINA
MEDICINE CORPORATION AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
December
31, 2009
Foreign currency
translation
The
reporting currency of the Company is the US dollar. The Company uses their local
currency, Renminbi (RMB), as its functional currency. Results of operations and
cash flow are translated at average exchange rates during the period, and assets
and liabilities are translated at the unified exchange rate as quoted by the
People’s Bank of China at the end of the period. Translation adjustments
resulting from this process are included in accumulated other comprehensive
income in the Consolidated Statements of Shareholders’
Equity. Because cash flows are also translated at average translation
rates, amounts reported on the Consolidated Statements of Cash Flows will not
necessarily agree with changes in the corresponding balances on the Consolidated
Balance Sheets.
Asset and
liability accounts at December 31, 2009 and 2008 were translated at 6.82 RMB to
$1.00, respectively. Equity accounts were stated at their historical rate. The
average translation rates applied to income and cash flow statements for the
year ended December 31, 2009 and 2008, were 6.82 RMB and 6.94 RMB,
respectively.
Transaction
gains and losses that arise from exchange rate fluctuations on transactions
denominated in a currency other than the functional currency are included in the
results of operations as incurred. No material transaction gains and losses were
recognized during the years ended December 31, 2009, and 2008. Historically, the
Company has not entered into any currency trading or hedging transactions,
although there is no assurance that the Company will not enter into such
transactions in the future.
Income
taxes
The
Company records income taxes pursuant to the FASB’s accounting standards for
income taxes. The provision consists of the recognition of deferred
income tax liabilities and assets for the expected future tax consequences of
temporary differences between the income tax basis and financial reporting basis
of assets and liabilities. Provision for income taxes consist of taxes currently
due plus deferred taxes.
The
charge for taxation is based on the results for the year as adjusted for items,
which are non-assessable or disallowed. It is calculated using tax rates that
have been enacted or substantially enacted as of the balance sheet
date.
Deferred
tax is accounted for using the balance sheet liability method in respect of
temporary differences arising from differences between the carrying amount of
assets and liabilities in the financial statements and the corresponding tax
basis used in the computation of assessable tax profit. In principle, deferred
tax liabilities are recognized for all taxable temporary differences, and
deferred tax assets are recognized to the extent that it is probable that
taxable profit will be available against which deductible temporary differences
can be utilized.
F-15
CHINA
MEDICINE CORPORATION AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
December
31, 2009
Deferred
tax is calculated at the tax rates that are expected to apply to the period when
the asset is realized or the liability is settled. Deferred tax is charged or
credited in the income statement, except when it is related to items credited or
charged directly to equity, in which case the deferred tax is also dealt with in
equity. Deferred tax assets and liabilities are offset when they relate to
income taxes levied by the same taxation authority and the Company intends to
settle its current tax assets and liabilities on a net basis.
Under the
FASB’s accounting standards, a tax position is recognized as a benefit only if
it is “more likely than not” that the tax position would be sustained in a tax
examination, with a tax examination being presumed to occur. The amount
recognized is the largest amount of tax benefit that is greater than 50% likely
of being realized on examination. For tax positions not meeting the “more likely
than not” test, no tax benefit is recorded.
Stock-based
compensation
The
Company records and reports the employee stock-based compensation in accordance
with FASB’s accounting standards for share-based payments. This accounting
standard requires a public entity to measure the cost of services received in
exchange for an award of equity instruments based on the grant-date fair value
of the award. That cost is recognized over the period during which services are
received. Stock compensation for stock granted to non-employees is determined in
accordance with the FASB’s accounting standards regarding accounting for
stock-based compensation and accounting for equity instruments that are issued
to other than employees for acquiring or in conjunction with selling goods or
services, as the fair value of the consideration received or the fair value of
equity instruments issued, whichever is more reliably measured.
Earnings per
share
The
Company reports earnings per share in accordance with the FASB’s accounting
standards for earnings per share, which requires presentation of basic and
diluted earnings per share in conjunction with the disclosure of the methodology
used in computing such earnings per share. Basic earnings per share are computed
by dividing income available to common stockholders by the weighted average
common shares outstanding during the period. Diluted earnings per share takes
into account the potential dilution that could occur if securities or other
contracts to issue common stock were exercised and converted into common
stock.
Business
combination
Effective
January 1, 2009, we account for business combinations using the acquisition
method of accounting. The acquisition method requires an acquirer to recognize
the assets acquired, the liabilities assumed, and any noncontrolling interest in
the acquiree at the acquisition date, measured at their fair values as of that
date. The provisions of the acquisition method related to income tax adjustments
apply to all business combinations regardless of consummation
date.
F-16
CHINA
MEDICINE CORPORATION AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
December
31, 2009
Fair
value is defined as the price that would be received to sell an asset or paid to
transfer a liability in an orderly transaction between market participants at
the measurement date. This is an exit price concept for the valuation of the
asset or liability. In addition, market participants are assumed to be buyers
and sellers in the principal market for the asset or liability. Fair value
measurements for an asset assume the highest and best use by these market
participants. As a result of these standards, we may be required to record
assets which we do not intend to use or sell (defensive assets) and/or to value
assets at fair value measures that do not reflect our intended use of those
assets. Many of these fair value measurements can be highly subjective and it is
also possible that other professionals, applying reasonable judgment to the same
facts and circumstances, could develop and support a range of alternative
estimated amounts.
Recently issued accounting
pronouncements
In
January 2009, the FASB issued an accounting standard amending the Impairment
Guidance of recognition of interest income and impairment on purchased and
retained beneficial interests in securitized financial assets. The newly issued
accounting standard changes the impairment model included to be more consistent
with the impairment model of another accounting standard for accounting for
securities. The new accounting standard remove its exclusive reliance
on “market participant” estimates of future cash flows used in determining fair
value. Changing the cash flows used to analyze other-than-temporary impairment
from the “market participant” view to a holder’s estimate of whether there has
been a “probable” adverse change in estimated cash flows allows companies to
apply reasonable judgment in assessing whether an other-than-temporary
impairment has occurred. The adoption of this FASB Staff Positions did not have
a material impact the Company’s consolidated financial statements.
In April
2009, the FASB issued three related FASB Staff Positions: (i) Recognition of
Presentation of Other-Than-Temporary Impairments, (ii) Interim Disclosures about
Fair Value of Financial Instruments, and (iii) Determining the Fair Value When
the Volume and Level of Activity for the Asset or Liability Have Significantly
Decreased and Identifying Transactions That Are Not Orderly, which are effective
for interim and annual reporting periods ending after June 15, 2009. The first
Staff Position modifies the requirement for recognizing other-than-temporary
impairments, changes the existing impairment model, and modifies the
presentation and frequency of related disclosures. The second Staff Position
requires disclosures about fair value of financial instruments for interim
reporting periods as well as in annual financial statements. The
third Staff Position requires new disclosures regarding the categories of fair
value instruments, as well as the inputs and valuation techniques utilized to
determine fair value and any changes to the inputs and valuation techniques
during the period. The adoption of these FASB Staff Positions did not
have a material impact the Company’s consolidated financial
statements.
F-17
CHINA
MEDICINE CORPORATION AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
December
31, 2009
In June
2009, the FASB issued an accounting standard amending the accounting and
disclosure requirements for transfers of financial assets. This accounting
standard requires entities to provide more information regarding sales of
securitized financial assets and similar transactions, particularly if the
entity has continuing exposure to the risks related to transferred financial
assets. In addition, it eliminates the concept of a “qualifying special-purpose
entity,” changes the requirements for derecognizing financial assets and
requires additional disclosures. This accounting standard is
effective for financial statements issued for fiscal years beginning after
November 15, 2009. The Company is currently evaluating the impact of this
ASU; however, the Company does not expect the adoption of this ASU to have a
material impact on its consolidated financial statements.
In June
2009, the FASB issued an accounting standard amending the accounting and
disclosure requirements for the consolidation of variable interest entities
(“VIEs”). This standard modifies how a company determines when
an entity that is insufficiently capitalized or is not controlled through voting
(or similar rights) should be consolidated. It clarifies that the
determination of whether a company is required to consolidate an entity is
based on, among other things, an entity’s purpose and design and a
company’s ability to direct the activities of the entity that most significantly
impact the entity’s economic performance. An ongoing reassessment is
required of whether a company is the primary beneficiary of a
variable interest entity. Further, it also requires additional disclosures
about a company’s involvement in variable interest entities and any
significant changes in risk exposure due to that involvement. The standard
is effective for fiscal years beginning after November 15, 2009. The
Company is currently evaluating the impact of this ASU; however, the Company
does not expect the adoption of this ASU to have a material impact on its
consolidated financial statements.
In August
2009, the FASB issued an Accounting Standards Update (“ASU”) regarding measuring
liabilities at fair value. This ASU provides additional guidance clarifying the
measurement of liabilities at fair value in circumstances in which a quoted
price in an active market for the identical liability is not available; under
those circumstances, a reporting entity is required to measure fair value using
one or more of valuation techniques, as defined. This ASU is effective for the
first reporting period, including interim periods, beginning after the issuance
of this ASU. The adoption of this ASU did not have a material impact the
Company’s consolidated financial statements.
F-18
CHINA
MEDICINE CORPORATION AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
December
31, 2009
In
October 2009, the FASB issued an ASU regarding accounting for own-share lending
arrangements in contemplation of convertible debt issuance or other
financing. This ASU requires that at the date of issuance of the
shares in a share-lending arrangement entered into in contemplation of a
convertible debt offering or other financing, the shares issued shall be
measured at fair value and be recognized as an issuance cost, with an offset to
additional paid-in capital. Further, loaned shares are excluded from basic and
diluted earnings per share unless default of the share-lending arrangement
occurs, at which time the loaned shares would be included in the basic and
diluted earnings-per-share calculation. This ASU is effective for
fiscal years beginning on or after December 15, 2009, and interim periods within
those fiscal years for arrangements outstanding as of the beginning of those
fiscal years. The Company is currently evaluating the impact of this ASU;
however, the Company does not expect the adoption of this ASU to have a material
impact on its consolidated financial statements.
In
January 2010, the FASB issued ASU No. 2010-02 regarding accounting and reporting
for decreases in ownership of a subsidiary. Under this guidance, an
entity is required to deconsolidate a subsidiary when the entity ceases to have
a controlling financial interest in the subsidiary. Upon
deconsolidation of a subsidiary, an entity recognizes a gain or loss on the
transaction and measures any retained investment in the subsidiary at fair
value. In contrast, an entity is required to account for a decrease
in its ownership interest of a subsidiary that does not result in a change of
control of the subsidiary as an equity transaction. This ASU
clarifies the scope of the decrease in ownership provisions, and expands the
disclosures about the deconsolidation of a subsidiary or de-recognition of a
group of assets. This ASU is effective beginning in the first interim
or annual reporting period ending on or after December 31, 2009. The
adoption of this ASU did not have a material impact the Company’s consolidated
financial statements.
In
January 2010, FASB issued ASU No. 2010-06 – Improving Disclosures about Fair
Value Measurements. This update provides amendments to Subtopic 820-10 that
requires new disclosure to include transfers in and out of Levels 1 and 2 and
activity in Level 3 fair value measurements. Further, this update
clarifies existing disclosures on level of disaggregation and Disclosures about
inputs and valuation techniques. A reporting entity should provide
fair value measurement disclosures for each class of assets and liabilities and
should provide disclosures about the valuation techniques and inputs used to
measure fair value for both recurring and nonrecurring fair value measurements.
Those disclosures are required for fair value measurements that fall in either
Level 2 or Level 3. The new disclosures and clarifications of
existing disclosures are effective for interim and annual reporting periods
beginning after December 15, 2009, except for the disclosures about purchases,
sales, issuances, and settlements in the roll forward of activity in Level 3
fair value measurements. Those disclosures are effective for fiscal years
beginning after December 15, 2010, and for interim periods within those fiscal
years. The Company is currently evaluating the impact of this ASU;
however, the Company does not expect the adoption of this ASU to have a material
impact on its consolidated financial statements.
F-19
CHINA
MEDICINE CORPORATION AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
December
31, 2009
Reclassification
$152,060
was reclassified from selling, general and administrative expenses to research
and development in prior year’s consolidated income statement to conform to
classifications used in the current year.
Note
3 – Accounts receivable
Accounts
receivable consisted of the following:
December 31, 2009
|
December 31, 2008
|
||||||
Trade
accounts receivable
|
$
|
22,471,743
|
$
|
19,321,700
|
|||
Allowance
for doubtful accounts
|
(157,083
|
) |
(96,609
|
)
|
|||
Trade
accounts receivable, net
|
$
|
22,314,660
|
$
|
19,225,091
|
December 31, 2009
|
December 31, 2008
|
|||||||
Beginning
allowance for doubtful accounts
|
$ | 96,609 | $ | 55,640 | ||||
Additions
charged to bad debt expense
|
60,474 | 36,428 | ||||||
Foreign
currency translation adjustments
|
- | 4,541 | ||||||
Ending
allowance for doubtful accounts
|
$ | 157,083 | $ | 96,609 |
Note
4 – Inventories
Inventories
consisted of the following:
December 31, 2009
|
December 31, 2008
|
|||||||
Raw
materials
|
$
|
328,586
|
$
|
-
|
||||
Work
in progress
|
389,346
|
-
|
||||||
Finished
goods
|
2,013,165
|
4,725,322
|
||||||
Totals
|
$
|
2,731,097
|
$
|
4,725,322
|
F-20
CHINA
MEDICINE CORPORATION AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
December
31, 2009
Note
5 – Plant and equipment
Plant and
equipment consisted of the following:
December 31, 2009
|
December 31, 2008
|
|||||||
Buildings
and leasehold improvements
|
5,089,384
|
318,398
|
||||||
Production
equipment
|
7,025,291
|
3,761,419
|
||||||
Furniture,
fixture and office equipment
|
$
|
270,661
|
$
|
169,305
|
||||
Motor
vehicles
|
409,396
|
433,768
|
||||||
Construction
in progress
|
3,051,360
|
-
|
||||||
Total
|
15,846,092
|
4,682,890
|
||||||
Less
accumulated depreciation
|
(3,845,405
|
)
|
(921,253
|
)
|
||||
Buildings
and equipment, net
|
$
|
12,000,687
|
$
|
3,761,637
|
Majority
of the construction in progress represents the costs incurred in connection with
the construction of equipment for manufacturing aflatonix-detoxifizyme
“rADTZ”. Management expects the equipment will be completed in 2010
and has outstanding commitments of approximately $762,000 as of December 31,
2009.
In
November 2009, the Company entered into a construction design contract for
expansion of LifeTech. The Company made a prepayment of
$1.1M. Refer to Note 6 for further discussion.
Depreciation
expense amounted to $945,936 and $420,769 for the years ended December 31, 2009
and 2008, respectively.
Note 6 – Long term
prepayments
Long term
prepayments consist of the following:
December 31, 2009
|
December 31, 2008
|
|||||||
Prepayment
for exclusive distribution rights
|
$
|
880,200
|
$
|
880,200
|
||||
Advances
to suppliers
|
1,276,272
|
362,864
|
||||||
Long
term deferred expense
|
71,150
|
150,806
|
||||||
Deposit
for exclusive distribution rights
|
2,225,140
|
1,687,050
|
||||||
Deposit
for technology know-how
|
2,347,200
|
2,934,000
|
||||||
Deposit
for construction design project
|
1,100,250
|
-
|
||||||
Total
long term prepayment
|
$
|
7,900,212
|
$
|
6,014,920
|
F-21
CHINA
MEDICINE CORPORATION AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
December
31, 2009
In 2008,
the Company entered into two separate contracts with a bio-technological company
relating to acquisition of distribution rights to a multivitamin pack and
manufacturing of the multivitamin pack and to self-develop various types of
herbal tea. The Company prepaid ten years of exclusive distribution
rights of $880,200, which will begin amortization once the products are ready
for commercial sales. The total contractual term of the exclusive distribution
rights is 15 years. As of December 31, 2009, the Company was in the
process of applying for government approval. The Company also
advanced the bio-technological company approximately $1.47 million of payment
for future inventory purchase. Based on the anticipated completion
time, the balance of approximately $130,000 was included in advance to suppliers
– current, and the balance of $1.28 million was included in advance to suppliers
– long term as of December 31, 2009. The difference of approximately $60,000 was
applied to inventory purchase. As of December 31, 2008, the entire prepayment of
$1.5 million was included in advances suppliers-current.
Long term
deferred expense represents prepayment for the research and development of
rADTZ. The decrease was due to amortization over the term of the
contract.
As of
December 31, 2009 and 2008, the Company had made long term deposits in
the aggregate of $2,225,140 and $1,687,050, respectively to secure
its position of purchasing national exclusive distribution rights. Deposits are
refundable upon the termination or signing of the contracts.
In
November 2009, the Company entered into a construction design contract for
expansion of LifeTech. The Company made a prepayment of $1.1M related
to designing the plant. As of December 31, 2009, the design had not
yet commenced. The Company, however, expects the project to be
completed by the end of 2010.
In
October and November 2009, the Company entered into a series of agreements with
a purpose of acquiring prescription drug know-how developed by third parties,
which were unrelated to agreements entered in 2008. As of December
31, 2008, the Company prepaid $2,934,000 to a third party to purchase the
ownership of Bacillus Calmette-Guerin vaccine. The agreement was terminated in
2009 and the entire amount of the deposit made was refunded as of December 31,
2009.
F-22
CHINA
MEDICINE CORPORATION AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
December
31, 2009
Note
7 – Intangible assets
Intangible
assets consisted of the following as of December 31, 2009 and 2008:
December 31, 2009
|
December 31, 2008
|
|||||||
Land
use rights
|
$ | 11,877,954 | $ | - | ||||
Patents
|
5,063,202 | 1,247,772 | ||||||
Total
|
16,941,156 | 1,247,772 | ||||||
Less:
accumulated amortization
|
(259,302 | ) | (205 | ) | ||||
Intangible
assets, net
|
$ | 16,681,854 | $ | 1,247,567 |
Amortization
expense amounted to approximately $66,213 and $0 for the years ended December
31, 2009 and 2008, respectively.
As of
December 31, 2009, the future amortization for each of the years ending December
31, are as follows,
2010
|
2011
|
2012
|
2013
|
2014
|
Thereafter
|
|||||||||||||||||||
Amortization
expense
|
$ | 662,885 | $ | 662,885 | $ | 662,885 | $ | 662,885 | $ | 626,210 | $ | 13,404,104 |
Note
8 – Short-term loans
Short
term loans represent amounts due to various banks and are normally due within
one year. The loan principal is due at maturity and can be renewed
with the banks. The Company had no bank loan balance as of December 31,
2008. The short-term loans at December 31, 2009 consisted of the
following:
December 31,
|
||||
2009
|
||||
Two
loans with Industrial and Commercial Bank due on 8/13/2010, and with
interest rates at 5.31%, secured by the Company's
properties
|
$ | 5,838,660 | ||
Government
grants through Bank of China, due on December 1, 2010 with stated interest
rates of 5.31%, guaranteed and secured by Co-Win and the Company’s
officers – (a)
|
3,667,500 | |||
Total
– bank loans
|
$ | 9,506,160 |
F-23
CHINA
MEDICINE CORPORATION AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
December
31, 2009
(a)
|
The
Chinese government refunded a partial amount of interest paid by the
Company as grants. For the year ended December 31, 2009, the Company
received refunds of $67,299 and was recognized as a reduction of interest
expense. The effective interest rate of this loan was 0.96% for the year
ended December 31, 2009.
|
For the
year ended December 31, 2009 and 2008, total interest incurred amounted to
$75,785 and $0, respectively.
Note
9 - Taxes
Income
Taxes
The
Company and its subsidiaries file separate income tax returns.
The
United States of America
The
Company is incorporated in the U.S., and is subject to a gradual U.S. federal
corporate income tax of 15% to 35%.
PRC
The
Company conducts all its operating business through its operating subsidiaries
in China. The operating subsidiaries are governed by the income tax laws of the
PRC and do not have any deferred tax assets or deferred tax liabilities under
the income tax laws of the PRC because there are no temporary differences
between financial statement carrying amounts and the tax bases of existing
assets and liabilities.
The
Company’s subsidiaries are governed by the Income Tax Law of the People’s
Republic of China (PRC) concerning Foreign Investment Enterprises and Foreign
Enterprises and various local income tax laws (the Income Tax Laws). Beginning
January 1, 2008, the new Chinese Enterprise Income Tax (“EIT”) law replaced the
existing laws for Domestic Enterprises (“DES”) and Foreign Invested Enterprises
(“FIEs”).
The key
changes are:
a.
|
The
new standard EIT rate of 25% replaced the 33% rate currently applicable to
both DES and FIEs, except for High Tech companies who pay a reduced rate
of 15%;
|
b.
|
Companies
established before March 16, 2007 will continue to enjoy tax holiday
treatment approved by local government for a grace period of either the
next 5 years or until the tax holiday term is completed, whichever is
sooner. These companies will pay the standard tax rate as defined in point
“a” above when the grace period
expires.
|
F-24
CHINA
MEDICINE CORPORATION AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
December
31, 2009
The
Company and its subsidiaries were established before March 16, 2007 and
therefore are qualified to continue enjoying the reduced tax rate as described
above.
Under the
Income Tax Laws of PRC, the Company is generally subject to income tax at an
effective rate of 33% (30% state income taxes plus 3% local income taxes) on
income reported in the statutory financial statements after appropriate tax
adjustments, unless the enterprise is located in a specially designated region
where it allows foreign enterprises a two-year income tax exemption and a 50%
income tax reduction for the following three years.
The
Company’s subsidiaries, Konzern, Co-Win, Kozern Bio-Tech, LifeTech and
Technology are located and doing business in China. Konzern was
approved as a foreign joint-venture enterprise in 2004 and as a wholly-owned
foreign enterprise in 2006. Konzern had an income tax exemption for
2004 and 2005 and a 50% reduction on the income tax rate for 2006, 2007 and
2008. For the years ended December 31, 2009 and 2008, it was subject
to an effective rate of 25% and 12.5%, respectively.
Co-Win
was subject to an effective rate of 25% for the years of 2009 and
2008. Kozern Bio-Tech and Technology were newly established or
acquired in 2009 and were subject to an effective rate of 25% for
2009. LifeTech is entitled to a 50% reduction of the income tax rate
of 25% (or a rate of 12.5%) from 2009 through 2011.
The
estimated tax savings for the years ended December 31, 2009 and 2008 were $112,
222 and $964,476, respectively. The net effect on earnings per share if the
income tax had been applied would decrease earnings per share from $0.11 to
$0.105 for the year ended December 31, 2009 and from $0.60 to $0.47 for the year
ended December 31, 2008, respectively.
The
provision for income taxes for the year ended December 31, 2009 and 2008,
consisted of the following:
For
the year ended
December
31,
|
||||||||
2009
|
2008
|
|||||||
Provision
for China income tax
|
$ | 3,549,680 | $ | 1,823,761 | ||||
Provision
for local tax
|
- | 182,376 | ||||||
Tax
provision - PRC
|
$ | 3,549,680 | $ | 2,006,137 |
F-25
CHINA
MEDICINE CORPORATION AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
December
31, 2009
The
following table reconciles the U.S. statutory rates to the Company's effective
tax rate for the year ended December 31:
For the year ended
December 31,
|
||||||||
2009
|
2008
|
|||||||
U.S.
statutory rates
|
34.0 | % | 34.0 | % | ||||
Foreign
income not recognized
|
(34.0 | ) | (34.0 | ) | ||||
China
tax rates
|
25.0 | 25.0 | ||||||
China
income tax exemption
|
(0.8 | ) | (12.5 | ) | ||||
Other
|
47.5 | 5.7 | ||||||
Effective
income tax rates
|
71.7 | % | 18.2 | % |
For the
year ended December 31, 2009 and 2008, the Company’s effective tax rate was
71.7% and 18.2%. Income before income taxes and noncontrolling
interest includes losses from non-Chinese entities which are not deductible,
after adjusting these losses; the Company’s effective rate was equivalent to the
effective rate in China for both years. Further, certain non-cash transactions,
such loss on change of warrant liability is not tax-deducible, resulting in
higher effective income tax rate.
Taxes
payable consisted of the following:
December 31, 2009
|
December 31, 2008
|
|||||||
Income
taxes payable
|
$
|
664,248
|
$
|
12,042
|
||||
Value
added tax
|
1,451,693
|
758,168
|
||||||
Other
taxes
|
3,804
|
2,079
|
||||||
Total
|
$
|
2,119,745
|
$
|
772,289
|
The
Company was incorporated in the United States and has incurred net operating
losses for income tax purposes for the years ended December 31, 2009 and 2008,
respectively. The estimated net operating loss carry forwards for United States
income taxes amounted to approximately $3,532,000 and $2,125,000 as of December
31, 2009 and December 31, 2008, respectively, which may be available to reduce
future years’ taxable income. These carry forwards will expire, if not utilized,
through 2029. Management believes that the realization of the benefits from
these losses appears uncertain due to the Company’s limited operating history
and continuing losses for United States income tax purposes. Accordingly, the
Company has provided a 100% valuation allowance on the deferred tax asset
benefit to reduce the asset to zero. The valuation allowance at December 31,
2009 was approximately $1,201,000. The net change in the valuation allowance for
the year ended December 31, 2009 was an increase of approximately $334,000.
Management will review this valuation allowance periodically and make
adjustments as warranted.
F-26
CHINA
MEDICINE CORPORATION AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
December
31, 2009
The
Company has cumulative undistributed earnings of foreign subsidiaries of
approximately $35.2 million as of December 31, 2009, which was included in
consolidated retained earnings and will continue to be indefinitely reinvested
in international operations. Accordingly, no provision has been made for
U.S. deferred taxes related to future repatriation of these earnings, nor is it
practicable to estimate the amount of income taxes that would have to be
provided if we concluded that such earnings will be remitted in the future.
Note
10 - Retirement benefit plans
Regulations
in the PRC require the Company to contribute to a defined contribution
retirement plan for all permanent employees. The contribution is based on a
percentage required by the local government and the employees' current
compensation. The Company contributed $98,179 and $69,211 for the years ended
December 31, 2009 and 2008, respectively.
Note
11 - Commitments and contingencies
In 2008,
the Company entered into agreements with a bio-technological company relating to
acquisition of distribution rights to a multivitamin pack and manufacturing of
the multivitamin pack and to self-develop various types of herbal
tea. The total contractual term of the exclusive distribution rights
is 15 years. The Company prepaid ten years of exclusive distribution
rights of $880,200, with the remaining $440,000 to be fulfilled starting in
2019.
The
Company leases its facilities under short-term and long-term, non-cancelable
operating lease agreements expiring through November 2013. The non-cancelable
operating lease agreement states for various lease periods that the Company pays
certain monthly operating expenses applicable to the leased
premises.
The
future minimum annual lease payments required are as follows:
For
the year ended December 31,
|
Amount
|
|||
2010
|
$
|
168,974
|
||
2011
|
81,710
|
|||
2012
|
10,058
|
|||
2013
|
1,259
|
|||
Thereafter
|
-
|
|||
Total | $ |
262,001
|
For year
ended December 31, 2009 and 2008, total rental expense amounted to $157,979 and
$130,258, respectively.
F-27
CHINA
MEDICINE CORPORATION AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
December
31, 2009
Note
12 - Statutory reserves
The laws
and regulations of the People’s Republic of China require that before an
enterprise distributes profits to its partners, it must first satisfy all tax
liabilities, provide for losses in previous years, and make allocations, in
proportions determined at the discretion of the board of directors, after the
statutory reserve. The statutory reserves include the surplus reserve fund and
the enterprise fund and represents restricted retained earnings.
Surplus reserve
fund
The
Company is required to transfer 10% of its net income, as determined in
accordance with the PRC accounting rules and regulations, to a statutory surplus
reserve fund until such reserve balance reaches 50% of the Company’s registered
capital.
The
transfer to this reserve must be made before distribution of any dividend to
shareholders. The surplus reserve fund is non-distributable other
than during liquidation and can be used to fund previous years’ losses, if any,
and may be utilized for business expansion or converted into share capital by
issuing new shares to existing shareholders in proportion to their shareholding
or by increasing the par value of the shares currently held by them, provided
that the remaining reserve balance after such issue is not less than 25% of the
registered capital.
Kozern,
Co-win, LifeTech, Technology, Kozern Bio-tech are subject to the statutory
surplus reserve. 50% of registered capital of those entities was approximately
$7.86 million. The Company has contributed in aggregate $4.29 million, and
approximately $3.57 million in additional contributions are to be contributed
from future earnings as of December 31, 2009.
Enterprise
fund
The
enterprise fund may be used to acquire plant and equipment or to increase the
working capital to expend on production and operation of the business. No
minimum contribution is required and the Company did not make any contribution
to this fund for the years ended December 31, 2009 and 2008,
respectively.
Note
13- Shareholders’ equity
Preferred
stock
Holders
of Series A convertible preferred stock converted 111,649 shares into 115,101
shares of the Company’s common stock, par value $0.0001 per share during the
year ended December 31, 2008. As of December 31, 2009 and 2008, there were no
shares of preferred stock issued and outstanding.
F-28
CHINA
MEDICINE CORPORATION AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
December
31, 2009
Stock
options
In
January 2006, the Company created the 2006 Long-Term Incentive
Plan. This plan authorized the issuance of 1,575,000 shares of the
Company’s common stock. All grants have been at prices which
approximate the fair market value of the Company’s common stock at the date of
grant. The contractual term is generally 5 years.
On July
31, 2008, the Company granted a total of 15,000 stock options to three of its
independent directors. The options become exercisable for 7,500 shares of common
stock six months from the grant date and the remaining 7,500 options, eighteen
months from the grant date. The grant date fair value was $1.25 per
share
On June
2, 2009, the Company granted a total of 15,000 stock options to three of its
independent directors. The options become exercisable for 7,500 shares of common
stock six months from the grant date and the remaining 7,500 options, eighteen
months from the grant date. The grant date fair value was $1.41 per
share.
On August
25, 2009, the Company granted 240,000 shares of stock options to the Company’s
CFO. The options become exercisable for 60,000 shares of common stock one year
from the grant date, and the remaining 180,000 options will become exercisable
on the second anniversary of the grant date at a rate of 15,000 shares per
quarter. The grant date fair value was $1.10 per share. The CFO resigned in
December 2009; all 240,000 options were forfeited in accordance with the
employment agreement.
The fair
value of the options was estimated on the date of grant using a Black-Scholes
Option Pricing model using the following assumptions:
2009
|
2008
|
|||||||
Annual
dividend yield
|
- | - | ||||||
Expected
life (years)
|
4.00 - 5.00 | 4.98 | ||||||
Risk-free
interest rate
|
1.52% - 2.02 | % | 3.25 | % | ||||
Expected
volatility
|
88.0% - 90.0 | % | 76.0 | % |
For the
year ended December 31, 2009 and 2008, 40,000 and 290,000 options were exercised
at $1.25 per share. The Company received a total of $50,000 and
$362,500 from the exercise of stock options. The Company expensed $131,127 and
$88,463 related to the stock options and warrants for the year ended December
31, 2009 and 2008, respectively.
F-29
CHINA
MEDICINE CORPORATION AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
December
31, 2009
Summary of option
activity:
Outstanding
Options
|
Weighted
Average
Exercise
Price
|
Average
Remaining
Contractual
Term
(Year)
|
Exercisable
Options
|
Weighted
Average
Exercise
Price
|
Intrinsic Value
|
||||||||||||||||
12/31/2007
|
1,105,000 | $ | 1.91 |
|
671,500 | $ | 1.91 | $ | 1,041,750 | ||||||||||||
Granted
|
15,000 | $ | 2.01 |
|
7,500 | $ | 2.01 |
|
|||||||||||||
Exercised
|
(290,000 | ) | $ | 1.25 |
|
(290,000 | ) | $ | 1.25 |
240,000
|
|||||||||||
Forfeited
|
(450,000 | ) |
|
|
(16,500 | ) |
|
||||||||||||||
12/31/2008
|
380,000 | $ | 1.35 |
|
372,500 | $ | 1.34 |
|
|||||||||||||
Granted
|
255,000 | $ | 1.67 |
|
15,000 | $ | 1.81 |
|
|||||||||||||
Exercised
|
(40,000 | ) | $ | 1.25 |
|
(40,000 | ) | $ | 1.25 | 29,825 | |||||||||||
Forfeited
|
(240,000
|
)
|
$ | 1.70 |
|
- |
|
||||||||||||||
12/31/2009
|
355,000 | $ | 1.39 |
1.80
|
347,500 | $ | 1.38 | $ | 1,033,100 | ||||||||||||
Exercisable
at 12/31/2009
|
1.74
|
$ | 1,016,225 |
Warrants
Contemporaneously
with the reverse acquisition, the Company entered into a Preferred Stock
Purchase Agreement (“PSPA”), dated February 8, 2006, with Barron Partners L.P.,
Ray and Amy Rivers, JTROS, Steve Mazur and William Denkin pursuant to which the
Company issued and sold 3,120,000 shares of its Series A convertible preferred
stock, a newly-created series of preferred stock, and warrants to purchase
3,694,738 shares of common stock at $1.75 per share and 3,694,738 shares of
common stock at $2.50 per share. On April 23, 2007, the Company and
the holders of the warrants executed a Waiver and Agreement that reduced the
conversion price for preferred stock and the exercise price of the warrants by
3% of the original conversion amounts. The warrants have a term of
five years and are exercisable by the holder at any time within the
term.
Effective
January 1, 2009, the Company adopted the provisions of an accounting
standard regarding whether an instrument (or embedded feature) is indexed to an
entity’s own stock. This accounting standard specifies that a
contract that would otherwise meet the definition of a derivative but is both
(a) indexed to the Company’s own stock and (b) classified in stockholders’
equity in the statement of financial position would not be considered a
derivative financial instrument. It provides a new two-step model to
be applied in determining whether a financial instrument or an embedded feature
is indexed to an issuer’s own stock and thus able to qualify for the scope
exception within the standards.
F-30
CHINA
MEDICINE CORPORATION AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
December
31, 2009
As a
result of adoption, 3,348,686 warrants previously treated as equity pursuant to
the derivative treatment exemption are no longer afforded equity treatment
because the strike price of the warrants is denominated in US dollars, a
currency other than the Company’s functional currency, the Chinese
Renminbi. As a result, the warrants are not considered indexed to the
Company’s own stock, and as such, all future changes in the fair value of these
warrants will be recognized currently in earnings until such time as the
warrants are exercised or expire.
As such,
effective January 1, 2009, the Company reclassified the fair value of these
warrants from equity to liability, as if these warrants were treated as a
derivative liability since their issuance in February 2006. On January 1,
2009, we reclassified from additional paid-in capital, as a cumulative effect
adjustment, $125,993 to beginning retained earnings and $415,542 to warrant
liabilities to recognize the fair value of such warrants. The Company
recognized a $7,232,388 loss from the change in fair value for the year ended
December 31, 2009, respectively.
These
common stock purchase warrants do not trade in an active securities market, and
as such, we estimate the fair value of these warrants using the Black-Scholes
Option Pricing Model using the following assumptions:
December 31, 2009
|
January 1, 2009
|
||||
Annual
dividend yield
|
-
|
-
|
|||
Expected
life (years)
|
1.10
|
2.10
|
|||
Risk-free
interest rate
|
0.54%
|
0.76%
|
|||
Expected
volatility
|
95%
|
84%
|
Expected
volatility is based on historical volatility. Historical volatility was computed
using daily pricing observations for recent periods that correspond to the term
of the warrants. We believe this method produces an estimate that is
representative of our expectations of future volatility over the expected term
of these warrants. We have no reason to believe future volatility over the
expected remaining life of these warrants likely to differ materially from
historical volatility. The expected life is based on the remaining term of the
warrants. The risk-free interest rate is based on U.S. Treasury securities
according to the remaining term of the warrants.
On May
27, 2009, the Company granted a total of 70,000 warrants to a third party for
investor relations services. These warrants are accounted for as
equity instruments issued in exchange for the receipt of
services. Costs are measured at the estimated fair value of the
equity instruments issued. The Company valued these warrants at
$93,663 using the Black Scholes model with the following factors: market price
of $1.85; volatility of 88%; risk free rate of 1.64%; exercise price of $0.85;
and an estimated life of 3.00 years. For the year ended December 31, 2009, the
Company recorded amortization expense of $93,663 related to these
warrants.
F-31
CHINA
MEDICINE CORPORATION AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
December
31, 2009
On
September 21, 2009, an investor performed a cashless exercise of 179,474 warrant
A shares, which were converted to 53,397 shares of common stock. The
Company valued the conversion on exercise date and recorded $111,957 losses from
changes in fair value of warrants.
On
December 15, 2009, an investor performed a cashless exercise of 179,474 warrant
A and 126,474 warrants B shares, which were converted to 130,966 shares of
common stock. The Company valued the conversion on exercise date and
recorded $617,905 losses from changes in fair value of warrants
Summary of
warrant activity:
Outstanding
|
Weighted
Average
Exercise
Price
|
Average
Remaining
Contractual
Term (Years)
|
|||||||
December
31, 2007
|
3,418,686
|
$
|
2.35
|
3.17
|
|||||
Granted
|
-
|
||||||||
Exercised
|
-
|
||||||||
Forfeited
|
-
|
||||||||
December
31, 2008
|
3,418,686
|
$
|
2.35
|
2.17
|
|||||
Granted
|
70,000
|
||||||||
Exercised
|
(485,422
|
)
|
|||||||
Forfeited
|
-
|
||||||||
December
31, 2009
|
3,003,264
|
$
|
2.38
|
1.15
|
F-32
CHINA
MEDICINE CORPORATION AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
December
31, 2009
Note
14 – Earnings per share
The
following is a reconciliation of the basic and diluted earnings per share
computations for the year ended December 31:
For
the year ended
|
2009
|
2008
|
||||||
Net
income
|
$
|
1,717,677
|
$
|
9,125,616
|
||||
Shares
of common stock and common stock equivalents:
|
||||||||
Weighted
average shares used in basic computation
|
15,267,512
|
15,173,113
|
||||||
Diluted
effect of stock options, warrants, and preferred stock
|
143,632
|
135,416
|
||||||
Weighted
average shares used in diluted computation
|
15,411,144
|
15,308,529
|
||||||
Earnings
per share:
|
||||||||
Basic
|
$
|
0.11
|
$
|
0.60
|
||||
Diluted
|
$
|
0.11
|
$
|
0.60
|
For the
year ended December 31, 2009, 2,913,264 warrants and 45,000 options whose
exercises prices were higher than the average market price were excluded from
the calculation because of the anti-dilutive nature.
For the
year ended December 31, 2008, 2,969,738 warrants and 15,000 options whose
exercises prices were higher than the average market price were excluded from
the calculation because of the anti-dilutive nature.
Note
15 – Business combination
Purchase
price of the Acquisition included cash payments of approximately $8.2M (RMB
55,775,000). In connection with the acquisition, an independent third party
appraiser which is a certified public appraiser under the laws of PRC was
engaged by Konzern to perform an appraisal of certain of the assets of entities
to be acquired. The assets evaluated included fixed assets (equipment
and buildings) and intangible assets (land-use rights and patents). The
appraiser conducted an on-site visit, inspected each item, conducted market
research and investigation, followed some asset evaluation policies and
regulations issued by the Chinese government, and provided an evaluation report.
The Company’s management also performed an internal evaluation, taking into
account of the PRC certified public appraiser’s evaluation report, to determine
the fair value of these assets reported in the financial statements. Fair value
of other assets acquired and liabilities assumed approximated their book
value. Net assets acquired after the fair value measurement exceeded
the purchase consideration. Management reviewed the procedures and
methodologies used to measure the fair value of fixed assets and intangibles and
determined to reduce the excess to the value of intangible assets.
The
following table summarizes the net book value and the fair value of the assets
acquired and liabilities assumed at the date of acquisition:
F-33
CHINA
MEDICINE CORPORATION AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
December
31, 2009
Fair value
|
Book value
|
|||||||
Cash
and cash equivalent
|
$ | 165,945 | $ | 165,945 | ||||
Other
current assets
|
2,271,310 | 2,271,310 | ||||||
Buildings
and equipment
|
5,778,383 | 4,155,122 | ||||||
Intangible
assets
|
15,278,544 | 1,474,346 | ||||||
Total
assets
|
23,494,182 | 8,066,723 | ||||||
Total
liabilities
|
(15,306,412 | ) | (15,306,412 | ) | ||||
Net
Assets
|
$ | 8,187,770 | $ | (7,239,689 | ) |
The
actual amounts of LifeTech and Technology’s revenue and earnings included in the
Company’s consolidated income statement from the date of the acquisition,
October 26, 2009 to December 31, 2009 was $2.2M and $781,000,
respectively.
Pro
Forma
The
following unaudited pro forma condensed income statement for the years ended
December 31, 2009 and 2008 were prepared under generally accepted accounting
principles, as if the acquisition of LifeTech and Technology had occurred the
first day of the respective periods. The pro forma information may not be
indicative of the results that actually would have occurred if the acquisition
had been in effect from and on the date indicated.
For
the year ended December 31,
|
December 31, 2009
|
December 31, 2008
|
||||||
Sales
|
$ | 71,879,046 | $ | 57,173,854 | ||||
Cost
of sales
|
48,710,454 | 39,624,419 | ||||||
Gross
profits
|
23,168,592 | 17,549,435 | ||||||
Operating
expenses
|
7,562,216 | 6,574,477 | ||||||
Income
from operations
|
$ | 15,606,376 | $ | 10,974,958 | ||||
Other
expense(Income), net
|
7,912,150 | 276,633 | ||||||
Income
tax
|
3,871,939 | 2,006,137 | ||||||
Net
income before noncontrolling interest
|
$ | 3,822,287 | $ | 8,692,188 | ||||
Net
income attributable to controlling interest
|
$ | 4,137,818 | $ | 9,363,720 |
F-34
CHINA
MEDICINE CORPORATION AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
December
31, 2009
Note
16 – Subsequent events
Equity
financing
On
December 31, 2009, the Company entered into a Stock Subscription Agreement for
an equity private placement (the "Subscription Agreement") with One Equity
Partners ("OEP"), the global private equity investment arm of JPMorgan Chase
& Co. This agreement became effective on January 29, 2010 as described
below.
Subject
to certain closing conditions, OEP agreed to purchase 4,000,000 of the Company's
common shares at $3.00 per share and 1,920,000 of the Company's redeemable
convertible preferred shares at $30 per share, for an aggregate purchase price
of $69.6 million. Each redeemable convertible preferred share is initially
convertible into ten common shares. At closing, the Company received $12 million
in proceeds while the remaining $57.6 million in proceeds was placed in escrow
until released to fund additional capital expenditures and acquisition
projects.
The
Company expects to use the net proceeds of the financing for capital
expenditures relating to its recent acquisition of LifeTech for working capital
purposes, and for future expansion and/or acquisition projects subject to
approval from OEP and the Company's board of directors.
On
January 29, 2010, Company completed the equity private placement with
OEP. The certificates of 4,000,000 shares common stock and 1,920,000
preferred stocks were issued, resulting in gross proceeds to the Company of
$69,600,000 and net proceeds of approximately $66,500,000 pursuant to the
Subscription Agreement.
Formed a new
subsidiary
On
January 7, 2010, the Company set up Konzern Company Limited (Konzern Ltd.) which
is 100% owned by CMC. Konzern Ltd was formed in China under PRC law.
The business license is valid for 50 years from January 7, 2010. The registered
capital of Konzern Ltd. is approximately $29,340,000 (RMB 200 million) of which
$5.5 million has been received as of February 4, 2010. To fulfill the
requirement of the PRC local administrative affair, the remaining amount of
approximately $19,340,000 has to be invested within 2 years after the issuance
date of the business license.
F-35
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH
ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM
9A(T). CONTROLS AND PROCEDURES
Disclosure
Controls and Procedures
37
As required by Rule 13a-15 under the
Exchange Act, our management, including our Chief Executive Officer and our
Chief Financial Officer, evaluated the effectiveness of the design and operation
of our disclosure controls and procedures as of December 31, 2009.
Disclosure controls and procedures
refer to controls and other procedures designed to ensure that information
required to be disclosed in the reports we file or submit under the Securities
Exchange Act is recorded, processed, summarized and reported within the time
periods specified in the rules and forms of the SEC and that such information is
accumulated and communicated to our management, including our chief executive
officer and chief financial officer, as appropriate, to allow timely decisions
regarding required disclosure. In designing and evaluating our 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, and management is required to apply
its judgment in evaluating and implementing possible controls and
procedures.
Management conducted its evaluation of
disclosure controls and procedures under the supervision of our chief executive
officer and our chief financial officer. Based on that evaluation, management
concluded that because of the material weakness in internal control over
financial reporting described below, our disclosure controls and procedures were
not effective as of December 31, 2009.
Management’s
Annual Report on Internal Control over Financial Reporting
Our management is responsible for
establishing and maintaining adequate internal control over financial reporting
as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange
Act. Our internal control over financial reporting is designed to
provide reasonable assurance regarding the (i) effectiveness and efficiency of
operations, (ii) reliability of financial reporting and the preparation of
financial statements for external purposes in accordance with generally accepted
accounting principles, and (iii) compliance with applicable laws and
regulations.
Because of its inherent limitations,
internal control over financial reporting may not prevent or detect
misstatements. Also, projections of any evaluation of effectiveness to future
periods are subject to the risk that controls may become inadequate because of
changes in conditions, or that the degree of compliance with the policies and
procedures may deteriorate.
Management assessed the effectiveness
of our internal control over financial reporting as of December 31,
2009. In making this assessment, we used the criteria set forth by
the Committee of Sponsoring Organizations of the Treadway Commission
(COSO) in Internal Control - Integrated Framework. Based on our assessment,
we determined that, as of December 31, 2009, our internal control over
financial reporting was ineffective based on those criteria.
During our assessment of the
effectiveness of internal control over financial reporting as of
December 31, 2009, management identified the following significant
deficiencies:
1.
|
Accounting
and Finance Personnel Lack of US GAAP expertise. Our current accounting
staff is relatively new and inexperienced, and needs substantial training
to meet the higher demands of being a US public company. The accounting
skills and understanding necessary to fulfill the requirements of US GAAP
based reporting, including the skills of subsidiary financial statements
consolidations, are inadequate and were inadequately supervised. The lack
of sufficient and adequately trained accounting and finance personnel
resulted in multiple audit
adjustments.
|
2.
|
Lack
of Internal Audit Function – We lack qualified resources to perform the
internal audit functions properly. In addition, the scope and
effectiveness of the internal audit function are yet to be
developed.
|
The Company’s management determined
that the number and nature of these significant deficiencies, when aggregated,
amounted to a material weakness.
38
A material weakness (within the meaning
of PCAOB Auditing Standard No. 5) is a deficiency, or a combination of
deficiencies, in internal control over financial reporting, such that there is a
reasonable possibility that a material misstatement of our annual or interim
financial statements will not be prevented or detected on a timely basis. A
significant deficiency is a deficiency, or a combination of deficiencies, in
internal control over financial reporting that is less severe than a material
weakness, yet important enough to merit attention by those responsible for
oversight of the company's financial reporting.
Remediation
Initiative
In 2009, the Company took the following
actions to remediate the foregoing weakness: (i) engaged in modernization of
inventories management and reporting system through a number of measures such as
warehouse hardware upgrade and improvement of inventories control system, (ii)
hired additional English speaking personnel in the administrative division,
(iii) continued to implement its written control and accountability policies for
administrative personnel, and (iv) continued our search for US GAAP
knowledgeable financial professionals. Additionally, during 2009 the
Company’s staff in the accounting department gained more expertise in internal
audit functions. We plan to continue to take measures to remediate the material
weakness as soon as practicable including providing US GAAP training to our
staff in the accounting department.
Auditor
Attestation
This annual report does not include an
attestation report of our registered public accounting firm regarding internal
control over financial reporting. Management’s report was not subject
to attestation by our registered public accounting firm pursuant to temporary
rules of the Securities and Exchange Commission that permit us to provide only
management’s report in this annual report.
Changes
in Internal Controls over Financial Reporting
Except as described above, there were
no changes in our internal controls over financial reporting during the fourth
quarter of the fiscal year 2009 that have materially affected, or are reasonably
likely to materially affect, our internal control over financial
reporting.
ITEM
9B. OTHER INFORMATION
None.
PART III
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND
CORPORATE GOVERNANCE.
The
information required by this Item is incorporated by reference to the applicable
information in our Proxy Statement related to the 2010 Annual Meeting of
Stockholders (the “2010 Proxy Statement”).
ITEM 11. EXECUTIVE
COMPENSATION
The
information required by this Item is incorporated by reference to the applicable
information in the 2010 Proxy Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN
BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER
MATTERS
The
information required by this Item is incorporated by reference to the applicable
information in the 2010 Proxy Statement.
39
ITEM
13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR
INDEPENDENCE
The information required by this Item
is incorporated by reference to the applicable information in the 2010 Proxy
Statement.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND
SERVICES
The
information required by this Item is incorporated by reference to the applicable
information in the 2010 Proxy Statement.
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT
SCHEDULES
(a)(1)(2)
Financial Statements.
The
financial statements listed in the Index to Financial Statements are filed as
part of this Annual Report on Form 10-K.
(a)(3)
Exhibits.
The
exhibits required by this item are set forth on the Exhibit Index attached
hereto.
Number
|
Description
|
|
2.1
|
Agreement
and Plan of Merger dated as of May , 2009 between
China Medicine Corporation (Delaware) and China Medicine Corporation
(Nevada); (1)
|
|
3.1
|
Certificate
of Incorporation filed with the Nevada Secretary of State in June 2009;
(1)
|
|
3.2
|
By-laws
of the Company;(1)
|
|
4.1
|
;
Ce Certificate of Designation, Rights and Preferences for the Redeemable
Convertible Preferred Stock (2);
|
|
4.2
|
Form
of warrant issued to investors in the February 2006 private placement
(3);
|
|
10.1
|
Preferred
stock purchase agreement , dated February 8, 2006, between the Registrant
and the investors in the February 2006 private placement
(3);
|
|
10.2
|
Equity
Ownership Transfer Agreement, dated October 26, 2009, between Guangzhou
Konzern Pharmaceuticals Co., Ltd., and Sinoform Limited
(4);
|
|
10.3
|
Stock
Subscription Agreement, dated December 31, 2009, by and among the
Registrant, Senshan Yang and the OEP CHME Holdings, LLC
(5);
|
|
21.1
|
List
of Subsidiaries (6);
|
|
31.1
|
Certification
of Senshan Yang pursuant to Exchange Act Rules 13a-14(a) and 15d-14(a), as
adopted pursuant to Section 302 of the Sarbanes-Oxley Act of
2002;
|
40
31.2
|
Certification
of Robert Lu pursuant to Exchange Act Rules 13a-14(a) and 15d-14(a), as
adopted pursuant to Section 302 of the Sarbanes-Oxley Act of
2002;
|
|
32.1
|
Certification
pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002;
|
|
99.4
|
2006
Long-term incentive plan (2).
|
Footnotes:
|
(1)
|
Incorporated
by reference from the Appendix to the Definitive Proxy
Statement on Form 14A filed by the Registrant with the Commission on May
5, 2009.
|
|
(2)
|
Incorporated
by reference from Exhibit 3.1 to the Current Report on Form 8-K filed by
the Registrant with the Commission on February 2,
2010.
|
|
(3)
|
Incorporated by reference from
the exhibit to the Current Report on Form 8-K filed by the Registrant with
the Commission on February 14,
2006.
|
|
(4)
|
Incorporated
by reference from Exhibit 10.1 to the Current Report on Form 8-K filed by
the Registrant with the Commission on October 30,
2009.
|
|
(5)
|
Incorporated
by reference from Exhibit 10.1 to the Current Report on Form 8-K filed by
the Registrant with the Commission on January 7,
2010.
|
|
(6)
|
Incorporated
by reference from Exhibit 21.1 to the Post-Effective Amendment No.1 on
Form S-1 filed by the Registrant with the Commission on January 12,
2010.
|
41
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
MEDICINE CORPORATION
|
|||
Date: March
30, 2010
|
By:
|
/s/ Senshan Yang
|
|
Senshan
Yang, Chief Executive Officer
|
|||
(principal
executive officer)
|
By:
|
/s/ Robert Lu
|
||
Robert
Lu, Chief Financial Officer
|
|||
(principal
financial officer and principal accounting officer)
|
Pursuant
to the requirements of Section 13 or 15(d) of the Securities Exchange Act of
1934, this Report has been signed below by the following persons on behalf of
the Registrant in the capacities and on the dates indicated.
Name
|
Title
|
Date
|
||
/s/
Senshan Yang
|
Chief
Executive Officer and
|
March
30, 2010
|
||
Senshan
Yang
|
Director
|
|||
(principal
executive officer)
|
||||
/s/
Minhua Liu
|
Director
|
March
30, 2010
|
||
Minhua
Liu
|
||||
/s/
Robert Adler
|
Director
|
March
30, 2010
|
||
Robert
Adler
|
||||
/s/
Yanfang Chen
|
Director
|
March
30, 2010
|
||
Yanfang
Chen
|
||||
/s/
Rachel Gong
|
Director
|
March
30, 2010
|
||
Rachel
Gong
|
||||
/s/
Ryan Shih
|
Director
|
March
30, 2010
|
||
Ryan
Shih
|
|
|
42